HK rates to rise after capital outflow
By Guo Jian'er (China Daily)
Updated: 2004-11-26 09:20

Hong Kong interest rates will eventually rise in line with US rates because the speculation using Hong Kong dollar as a proxy for renminbi is "far-fetched", Joseph Yam, chief executive of the Hong Kong Monetary Authority (HKMA), said yesterday.

Yam made the comments as Hong Kong's banking system is awash with liquidity due to recent massive capital inflows betting on revaluation of the renminbi.

The Hong Kong dollar interest rates were cut rather than raised following the latest US rate hike, a rare move under the city's peg system.

The interest rate spreads between Hong Kong and the US have widened to nearly two percentage points, which implies higher opportunity costs for capital inflows. It is a level far greater than that seen during a large capital inflow late last year, as speculators believe China could revalue its exchange rate imminently.

Yam, head of the city's de facto central bank, cautioned that the timing for a change in renminbi exchange rate policy was, in any case, open to question.

"Exchange rate reform is admittedly on the cards on the mainland, but it is a long-term issue and there is doubt about whether it will be undertaken at a time when macro-adjustment and control is in progress," Yam wrote in a weekly column published on the HKMA website yesterday.

"I have doubts about the advisability of tacking additional complex structural issues at this time. And to be taking a long position in the renminbi, using the Hong Kong dollar as a proxy, is, to put it mildly, a little far fetched," he added.

Eventually the market will realize this and the consequent outflow from the Hong Kong dollar will then occur. "When it does, Hong Kong dollar interest rates will rise," said Yam.

Meanwhile, Bank of China (Hong Kong) said in its latest economic review that a higher degree of speculation was found in recent capital inflows as reflected by the over-reliance of investment returns on a single and uncertain renminbi revaluation.

According to the bank, during the inflow late last year, the surging Chinese economy, rising expectation of renminbi revaluation as well as the strong rebound of the Hong Kong economy and the still-low US interest rate environment all created tremendous incentives for inflows.

But it should be noted that economic and financial circumstances have vastly changed, and excess returns required to justify recent inflows can only come from a possible reminbi revaluation, it said.

"It must be pointed out that rising expectation of revaluation doesn't necessarily mean rising probability of such an outcome," the bank said, adding the change in renminbi exchange rate under China's current exchange regime is not directly linked to market expectation and behaviour.

"Therefore, its sustainability is in doubt. Ordinary investors need to closely monitor the sustainability of current inflows and be prepared for any market risks arising from possible reversal of capital inflows," it said.

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