Spring 2014

INTERVIEW: Not ready to embrace the renminbi

John GreenwoodThere is an increasing number of people calling for the Hong Kong dollar to be pegged to the renminbi, but John Greenwood, who proposed the peg to the dollar three decades ago, tells Stefanie Eschenbacher that it is too early to abandon it.

US monetary policy brings challenges to Hong Kong because its currency is pegged to the dollar, but the architect of Hong Kong’s currency peg, John Greenwood, says it is too early to consider the renminbi as an alternative.

Hong Kong is the world’s ninth-largest trading economy and a major financial hub in Asia with a rapidly growing reserve of renminbi. Its most significant trading partner is China.

“There is no prospect of the Hong Kong dollar being pegged to the renminbi until the renminbi is fully and irreversibly convertible, and that will take many years,” says Greenwood, who proposed the currency peg to stabilise the Hong Kong dollar in 1983.

Greenwood says where currency pegs are necessary, it is generally best to fix the exchange rate to the currency of the country that is the dominant trade partner or the greatest driver of the business cycle.

“It would be desirable for that mechanism to work between China and Hong Kong, but it cannot work well because of the controls on capital flows and exchange controls.”

Hong Kong’s pegged rate mechanism depends significantly on interest rate arbitrage, that is people moving funds in and out to bring about interest rate convergence between Hong Kong and the US.

A peg to the renminbi would bring pricing issues and fluctuations against the dollar.

Greenwood, who is now chief economist at Invesco, adds that the dollar also remains the major currency for denominating trade and capital transactions throughout Asia.

Hong Kong benefits in being able to conduct lending and trade financing business in either Hong Kong dollars or dollars.

“It will be many years before the renminbi becomes a competitor with the dollar in terms of its use in international trade and capital,” he adds.
Another argument in favour of Hong Kong’s peg to the dollar Greenwood puts forward is that it enables Hong Kong to act as the prime capital market in Asia.

It is much easier, for example, to price loans, syndicated loans and new capital issuances in a currency that is either pegged to the dollar or the dollar itself.

Although this helps Hong Kong to retain its dominant position in capital markets in Asia, Greenwood acknowledges that the Hong Kong dollar being pegged to the dollar effectively “imports US capital market conditions to Hong Kong”.

Hong Kong interest rates tend to converge closely with US interest rates as a result of the link-rate system.

The reason that the interest rate relationship between Hong Kong and the US is so tight is because Hong Kong is a major financial centre and has had this fixed-rate arrangement for three decades.

“There are few perceptions in the market that this will change,” Greenwood says. “The natural expectation is that Hong Kong interest rates will remain aligned with US interest rates.”

The current stance of the US monetary policy is no different in its effect from previous decisions, and Greenwood says Hong Kong needs to decide whether it needs to take any special measures to counter the effects of low US interest rates.

This has been challenging because in recent years growth in the US has been subdued, whereas growth in Hong Kong and China has been strong.

“The low interest rates in the US have not been appropriate for Hong Kong so Hong Kong needed counter-measures, given that it cannot raise interest rates independently.”

Hong Kong has therefore taken macro-prudential measures – mainly restricting the ability of banks, companies and households to leverage up using cheap, borrowed funds.

This has been done by tightening the loan-to-value ratios applicable on mortgage lending in Hong Kong. Banks can only lend 50% of the value on high-value residential and commercial properties, 60% on medium-value residential properties, and 75% on low-value residential properties.

Hong Kong has been through three rounds of tightening these loan-to-value ratios and has implemented additional measures to counter speculation, mainly by restricting investment in the property market.

The stamp duty has increased and there are new limitations to the frequency of sale so people cannot buy a property and sell it a few months later, or buy a property off plan and sell it before it has even been built.

The Hong Kong Monetary Authority and other research centres say found that economies whose currencies have varied in value against the dollar – the New Taiwan dollar or the Singapore dollar, for example – have suffered equally in times of crisis.

“The real problem is that all of the Asian economies are massively exposed to the US because they are all major exporting economies and the US is the dominant driver of the global business cycle,” Greenwood says.

These downturns are a result of the export-orientation of the Asian economies, not because of the exchange arrangements in place.

Greenwood points to Japan, which has a floating exchange rate but suffered a severe downturn in 2008 and 2009.

Hong Kong had a floating exchange rate between 1974 and 1983, which Greenwood says was a disaster.

“There were wide fluctuations of the exchange rate, which translated into widely varying inflation rates for Hong Kong,” Greenwood recalls. “During the crisis in 1983, there were massive outflows, which the government at that time could do nothing about.”

Greenwood says the case of Hong Kong shows that currency pegs are necessary for small, open economies with large trade sectors. John Greenwood biography

©2014 funds global asia

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