Hong Kong Dollar to Face Toughest Test in ’97

For more than a decade, the value of Hong Kong’s dollar has been tied to the U.S. dollar, but with the British crown colony set to revert to mainland Chinese rule in mid-1997, some are wondering if the “Chinese dollar” will survive.

In recent weeks, bankers and officials from Hong Kong and China have echoed each other’s praise for the 11-year-old relationship which has kept rock solid the currency exchange of 7.8 Hong Kong dollars per U.S. dollar.

The link between the two currencies is so strong that the Hong Kong dollar has held within a range of less than 2% against the U.S. currency since 1983.

It has withstood the shocks of the 1987 stock market crash, the 1989 Tian An Men massacre, frequent Sino-British disputes and the recent red-hot inflow of foreign investment.

The Hong Kong dollar now trades at 7.7270 to the U.S. dollar. Market participants are happy to see the exchange stay fairly solid but expect it to face its toughest test as the handover to China approaches, analysts said.

“It’s very much China that wants the peg (currency link) to remain,” Enzio von Pfeil, an economist with S.G. Warburg, said in a recent interview.

China has shown commitment to Hong Kong’s monetary stability by supporting expansion of the colony’s capital markets by the Hong Kong Monetary Authority, the quasi-central bank, Von Pfeil said.

China also wants entry into the World Trade Organization, which will replace the General Agreement on Tariffs and Trade, and stable currencies on the mainland and in Hong Kong to support its case, he said.

Hong Kong interest rates must track U.S. rates to maintain the currency link. This draws the greatest criticism because Hong Kong cannot adjust its own monetary policy to control inflation, now averaging about 8%.

Adding to the pressure, the U.S. dollar’s recent slide against the yen has dragged the Hong Kong dollar down and made imported goods more expensive.

Events that could shake the currency from its slumber include a crisis of confidence before China regains Hong Kong, soaring inflation in China and Hong Kong, a collapse in local property, or a rapid rise in U.S. interest rates.

But these days many bankers barely watch the currency because they believe so strongly that the exchange rate will hold.