US embassy cable - 06HONGKONG1383

HONG KONG DOLLAR PEG'S FUTURE UNDER CONSIDERATION BY GOVERNMENT ADVISORY BODY

Identifier: 06HONGKONG1383
Wikileaks: View 06HONGKONG1383 at Wikileaks.org
Origin: Consulate Hong Kong
Created: 2006-04-03 10:39:00
Classification: CONFIDENTIAL
Tags: EFIN ECON PGOV HK CH
Redacted: This cable was not redacted by Wikileaks.
VZCZCXRO0218
PP RUEHCN
DE RUEHHK #1383/01 0931039
ZNY CCCCC ZZH
P 031039Z APR 06
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC PRIORITY 5885
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
C O N F I D E N T I A L SECTION 01 OF 02 HONG KONG 001383 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EAP/CM AND EB 
TREASURY FOR DAS DLOEVINGER AND OASIA GKOEPKE 
STATE PASS USTR 
USDOC FOR 4420 
 
E.O. 12958: DECL: 04/03/2031 
TAGS: EFIN, ECON, PGOV, HK, CH 
SUBJECT: HONG KONG DOLLAR PEG'S FUTURE UNDER CONSIDERATION 
BY GOVERNMENT ADVISORY BODY 
 
REF: A. 05 HONG KONG 1465 
     B. 05 HONG KONG 2512 
 
Classified By: EP Section Chief Simon Schuchat; Reasons: 1.4 (b/d) 
 
 
SUMMARY/COMMENT 
--------------- 
 
1. (C) The Chinese renminbi (RMB, 8.02=1 USD) and Hong Kong 
dollar (HKD, 7.76=1 USD) are likely to reach parity by 
year-end, assuming the RMB continues its gradual appreciation 
in line with most forecasts.  Looking at the evolution of the 
two currencies, such parity would merely be an accident of 
history.  However, considering Hong Kong's increasing 
economic integration with the mainland, the RMB becoming a 
dearer currency than the HKD is likely to spark widespread 
discussion here of scrapping the HKD-USD peg, not to mention 
much speculative activity against the HKD.  One financial 
contact told us that the conversation about the future of the 
peg has already begun within a Hong Kong Government (HKG) 
advisory committee that he sits on.  Local analysts with two 
of Hong Kong's paper currency-issuing banks, HSBC and 
Standard Chartered, doubt that change is coming within the 
next three years, but our HSBC contact said that there is a 
growing view within his organization that the HKD-USD peg 
should be re-examined in light of Hong Kong's growing role as 
a financial intermediary for mainland China.  Given the 
emphasis that Hong Kong places on maintaining its reputation 
as a stable and well-run international finance center, we 
anticipate that any move off the peg would occur only after a 
minimum of several years of discussion and debate.  During 
the ensuing period, however, neutralizing speculative 
activity could very well become an ongoing headache for the 
HKMA. END SUMMARY/COMMENT 
 
QUESTIONING THE PEG 
------------------- 
 
2. (SBU) Hong Kong has currency autonomy under "one country, 
two systems."  The link between the HKD and USD dates to 
October 1983.  At that time, the British colonial government 
responded to currency instability associated with uncertainty 
over Hong Kong's future under Chinese rule by instituting a 
link -- not technically a "peg" but generally referred to as 
such -- between the HKD and the USD.  The value of the fully 
convertible HKD is maintained through a currency board, i.e., 
a system that ensures all issued currency is fully backed by 
reserves of USD.  (See Ref A) 
 
3. (C) DBS Bank Managing Director Andrew Fung is among 153 
members of the HKG's Commission on Strategic Development, an 
entity that advises the Chief Executive (CE) on Hong Kong's 
long-term needs and goals.  Fung told us that commission 
members are actively discussing and submitting papers on the 
future of the HKD-USD peg.  Numerous commission members who, 
in Fung's words, "have the ear of senior officials" are 
arguing that the HKD-USD peg should be floated shortly after 
the Chinese renminbi (RMB) surpasses the HKD in value.  The 
RMB presently trades at 8.02 to the USD; the HKD is 
maintained within a small band centered at 7.80 to the USD. 
Conventional wisdom among currency watchers is that the RMB 
will appreciate at least 3 percent during the remainder of 
2006, thus putting it at or beyond parity with the HKD within 
the next nine months. 
 
