Hong Kong Confident Peg Will Survive U.S.-China Tensions

(Bloomberg) --

Hong Kong wants to send a clear message to its residents and the world: its currency peg isn't in doubt, despite the city being increasingly caught up in tensions between Beijing and Washington.

Focus has shifted to the safety of the peg in the wake of the Communist Party's proposal to impose national security laws on Hong Kong. That's led to concern that capital outflows could put pressure on the local currency. The Trump administration also has the power to limit the Hong Kong Monetary Authority's access to U.S. dollars, which could hamper the city's ability to defend its currency tie to the greenback.

Don't worry, say the territory's financial chief as well as the head of the HKMA.

China's central bank can provide U.S. dollars should Washington impose sanctions on the city, said Financial Secretary Paul Chan. Hong Kong can tap a currency swap line with the People's Bank of China, which will cover Hong Kong dollars and the greenback, he told China Central Television on Wednesday.

Eddie Yue, chief executive of the HKMA, said the 36-year old peg predates the 1992 U.S-China Policy Act which includes a provision allowing the U.S. dollar “to be freely exchanged” with the Hong Kong dollar. In a blog post on Tuesday, he dismissed suggestions that President Donald Trump's administration would take the extreme action of denying Hong Kong access to U.S. dollars as an “apocalyptic” scenario that could backfire.

“With Hong Kong's financial system closely integrated with the global economic and financial systems, any move that hits our financial system would also send shock waves across the global financial markets, including the U.S.,” he said. “Confidence of international investors in using the USD and holding U.S. financial assets could also be undermined.”

Investors shouldn't worry about the risk of capital controls being imposed in the city, because the city's mini constitution safeguards the free flow of funds, Yue said, advising investors not to make decisions based on unfounded speculation.

Banks and money exchange shops have seen queues in recent days as residents are looking to open offshore accounts or get hold of foreign currencies, according to local media reports.

There is little sign of pressure on the peg right now. The currency is trading at the strong end of its permitted band as impending public share sales boost demand for Hong Kong dollars. Going long on the currency against the greenback has been a profitable trade in recent months due to the city's higher borrowing costs relative to the U.S.

Evidence of outflows is scant. Bank deposits in Hong Kong increased 0.8% in April from the previous month, the biggest gain in six months. Panic has ebbed in the stock market, with the Hang Seng Index on Wednesday erasing earlier losses sparked by the national security legislation proposal.

Under the U.S.-Hong Kong Policy Act of 1992, the president is empowered to suspend the territory's special trading privileges at any time through an executive order. The law covers every facet of the relationship, from trade to recognizing passports to rules that affect air travel, shipping and investment. It even allows for U.S. dollars to be freely exchanged with Hong Kong dollars, which if revoked would amount to what some analysts have called the “nuclear option.”

Hong Kong currently has $440 billion of foreign-exchange reserves, which is more than two times the city's money in circulation, according to Yue's post.

The Hong Kong dollar last traded at 7.7502 per greenback, a fraction away from the 7.75 strong end.

(An earlier version corrected the size of the increase in deposits)

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