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Hong Kong To Continue With US Dollar Peg

by Mary Swire,, Hong Kong

25 September 2006

The US dollar continues to be the appropriate anchor for the Hong Kong dollar for the foreseeable future and no change is needed to the Linked Exchange Rate System, a Monetary Authority study has found.

With the renminbi not being a freely convertible currency nor a reserve currency, it is technically not possible for it to be a currency anchor, the HKMA has concluded.

The study noted that co-movements of business cycles in Hong Kong and the Mainland have increased steadily since the 1990s. There has also been a significant rise in the synchronisation of business cycles among the economies of the Mainland, Hong Kong and the US since 2000.

However, the authority's Chief Executive Joseph Yam said that despite increasing integration between the Hong Kong and Mainland economies, co-movements of business cycles between the two are mainly explained by developments in the US affecting both.

The analysis suggested that over 60% of the variations in output shocks and over 45% of the variations in price changes in Hong Kong can be explained by US shocks, whereas Mainland shocks explain over one third of Hong Kong's price movements. There is also little correlation between the components of the business cycles attributable to domestic shocks in Hong Kong and the Mainland.

However, the influence of the US shocks on these two economies leads to a high degree of synchronisation. In other words, the business cycle co-movements of Hong Kong and the Mainland are largely due to the common influence of economic conditions in the US and possibly their US dollar-pegged exchange rate systems.

Noting that the Mainland progressively liberalises its capital account by encouraging capital outflows, the study said that economic shocks, specifically financial market shocks, from the Mainland to Hong Kong are likely to increase progressively over time.

"This may increase synchronisation of real growth and inflation, but due to the continuing structural differences between the two economies and different stages of economic development, the domestic shocks will not necessarily become more similar," the HKMA argued.

"As the similarity of shocks is the most important factor in the choice of an exchange rate regime, it follows that the Linked Exchange Rate System based on the US dollar will continue to be preferable in the foreseeable future," the study concluded.

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