4. (C) Fung asserted that once the RMB appreciated beyond 
parity, speculators would assume the HKD would rise along 
with it, creating overwhelming market pressure.  If the Hong 
Kong Monetary Authority (HKMA) then maintained the HKD-USD 
peg, the result would be stock market and property bubbles as 
speculators chased assets denominated in HKD, hoping to make 
a profit once the peg was broken.  The speculative inflows 
would also create unwelcome interest rate volatility for 
property-focused Hong Kong, in Fung's view. 
 
POLITICALLY SENSITIVE 
--------------------- 
 
5. (C) Fung predicted that CE Donald Tsang would not go along 
with breaking the peg before the next CE election in 2007. 
The prospect of a float would be highly unsettling to Hong 
Kong savings account holders who often out of habit hold USD, 
Australian dollar, or New Zealand dollar accounts as a hedge 
against what for many years has been a fear of a HKD 
 
HONG KONG 00001383  002 OF 002 
 
 
devaluation (currently unwarranted).  It would also hurt 
leading businesses whose holdings tend to be invested in USD 
instruments on the assumption of a stable USD-HKD peg. 
 
6. (C) Fung said that Hong Kong's economy is now much more 
closely tied to that of the mainland rather than the U.S. 
Although it is not technically feasible to peg to the RMB (a 
non-convertible currency), any floating of the HKD would lead 
to its closely tracking the RMB's value.  Speculators know 
this and would start to get very excited about the prospect 
of the peg being broken once the RMB hit 7.5 to the USD, Fung 
predicted. 
 
VIEWS FROM TWO CURRENCY-ISSUING BANKS 
------------------------------------- 
 
7. (C) Standard Chartered Bank Global Research Economist Tai 
Hui predicted no change in the HKD-USD peg for at least three 
years.  He assessed HKMA as very capable of fighting 
speculators through reserves and sterilization measures.  Any 
float would create confidence issues for the HKD.  HSBC 
Senior China Economist Hongbin Qu said the HKD-USD peg would 
likely hold for at least several years.  He said that HSBC -- 
like Standard Chartered, an issuer of HKD paper currency -- 
does not publicly discuss the peg; however, there is a 
growing internal view that Hong Kong should rethink its 
currency tie to the USD.  Qu explained that if Hong Kong is 
to build upon its growing role as China's center for 
financial intermediation, it needs a currency more closely 
linked to the mainland, not to the U.S. 
 
ISSUE KEEPS REARING ITS HEAD 
---------------------------- 
 
8. (SBU) On May 18, 2005, the HKMA tweaked its currency 
policy for the first time since the 1998 Asian Financial 
Crisis, hoping to prompt speculators to reduce reliance on 
the Hong Kong dollar (HKD) as a proxy currency for 
anticipated Chinese renminbi (RMB) revaluation.  The 
introduction of a 0.6 percent trading band around a linked 
rate of 7.80 to the USD -- replacing what was a one-way 
depreciation floor -- suggested that HKMA viewed distortions 
to Hong Kong's financial system caused by RMB speculation as 
a significant and enduring economic challenge that could 
potentially worsen as China took steps to introduce RMB 
flexibility.  The change made it riskier for speculators to 
maintain positions using the HKD and seems to have worked. 
However, our contacts all pointed out that any significant 
and growing variance between the HKD and a stronger RMB would 
still likely invite speculation against the USD-HKD peg. (See 
Ref B) 
Cunningham 

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