The upshot of defending the dollar peg

Bankers and economists have said appreciation pressure stemmed mainly from the weakening renminbi. This has depreciated by a total of about 3 per cent against the greenback in recent months. This has triggered a flight from the renminbi in the Hong Kong offshore market, creating a strong demand for the local currency.
Since early September, the government has intervened in the forex market on 13 separate occasions that involved the purchase of US dollars worth a total of about HK$76 billion at the pegged exchange rate. Many forex traders predicted that the renminbi would continue to weaken, requiring further government interventions in managing the linked exchange rate system.
In effect, the government is forced into operations not dissimilar from quantitative easing. The resulting increase in the money supply and credit expansion will have predictable inflationary consequences.
The management of the linked exchange rate system is further complicated by the impending interest rate hike in the United States. Under normal circumstances, Hong Kong would have to follow the US in raising interest rates. But the strengthening of the Hong Kong dollar against the greenback and other major currencies has given Hong Kong the option of keeping rates at current abnormally low levels for as long as it needs.
Either way, the inflationary pressure is unlikely to ease any time soon. As import prices for foodstuffs and consumer goods from the mainland, Japan and other sources are expected to stay low, the brunt of inflation will be borne by assets, including equities and properties.
It has become widely known that plentiful supply of liquidity and cheap credit, stemming from the massive inflow of foreign capital – largely from the US – was mainly responsible for escalating property prices and for the stock market boom in the past couple of years. But the ending of quantitative easing in the US late last year and talks about interest rate hikes late last year triggered an outflow of capital from many emerging markets in Asia and elsewhere.
The flow was exacerbated by the depreciation of various Asian currencies against the US dollar in recent months. This has fed the fear of the possible outbreak of a financial crisis similar to the one in 1997.
In the past month, some investment analysts have published reports predicting a sharp decline in property prices in Hong Kong based on the assumption of credit contraction and increased interest rates.
With the government interventions in the forex market, those reports of the demise of Hong Kong’s property market seem to have been greatly exaggerated.