Experts debate fate of HK dollar on volatile day

Experts debate fate of HK dollar on volatile day

HONG KONG (Reuter): While Hong Kong money market dealers warily awaited monetary authority intervention and the local dollar slipped lower, analysts yesterday debated the future of Asia's last major U.S. dollar fixed exchange rate.

"With what's happening on the Indonesian rupiah, there's a little bit of tension here," Andrew Fung, head of Asian Capital Markets for Commonwealth Bank of Australia in Hong Kong, told Reuters Financial Television's daily programme Asia Today.

On Thursday, Indonesian officials effectively lifted the fixed exchange regime that had kept the currency's trade limited to a 12 percent band.

Spillover pressure from the managed flotation of the rupiah was being felt throughout Asia on Friday and was building up in Hong Kong where the local exchange rate has been fixed at HK$7.8 per US$1 since 1983.

Throughout the recent months of currency turmoil in Asia, the Hong Kong dollar has stayed on the strong side of its unofficial one percent trading band, rarely straying from HK$7.75 to the U.S. dollar.

But forward Hong Kong dollar rates have soared in response to regional pressures.

By Friday afternoon, six-month forward contracts were trading at a 1000 point premium to spot, and one-year money was at a 1500 point premium, making the carrying cost of a Hong Kong dollar short position very expensive.

In many traders' eyes, the Hong Kong dollar is starting to look very isolated in a region battered by waves of speculative pressure.

"I think there's definitely some reconsideration to be had," said Eric Nickerson, head of currency research at Bank of America.

"The fundamentals of Hong Kong are very much Asia-oriented, not U.S. oriented," said Nickerson. "Certainly the U.S. dollar is an important currency for this economy, but to have all of its financial policy dictated by the Federal Reserve really doesn't make any sense," he said.

Chi Lo, regional economist at Deutsche Morgan Grenfell in Singapore, said Hong Kong authorities may well want to rethink the link to the U.S. dollar, but will not be forced to do so for some time, at least until the end of the century.

But Nickerson disagreed, saying the uncertainty associated with the July 1 handover of Hong Kong to China was in the past, making the political justification of the peg less viable.

While agreeing that the political uncertainty of the handover was no longer a factor for the Hong Kong dollar, Lo pointed to continued jitters over the "one country, two systems" model that permits a westernized, capitalist Hong Kong to exist inside a communist ruled China.

"Foreigners, as well as Hong Kong people, they are all skeptical," about one country, two systems, said Lo. "They need a kind of confidence booster, and the Hong Kong dollar peg will serve this purpose in the medium term."

Nickerson admitted the resolve of Hong Kong authorities to maintain the peg is strong, and that the combined financial resources of the HKMA and the Peoples Bank of China - if called upon - would total more than US$200 billion.

But he warned that the market may not care.

"That's not necessarily going to be sufficient to keep the market at bay given the uncertain circumstances in the rest of the region," said Nickerson.

CBA's Fung said that, while the market is nervous, he does not expect the Hong Kong dollar to be shoved from its U.S. dollar peg amid the current pressure.

"I think the forward will stay higher, at a significant premium against the U.S. interest rate, as the major disincentive for speculators to try their luck here," he said.