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Following is a question by the Hon Frederick Fung and a written reply by the Financial Secretary, Mr John C Tsang, in the Legislative Council today (June 3):
It has been reported that since the onset of the financial tsunami, the Federal Reserve of the United States (US) has implemented the monetary policy of quantitative easing to help revive the credit market through capital injection measures such as purchasing corporate bonds, real estate mortgage-backed securities and long term Treasury bonds. Yet, there are comments that although such measures may temporarily alleviate the economic crisis, they may lead to problems such as devaluation of the US dollar and hyperinflation in the medium and long term. Moreover, as Hong Kong maintains a Linked Exchange Rate System (LER System) with the Hong Kong dollar pegged to the US dollar, substantial devaluation of the US dollar will have far reaching impact on Hong Kong's economy and financial system. In this connection, will the Government inform this Council whether:
(a) it has assessed what short, medium and long term impacts on Hong Kong's economy will be caused by the aforesaid monetary policy of US; if it has, of the outcome; if not, the reasons for that; and
(b) it will formulate measures to address the negative impact of substantial devaluation of the US dollar and hyperinflation on Hong Kong's economy, if it will, of the details of the various measures; whether it will make reference to the refinements to the operation of the LER System introduced by the Hong Kong Monetary Authority in 2005 to augment the convertibility zone as defined by the exchange rates of the strong-side and weak-side Convertibility Undertakings under the LER System, as well as consider switching to a LER System with the Hong Kong dollar pegged to a basket of currencies; if it will not, of the reasons for that?
Reply:
President,
(a) Under the Linked Exchange Rate System (LERS), Hong Kong dollar interbank interest rates have tracked their US dollar counterparts in declining to low levels recently. In the short run, the resulting accommodative monetary conditions are appropriate to the prevailing macroeconomic conditions in Hong Kong. Domestic economic activity has been weak and external trade performance poor. Low interest rates, combined with the Government's fiscal stimulus measures, should thus provide support to domestic demand in the economy and offset the negative shocks from the external environment.
On the price front, CCPI inflation has been moderating recently. The current economic downturn and the uncertain recovery prospects imply that deflation, not inflation, can be a major risk in the short run. Indeed, the underlying CCPI inflation rate has already dropped to a three-year low of 1.9% year on year in April 2009, compared with an annual rate of 5.6% in 2008. The more accommodative monetary environment should be helpful for cushioning or arresting a possible downward spiral of declining prices and contracting economic activity.
The potential effect of very easy monetary conditions on local asset prices may deserve attention. The stock market has rallied since March 2009, while the residential property market has also rebounded. Although there have not been visible signs of major asset price bubbles, the Government would remain watchful of asset price volatilities.
In the medium and long term, the impact hinges on a number of factors, including the exit strategy of the Federal Reserve of the United States (Fed) and the strength and pace of economic recovery around the world. While quantitative easing by the Fed could lay the groundwork for inflation in the future, such an outcome is not unavoidable. The Fed has the necessary tools to execute an exit and drain liquidity from the market at a pace that is consistent with certain inflation target, although the main challenge facing the Fed is to get the timing right.
When the US economy recovers, its monetary conditions will gradually tighten. This, in turn, should allow Hong Kong's monetary conditions to gradually tighten along with the US, thereby counteracting potential inflationary pressures in the local economy. It is also useful to note that, apart from monetary tightening along with the Fed, there are other instruments available to deal with goods and services price inflation and asset price inflation in Hong Kong, including stricter regulatory and prudential measures and fiscal policy measures.
There has been talk that the US dollar may soon be on a depreciating trend in the medium and longer term as a result of the Fed's quantitative easing. Despite the quantitative easing, the future movements in the US dollar remain highly uncertain, as other economies have also pursued quantitative easing, so in relative terms the US dollar will not necessarily depreciate sharply. In fact, when the Bank of Japan pursued quantitative easing in 2001-2006, the Japanese yen did not show a clear depreciation trend during the period. Even if the US dollar undergoes large depreciation, the experience after the Plaza Accord in the 1980s suggests that the adjustments of the Hong Kong economy will not necessarily be disruptive. The Hong Kong economy remained stable in 1984-1987, on average registering 8.4% real GDP growth and 4.3% CCPI inflation.
(b) Under the LERS, the monetary policy objective of Hong Kong is exchange rate stability, rather than to target asset prices or inflation. The Government may consider other policy measures, such as regulatory or prudential measures and fiscal policy measures, to address any inflationary concerns.
Widening the exchange rate band or re-pegging to the US dollar at a new level will likely fail to relieve pressures on rising inflation and buoyant asset prices, as it may invite market speculations on the likelihood of further band-widening or re-pegging in the future, thereby undermining the credibility of the LERS. Pegging to a basket of currencies is also not a good choice because it lacks the transparency in the currency board arrangement and such a change would only erode the credibility of the monetary regime. For a small and open economy like Hong Kong, the room for monetary and exchange rate changes to control inflation is substantially restricted by volatile capital flows and the global phenomenon of rising inflation.
Ends/Wednesday, June 3, 2009
Issued at HKT 12:45
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