China boosts reserves amid fears for HKD-USD peg 

Mainland’s dollar holdings can be mobilised to prevent reported US plans to undermine city’s currency in retaliation over new security law 

China boosts reserves amid fears for HKD-USD peg 
Rolled notes: Hong Kong Monetary Authority (HKMA) staff show off new $500 notes at a press conference. EyePress News / EyePress via AFP

(ATF) China has been growing its foreign reserves at a time when concern for the stability of Hong Kong’s dollar raised speculation the mainland might funnel funds to support the city’s currency.

Foreign exchange reserves held by the People’s Bank of China (PBoC) expanded to $3.1123 trillion at the end of June, an increase of $10.6 billion, or 0.3%, from the end of May, according to data released Tuesday by the State Administration of Foreign Exchange (SAFE).

SAFE spokesperson Wang Chunying said the uptick had been driven by factors, including a decline in the overseas value of the greenback making the US currency cheaper to buy. Wen Bin, chief analyst at China Minsheng Bank, added that cross-border capital inflows also contributed to the rise, saying that renminbi assets are attracting more global investors.

The increase comes amid reports that US President Donald Trump’s White House had sought to undermine Hong Kong’s currency in retaliation for China’s imposition of a new security law on the former British colony.

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Additionally, Texan hedge-fund manager Kyle Bass has reportedly been raising funds to launch a speculative assault to break the Hong Kong dollar’s peg from the US dollar. 

The PBoC has a swap arrangement through which it can send some of its own reserves to Hong Kong’s de-facto central bank, the HK Monetary Authority, to hold the local currency within a narrow range around HK$7.80. The HKMA has huge reserves of its own - about $420bn - but in the past it’s had to use large amounts to maintain the peg, especially during the 1997 Asian financial crisis.

While China’s central bank has made no indication it is about to mobilise funds, analysts said officials both sides of the Hong Kong border are ready to put measures in place.

“Hong Kong and China’s central government are prepared for this,” said Raymond Yeung, ANZ senior economist. “Hong Kong’s Financial Secretary Paul Chan has stated that even if the US takes measures to make Hong Kong dollar settlement inconvenient, the government has a contingency plan.”   

Bank access

Bloomberg News said the idea from some US officials to put a strain on the 37-year-old peg – possibly by limiting local banks' access to US dollars – was one of a number of measures flagged as Washington looks at ways to respond to the controversial law.

However, it cited unnamed sources as saying the move had not been discussed at senior levels of the Trump administration, while analysts said such a measure was unlikely owing to the upheaval it would cause to global markets.

Other measures being discussed included cancelling a US-Hong Kong extradition treaty and no longer cooperating with the city's police force, Bloomberg said.

The city's dollar was linked to the greenback in 1983 in a bid to prevent a sell-off as it wobbled over fears about China's reunification talks with the UK.

"I believe the threat is very real,” said Michael Every, Rabobank Head of Financial Markets Research Asia-Pacific. “Yes, we have an election ahead in the US. But if Trump loses, which he is on trend to do, he may well act on Hong Kong before leaving office in January. It’s quite normal for departing presidents to do controversial things. It would be entirely in keeping with the China hawks to move on the nuclear option to ensure there is no rollback under Biden – and with no electoral consequence.”

The HKMA has in recent months had to sell billions worth of local dollars to maintain the city's Linked Exchange Rate System, as cash floods into the city to take advantage of its relatively high interest rates.

Investors have also been rushing to join a string of big-ticket new listings of late, including Chinese e-commerce giant JD.com and tech firm Netease.

The currency remained wedged at HK$7.75 Wednesday, its strongest possible level.

Still, Stephen Innes at AxiCorp said the US was unlikely to do anything to hurt the peg as, firstly, it could put at risk the vast amount of assets held by China, particularly Treasuries.

"Second, such a move could destabilise dollar pegs elsewhere, including US allies around the world, especially those in the Middle East," said Innes. 

"Third, the unthinkable instability that it would trigger in the dollar-based global financial ecosystem could drive a selloff in US equity markets – an outcome abhorrent to the White House ahead of the November presidential election.”

ANZ’s Yeung agreed.

“Vigilance is needed, but people do not have to worry too much about it,” he said. “Hong Kong’s USD settlement will not be affected. Besides its own commercial interests in Hong Kong, the US needs to take into consideration the likelihood of retaliation from China or Hong Kong. Given this, we do not believe the US will penalise Hong Kong even if they are uncomfortable with the National Security Law."

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  • Additional reporting by Nadeem Xu, Umesh Desai and AFP