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US interest rate hikes weigh on Hong Kong’s virus-weakened economy

Issued on: 05/15/2022 – 05:02Modified: 05/15/2022 – 05:00

Hong Kong (AFP) – The Federal Reserve’s recent rate hikes came at an awkward time for Hong Kong, which, thanks to its peg to the US dollar, is having to follow suit despite its own flagging economy.

Hong Kong has pegged its currency to the US dollar since 1983, which has helped the city weather economic storms like the 1997 Asian financial crisis and bolstered its status as a major global financial center.

But it also means Hong Kong has little choice but to follow the Fed’s latest round of hawkish rate hikes – the largest of its kind in 22 years.

“The Covid outbreak in Hong Kong and mainland China is already hurting growth,” Lloyd Chan, senior economist at Oxford Economics, told AFP.

“The last thing Hong Kong needs right now is rising interest rates.”

The city on Friday revised down its 2022 GDP growth forecast to one to two percent after a worse-than-expected first-quarter contraction of four percent.

The low interest rates that Hong Kong has enjoyed for more than a decade are now on the verge of a reversal, the city’s finance minister said ISAAC LAWRENCE AFP

Finance Minister Paul Chan wrote last week that Hong Kong is now facing a reversal of the low interest rate environment it has enjoyed for more than a decade.

“As the economy has not yet fully recovered from the epidemic, we need to be mindful of the impact of the rate hike… (on) people and small and medium-sized businesses,” he wrote on his official website.

Impact on the housing market

Hong Kong banks have held steady at their best lending rates so far, but they will feel the squeeze in three to six months, analysts say.

Analysts say Hong Kong's housing market is likely to feel the heat from rate hikesAnalysts say Hong Kong’s housing market is likely to feel the heat from rate hikes ISAAC LAWRENCE AFP

“The interest rate could rise faster than in the past given the faster pace of the Fed and also the change in the general background risk sentiment in the world,” Natixis economist Gary Ng told AFP.

Homebuyers whose mortgages are linked to the Hong Kong Interbank Offered Rate (HIBOR) will be the first to feel the heat, said economist Heron Lim of Moody’s Analytics.

“This usually has a downward impact on property prices, which should contract in 2022 and into 2023, especially when demand from mainland Chinese investors is weak,” Lim told AFP.

The Hong Kong government said on Friday it expects signs of a rebound later this year after easing coronavirus restrictions that stalled the economy in the first quarter.

But the rate hikes could dampen a domestic recovery as the heavier burden on homebuyers will hurt their spending power.

Small and medium-sized businesses may also face a “really difficult time” if rising interest rates coincide with a Covid resurgence, DBS Bank economist Samuel Tse told AFP.

Hong Kong is still aiming for a lighter version of China’s zero-Covid model, which has weighed heavily on businesses in the city.

Dollar peg “reasonable”

Hong Kong allows its currency to trade in a 7.75 to 7.85 range against the greenback.

Capital outflows and intense selling of the Hong Kong dollar over the past few months has pushed it to the weak end of this trading range.

Last week, the Hong Kong Monetary Authority (HKMA) issued HK$8.53 billion (US$1.08 billion) in three attempts to prop up the local currency, the first intervention since 2019.

The Hong Kong dollar has been pegged to the US dollar since 1983The Hong Kong dollar has been pegged to the US dollar since 1983 ISAAC LAWRENCE AFP

Some commentators have begun to question the sustainability of the tie, citing pressures from the pandemic and geopolitical tensions between China and the United States.

Responding to a comment from Bloomberg, HKMA executive vice chairman Edmond Lau said earlier this month that the US dollar peg is a “very robust and transparent system” and “very resilient.”

“Hong Kong’s monetary base is fully backed by US dollar assets,” Lau wrote, adding that the government has ample fiscal reserves and no net debt.

All four analysts who spoke to AFP agreed Hong Kong would stick with the peg despite changes in the global economy.

“Although foreign exchange reserves have fallen from $500 billion to about $460 billion, it’s still a relatively high level that should be enough to defend the Hong Kong dollar,” DBS’s Tse said.

Moody’s Lim said the HKMA war chest ensured the tie was “very defensible,” adding that the deal had political merit as Hong Kong remains an international gateway to the Chinese economy.

Nataxis’ Ng noted that there had been no sell-off or panic selling of assets related to the Hong Kong dollar, which he said bodes well for the future of the peg.

“But in the medium or long term,” he added, “it depends on whether there are still benefits to this currency stability that outweigh the costs, such as the divergence … between China and the US.”

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