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HK dollar

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HONG KONG: The possibility of a run on the Hong Kong dollar by speculators is higher than the government thinks, Schroder Securities economist Dong Tao said in a recent report.

"We believe there are many factors which place Hong Kong under speculators' scrutiny, even if it is not the weakest economy in the world," he said.

Some of these include a weakening economy in which the currency is fixed to a bigger and rebounding economy and the 1997 handover to China with its uncertainties. Since 1983, the Hong Kong dollar has been pegged at 7.8 to the U.S. dollar.

Regarding Hong Kong's fundamentals, Tao said the gross domestic product growth gap between the colony and the U.S. is shrinking while the inflation gap remains wide.

"More importantly, Hong Kong's balance of goods and services is forecast to turn to a deficit in 1996 for the first time since the introduction of the peg system," he said in a telephone interview.

He said the Hong Kong government argues that because Hong Kong does not have the weakest economy in the world, its currency is not a likely target for speculators.

"We feel the possibility of some speculation against the Hong Kong dollar is a lot bigger than the government claims," Tao said.

He said reasons why Hong Kong might be a target include the fact that Hong Kong residents can easily switch between local currency and foreign currency accounts, with very low transaction costs.

Also, while the Hong Kong Monetary Authority has an estimated US$53 billion in foreign reserves with which to defend the currency, the colony's defacto central bank has limited connections with other major central banks.

The HKMA's limited contacts with other central banks would make any effort at joint intervention to stem a run on the Hong Kong dollar difficult and slow "if in fact any support would arrive at all," he said.

In addition, Tao said a remote but real threat exists of externally generated "panic" selling of the Hong Kong dollar, for example as the result of unexpected political upheaval in China.

Despite these issues, he said the currency is likely to remain stable, particularly given the HKMA's large foreign currency cushion.

In his report, Tao said if a run on the Hong Kong dollar were to occur, there is a 75 percent chance the HKMA would successfully defend the currency by using its reserves.

The other possibility is that the speculation would trigger capital outflows by local and international fund managers, forcing the HKMA to raise short-term interest rates.

If higher rates did not stem the run, the HKMA would either re-peg the currency to the U.S. dollar, to a basket of currencies, to the yuan or let it float freely.-Reuter