Hong Kong’s US dollar peg should stay, says S&P

SINGAPORE- Hong Kong's Linked Exchange Rate System remains credible and robust despite recent volatility and depreciation pressures in the Chinese yuan market, ratings agency Standard & Poor's says in a report published today.

S&P believes fears about the future of Hong Kong's currency stemming from ongoing volatility in the Chinese yuan market are overblown.

“The Hong Kong currency has been pegged to the US dollar for more than three decades, but financial media is reporting market participants as saying that the Hong Kong currency board is now vulnerable,” S&P says.

"The key to success for a currency board is a flexible economy - in particular, flexible prices - underpinned by a strong banking system," says Paul Gruenwald, S&P’s Asia-Pacific chief economist.

"Since the nominal exchange rate cannot adjust by construction, other nominal variables must be highly flexible in order to allow the economy to respond to external shocks.

“Flexible prices will allow the real effective exchange rate to move, even if the nominal exchange rate cannot. For Hong Kong, this would also include property prices, given the central role of that sector in the local economy." 

Over the longer term, Gruenwald says, the future of the Hong Kong dollar will depend on whether the Chinese yuan eventually becomes an international, widely traded reserve currency.

"Demand for Hong Kong dollars could fade away if the yuan becomes international as perhaps only the yuan and US dollars would circulate in Hong Kong.

“But that has not been the case so far. Indeed, demand for the Hong Kong dollar has remained strong even as offshore demand for the Chinese yuan has risen," Gruenwald says. www.standardandpoors.com (ATI).