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To: Investor-ex! who wrote (15873)	8/14/1998 2:39:00 AM
From: Alex	Read Replies (1) \| Respond to of 116814

The Money Markets Smell Blood Your Exchange Rate or Your Stock Market The latest assault on the Hong Kong dollar has raised question marks over the role of the Hong Kong Monetary Authority (HKMA), the territory's de facto central bank and guardian of its hefty foreign reserves. Acting on behalf of the government, the HKMA absorbed selling pressure over the past two weeks by intervening in the markets to buy Hong Kong dollars. The government needs the Hong Kong dollars to meet expenses, the HKMA explains. June to November is traditionally the "dry" season for funds, before tax receipts come in, and this year the requirement is exacerbated by the projected budget deficit of HK$21.4bn (œ1.7bn). But the timing of the HKMA's intervention, at a time when the currency was under attack, suggests that the government is unwilling to take the pain involved in maintaining Hong Kong's currency board mechanism. That, in turn, raises questions over the fate of the currency peg to the US dollar. As the last main fixed exchange rate among Asia's fully convertible currencies, the resolve of the Hong Kong government in maintaining the peg is being closely watched. Government officials have given repeated assurances that the peg will stay, and its US$96bn (œ59bn) foreign reserves are more than sufficient to fend of speculators. Donald Tsang, financial secretary, yesterday warned that speculators would be given short shrift. "If speculators wish to do something, we will deal with them very decisively," he said. Under the currency board mechanism, when selling hits the Hong Kong dollar, it automatically triggers a sharp rise in interbank interest rates. This, in turn depresses asset prices, in effect making Hong Kong's costs more competitive with those of neighbouring countries whose currencies have been devalued. The HKMA's intervention in the past two weeks throws into doubt the authorities' willingness to live with the resulting pain of high interest rates. Its intervention has also invited a more protracted tug-of-war between speculators and the government in the days ahead. "The slower rise in interest rates, and hence carrying-costs for borrowers, will enable speculators to sustain their attacks for a longer period of time," points out Eddie Wong, North Asia economist for ABN Amro. "More rumours will be spread around. The stock market will face more pressure. Expect more fights in the next couple of weeks," he notes. However, dismantling the peg would not bring relief to Hong Kong either. If the peg were dismantled, interest rates would rise and property prices would plunge. There would also be capital flight as foreign investors retreated. Even so, maintaining the peg is proving painful. The economy shrank 2.8 per cent in the first quarter, unemployment is at a 15-year high of 4.5 per cent and the stockmarket is at 1993 levels. Thus, when the government is seen to be tinkering at the edges of the currency board mechanism, the markets start to sniff blood. "Although this [buying of Hong Kong dollars] is totally legitimate under Hong Kong's currency board system and is based on a genuine need [to fund the deficit], it is still more of an excuse than anything," says Mr Wong. An HKMA spokesman demurs: "There were exactly the right market conditions for us to switch [into Hong Kong dollars]. We are adhering strictly to the currency board principle," he said. But doubts have been sown, and capitalising on these doubts are the hedge funds and investment banks, some of which have rushed out call warrants that will yield substantial profits for them if the Hong Kong dollar depreciates to HK$7.8 from current levels over HK7.75. With a long weekend round the corner in Hong Kong and its promise of thin trading, dealers reckon speculative activity will escalate. Mr Wong expects "a big showdown between the government and currency speculators." If that happens, "both sides could lose big", he warns. The Financial Times, August 14, 1998