MNI EXCLUSIVE: China Would Defend HK Peg In Emergency-Advisors

--Hong Kong Dollar Seen Strong For Rest Of 2020

--IPOs, Carry Trade Drive Capital Inflows

     BEIJING(MNI) - China would deploy its vast foreign reserves to support Hong

Kong's dollar peg if it ever came under serious pressure, policy advisors told

MNI, with an economist at Bank of China (Hong Kong) predicting that the

territory's currency would be supported by capital inflows for the rest of the

year thanks to interest rate differentials and share offerings.

     Continued Sino-U.S. tensions could eventually prompt capital outflows,

destabilising the local financial market and undermining property prices, said

one advisor in Beijing, asking to remain anonymous. If coupled with a depressed

economy, this would erode the reserves which maintain the 36-year-old currency

board keeping the Hong Kong dollar within a band of 7.75-7.85 to the U.S.

currency, he said, pointing to fears that the U.S. could restrict the access of

Hong Kong banks to U.S. dollars.

     But, while some investors have begun to probe the boundaries of the peg

since China announced it would extend its security law to the territory in May,

sending 1y and 2y forward points to their highest levels since 1999 and

prompting a jump in implied volatility, the currency has since been supported by

capital inflows. The Hong Kong Monetary Authority has intervened 18 times since

April, selling HKD51.8 billion to prevent any appreciation beyond 7.75,

including sales of HKD2.23 billion on Wednesday.

     --CURRENCY BOARD

     Hong Kong's USD437.5 billion of foreign exchange reserves are sufficient to

maintain the peg, said Zhou Xiaoming, former deputy Permanent Representative at

China's Permanent Mission to the United Nations Office in Geneva, adding that,

should it ever become necessary, the People's Bank of China would support the

currency board using its reserves of over USD3.1 trillion. Rather, the greatest

risk to Hong Kong's peg may come from an extended period of U.S. quantitative

easing, he said.

     Earlier this month the PBOC stressed its support for Hong Kong's role as an

international financial centre, in a statement which came as the U.S. threatened

to revoke the territory's trading privileges. U.S. Treasury Secretary Steven

Mnuchin said last Thursday he was working on capital market responses to China's

security law plans, including measures that could restrict capital flows.

     Hong Kong has so far benefited from moves in Washington to 0073ubject

Chinese firms to greater scrutiny, which have already prompted some companies to

seek secondary listings in the territory. The magnitude of continued capital

inflows from IPOs will depend on sustaining investor interest of the sort seen

in June's debut by NetEase, China's second-largest online gaming company, and

e-commerce firm JD.com, said Ding Meng, an economist at Bank of China (Hong

Kong). But he added that a carry trade funded by ultra-low U.S. borrowing rates

was also attracting money to the territory.

     The likelihood that the U.S. would take serious action to restrict capital

flows to Hong Kong is low, said Ding, noting that U.S. companies have over 1,300

regional headquarters and offices in the territory. He expects the HKD to remain

strong in 2020, if not to test levels towards 7.75, even as unemployment hits a

15-year high in the wake of coronavirus lockdowns and anti-government protests.

     --MAINLAND INVESTORS

     Mainland investors have been particularly active in purchasing Hong Kong

equities, via the Stock Connect cross-border investment channel. According to

Wind, a Chinese financial data provider, a net HKD286.5 billion of funds have

entered so far this year through Connect, compared with HKD249.3 billion for the

whole of 2019.

     The "darkest moment" of Sino-U.S. relations may be yet to come, said Zhou,

warning that the situation may deteriorate before November's U.S. election.

While China will not seek confrontation, it will not compromise on its core

interest and principles, he said.

     China's top diplomat Yang Jiechi met U.S. Secretary of State Mike Pompeo in

Hawaii on Tuesday and Wednesday, the People's Daily reported. Zhou said the

meeting failed to produce any agreement on specific issues, in a sign of the

deep differences between the two nations, and the poor prospects for an improved

relationship in the short run.

     But the meeting helped both sides to understand each other's position, and

continued communication may help prevent the situation from getting out of

control, Zhou noted.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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