(Bloomberg) -- Hong Kong’s central bank is buying Hong Kong dollars for the first time since 2005. And lots of them, too. It follows a long slide in the local currency that took it to the lower end of its trading band against the U.S. dollar. In the first week alone of intervention, the Hong Kong Monetary Authority blew $6.5 billion of reserves. That’s raising questions about how long this can continue and the implications for the city’s finances.
1. Should we be worried?
Not for now. The central bank had $440 billion of foreign reserves as of end-March (seven times the city’s money in circulation), so in its first week used up just 1.5 percent of the total. The HKMA and the city’s government are resolute about maintaining the 35-year-old peg. What might rock the boat would be massive speculative attacks on the currency, as experienced in 1997. But even then, the central bank held sway.
2. What happened in 1997?
As the Asian financial crisis unfolded, excessive optimism in Hong Kong stocks quickly turned into panic selling and triggered a run on the currency. But the HKMA held firm against speculators, allowing overnight interest rates to jump to 300 percent and making it harder for banks to borrow money overnight. This was enough to kill off the hedge fund attack as local banks could only raise funding for their own needs, so there were no Hong Kong dollars left to finance short sellers.
3. Are speculators targeting the currency this time?
The HKMA said April 19 it doesn’t see any large-scale shorting of the Hong Kong dollar. And activity among options trading -- another indicator of increased speculation -- remains subdued.
4. Does the central bank see a weak currency as a problem?
Not according to its chief, Norman Chan. He said in March the authorities were "looking forward to" seeing the currency reaching 7.85 per U.S. dollar, the level at which the central bank is mandated to take action. (The band has been $7.75 to $7.85 since 2005). That’s because such action would allow interest rates to rise -- counteracting the key reason why the Hong Kong dollar has been weakening.
5. So this could all resolve itself soon enough?
Some analysts see it that way. In buying local dollars, the HKMA is addressing the very reason local interest rates are not advancing in synch with U.S. rates: the abundance of liquidity in Hong Kong. With its intervention, the central bank is draining that excess. Its first week of purchases alone was forecast to soak up about 30 percent of liquidity, according to one measure. And that’s already having an effect: within a week of intervening, interest rates rose to their highest level since 2008.
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