Since its introduction in October 1983, the Linked Exchange Rate System (LERS) has weathered numerous economic and interest rate cycles, as well as multiple global and regional financial crises. It has become a core component of Hong Kong’s economic and financial system.
The LERS has shown remarkable resilience, providing a stable monetary environment for Hong Kong for more than 40 years. Throughout this period, particularly when facing cyclical or external challenges, there have been discussions regarding its pros and cons. Recently, there have been a range of opinions in the community concerning the LERS.
As the authority responsible for the operation of the LERS, we pay close attention to these comments. While some reflect misconceptions due to a lack of understanding about the system, and others piece together unrelated news fragments that present an inaccurate picture, we are encouraged to see that much of the feedback is based on facts and objective analysis. Such rational discussions are invaluable. Indeed, many market experts have endorsed the LERS as the most suitable monetary arrangement for Hong Kong, and it enjoys robust credibility in the financial markets. Despite the recent interest on LERS and even speculation regarding potential geopolitical shocks, the Hong Kong dollar market has continued to operate smoothly in accordance with the design of the LERS. Indeed the Hong Kong dollar has traded within a narrow range on the strong side of the 7.75 – 7.85 range against the US dollar since mid-September of last year, demonstrating the market’s unwavering confidence in the system.
Given the importance of the LERS and the ongoing interest from the community, I would like to share my views on several issues with our readers.
One perspective focuses on the fundamental issue of economic cycles. In essence, this view holds that a strengthening in the Hong Kong dollar alongside the US dollar, combined with a possible slower pace in the US rate cuts, would hinder Hong Kong’s economic recovery. I have previously addressed this in my inSight article on 17 October 2023 and would like to expand on a few points:
- As a small, open economy and major international financial centre, exchange rate stability is crucial for Hong Kong. We have witnessed extraordinary volatility in global foreign exchange markets in 2024, with many currencies experiencing significant declines against the US dollar. For example, the Australian dollar fell by 9%, the Korean won by 12%, the Mexican peso by over 20%, and the Japanese yen by more than 9%. In contrast, the Hong Kong dollar has remained stable against the US dollar, and this limited exchange rate risk is a distinct advantage in fostering a conducive environment for business and investment. A stable exchange rate and a proven effective monetary system are essential in attracting global investors to use Hong Kong as a platform and an intermediary for financial transactions, and are of utmost importance to reinforcing its status as an international financial centre.
- Regarding Hong Kong dollar interest rates, since the US entered its current interest rate cutting cycle, banks in Hong Kong have responded swiftly by reducing local interest rates three times, effectively lowering borrowing costs for businesses and individuals.
- The Hong Kong economy faces both cyclical and structural challenges. Both the government and the private sector are taking concrete steps to develop new industries and growth drivers to enhance Hong Kong’s overall competitiveness. This structural adjustment will take time and require the joint effort of all stakeholders. At the HKMA, we are focused on alleviating cyclical issues, including introducing measures to ease the borrowing cost burden on individuals and businesses, especially small and medium-sized enterprises (SMEs). We are working with the banking sector to support SMEs in securing finance, and have basically lifted all the countercyclical macroprudential measures for property mortgage lending that have been in place since 2009, minimising the impact of the economic cycle.
Some commentators have raised concerns regarding the basis of the LERS. Every economy determines its monetary system based on its unique circumstances, which may include pegging its own currency to a foreign currency or a basket of foreign currencies. According to the International Monetary Fund, 37 countries and regions (including Hong Kong) currently employ varying forms of link to the US dollar. The operational model involves the relevant monetary authorities buying and selling US dollars to anchor the exchange rate of their own currency. This is essentially a market behaviour and is the operational model adopted by the LERS since its inception.
Concerns have also been expressed about certain extreme scenarios in which the LERS might be impacted by geopolitical developments. The global financial system is intricately interconnected, and experience has shown that financial turmoil in one region can rapidly spill over to others, triggering volatility and even crises in global financial markets and economies. As the most important international financial centre in Asia, financial stability in Hong Kong is not only crucial for our own economy, but also for regional and global financial stability. As a responsible authority, we continuously assess risks that may affect Hong Kong's financial stability and safety to ensure that we are prepared for any challenges.
The LERS operates under a highly transparent, rules-based and disciplined currency board arrangement. In addition, Hong Kong has sizable foreign reserves of over US$420 billion, equivalent to about 1.7 times of our monetary base, ensuring the smooth functioning of the LERS at all times. The systemic stability of the LERS is highly regarded in the financial markets, and the International Monetary Fund has consistently viewed it as the most suitable monetary system for Hong Kong.
While risk management is important, let’s not be swayed by unfounded concerns. And let me reiterate, we have no intention and we see no need to change the LERS.
Eddie Yue
Chief Executive
Hong Kong Monetary Authority
9 January 2025
