It is no secret that political events, and strong confrontations in particular - wars, revolutions, protests, have a very direct effect on the currencies exchange rate of the countries involved in the conflict. However, Forex traders often underestimate this factor. Below we look at the impact of ongoing protests in Hong Kong on the exchange rate of the Chinese yuan and the Hong Kong dollar.
The protests in Hong Kong, which attracted the attention of the whole world, have already become a kind of example of the struggle to uphold the democratic rights and freedoms of the former British colony. Of course, it is hardly worth asserting that it was the protests that led to the long-term fall of the Chinese currency. Rather, they have become a very significant additional factor that does not allow the yuan, already shaken and exhausted by the long exhausting trade war with the United States, to stabilize.
Recall that the yuan fell below the key level of 7 to the US dollar last week, for the first time in 11 years, which, among other things, could hit Hong Kong's tourism and retail spending, which is connected with the vast tourist and business “flow” to mainland China.
The Hong Kong economy, which is already straining under the weight of anti-government protests, as well as a trade war between the US and China, will now be forced to feel the effects of a weakened Chinese yuan.
Retailers, restaurants, hotels and real estate agents will be the first to feel the impact of a weak yuan. Perhaps it will weaken even more, while the Hong Kong dollar is pegged to the US dollar, which makes visiting the city more expensive for a huge number of tourists from mainland China.
The People’s Bank of China (NBK) movement has prompted speculation that China will continue to allow the yuan to depreciate in order to mitigate the escalation of the trade war with the United States, but at a certain pace to avoid the massive exodus of capital.
This influence can also spread to Hong Kong's financial markets, as expectations of a cheaper yuan, a sign of a gradual weakening of the Chinese economy, have in the past encouraged international speculators to place large bets against the Chinese currency in Hong Kong. A closed capital account in China gives protection against such attacks, but Hong Kong, as a free financial center, offers an ideal platform for speculators.
Hong Kong could be a key battleground in the financial war between China and the United States, as shares of Chinese companies trading in Hong Kong are particularly vulnerable to attacks.
Hong Kong has already proven its worth in the last two rounds of the yuan weakening. In 1998, the city faced investors like George Soros with unprecedented stock activity worth 118 billion Hong Kong dollars (15 billion US dollars).
And in the last cycle of the yuan weakening in 2015 and 2016, Hong Kong achieved good results due to the large outflow of funds from the mainland through stocks and the real estate market.
The Hong Kong dollar has been pegged at 7.8 to the US dollar since 1983, and since 2005, the Hong Kong monetary authority was forced to introduce special regulatory measures - to buy local currency to support it when it reaches 7.85, and vice versa, to sell if the city’s currency strengthens to 7.75. The current exchange rate for this currency (USDHKD) is 7, 84.
This may not be a good sign for Hong Kong, as this fact will deter tourists to reduce costs, and also increase pressure on already weak exports.
The prospect of weaker consumption and recession in Hong Kong tourism threatens big problems for the regional economy.
Hong Kong's economy grew by 0.6 percent in the second quarter of 2019 compared to a year earlier, but quarterly it fell by 0.3 percent, which is significantly lower than growth by 1.3 percent in the first quarter.
As a major free port city with a large re-export and re-import business, Hong Kong has already been hit hard by the U.S.-China trade war: exports fell 5.4% and imports fell 7% in the second quarter.
In the first half of the year, the number of tourist groups from mainland China visiting Hong Kong grew by 34 percent compared to the same period last year, but in July growth slowed to 1.6 percent, according to the Hong Kong tourism industry council.
Moreover, in the first seven days of August, the number of tourist groups from mainland China fell by 40 percent compared with the same period a year earlier, with the sharp drop mainly due to recent mass protests.
In Times Square, one of the city’s main shopping centers, sales of small and medium-sized businesses fell by 50 percent, which speaks for itself.
But, despite the negative consequences for the Hong Kong economy, a weakening yuan may prove beneficial for the financial sector.
If the United States continues to prevent Chinese firms from raising capital in their country, then more and more Chinese companies will apply for listing in Hong Kong to receive an IPO (initial public offering). This will have a positive effect on Hong Kong.
Many economists expect the Chinese regulator to allow the yuan to drop to 7.2 against the US dollar later this year to offset the impact of the new 10 percent duties on Chinese goods that the US plans to introduce in September. If subsequently this tariff is increased to 25 percent, which means that all Chinese goods exported to the United States will be subject to a higher tariff rate, the yuan may fall even further - to 7.5 against the US dollar.
The question now is how much Chinese investors are inclined to predict a further weakening of the yuan in order to transfer some of their assets to Hong Kong, which will certainly be very positive for the local financial market.
However, it is worth considering also the question to what extent China will allow the outflow of its capital to Hong Kong, given its massive character that occurred after the devaluation of the national currency in 2015. Also, it is worthwhile to monitor the further development of the trade war between the USA and China, the further escalation of which can lead to economic upheaval both in mainland China itself and in Hong Kong.
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