Hong Kong peg is a code Alibaba couldn't break

ANALYST'S VIEW

For a while, it looked as if the initial public offer of Alibaba.com in Hong Kong would end up becoming "Open Sesame'' for the territory's pegged currency.

Investors needed Hong Kong dollars to order shares in the Chinese Internet company's $1.5 billion IPO, the biggest for an Internet company since Google Inc.'s 2004 offer.

And Alibaba was just one of the 33 companies that sought a total sum of HK$69 billion ($8.9 billion) last month from overeager investors. This demand for Hong Kong stock worsened a demand-supply mismatch in the city's currency.

On October 26 and again on October 31, the Hong Kong dollar tested the upper end of its trading range, which allows the currency to fluctuate between 7.75 and 7.85 to the US dollar with 7.80 as the midpoint. The 24-year-old linked exchange rate came under pressure, though it didn't break down. And chances are it won't, at least not in the foreseeable future.

To be sure, keeping the peg won't be a free lunch.

If the US Federal Reserve further pares the cost of money to deal with the impact on the economy of the housing-market collapse, Hong Kong will be in an unenviable situation: To save the peg, it will have to pump more liquidity into the banking system, stoking an asset-market frenzy that the city has borrowed from China. Prudence suggests the opposite course: Hong Kong should abandon its dollar fixation and raise domestic rates.

But when the city didn't give up the linked-rate regime in the bad times, why should it dismantle it in the good times?

Easy to Defend
When Hong Kong was hit by the Asian crisis in 1998, the government bought HK$30 million of stocks every minute for two days to save the currency from getting pummeled, say Credit Suisse economists Dong Tao and Christiaan Tuntono in Hong Kong.

Compared with that, the only cost of reining in a strengthening currency is to flood banks with Hong Kong dollars. That's just what the Hong Kong Monetary Authority did recently when it bought US dollars, pushing up the aggregate balance in banks' clearing accounts to HK$10.6 billion on November 2, from HK$1.3 billion on October 23.

By November 2, Hong Kong dollar interest rates had fallen to their lowest level in 1 1/2 months when compared with US dollar deposits. The 12-month forward rate for the currency eased to 7.7156 to the dollar, from 7.7090 on October 31.

The author is a Bloomberg News columnist.