In Hong Kong, zero interest rate lives on Savers in Hong Kong will continue to receive zero or near-zero interest rates on their deposits as banks in the city have chosen to leave both lending and deposit rates unchanged even as the citys de facto central bank increased its base rate offered to banks by 25 basis points on Thursday (17 December 2015).

HSBC, Bank of China (Hong Kong) and Hang Seng Bank confirmed they will continue to maintain their interest rates on Hong Kong dollar deposits at zero. Standard Chartered and Citi will continue to offer just 0.01 per cent. Among the smaller players, Chong Hing Bank and Dah Sing Bank will continue to pay 0.025 per cent and 0.03 per cent.

For homebuyers and businesses looking to borrow in the city, the prime rate that banks offer as their best deal to customer will also stay flat for now. It will be kept at 5 per cent by HSBC, BOCHK and Hang Seng. Citi, Standard Chartered and Chong Hing are offering 5.25 per cent.

Lending rates in Hong Kong have stayed unchanged since November 2008, when they were slashed to 5 per cent after the US Federal Reserve trimmed rates to near zero in the wake of the global financial crisis. Before the crisis, the prime rate offered by HSBC, in November 2007, was at 6.75 per cent.

Banks in Hong Kong have the leverage not to follow the US Federal Reserve on its interest rate policy. Of course, there is still the chance that liquidity may leave the banking system. But banks have the flexibility to hike rates in their own pace when that happens. The rate hike cycle will be slow and limited in scale this time, said Tristan Zhuo, senior economist at BOCHK.

There was no sign on Thursday that there is any major liquidity outflow from the local banking system after the Federal Reserve decision to lift its rate by 0.25 basis points. On the contrary, banks are awash with liquidity. The capital flow this year from mainland China has been strong and consistent this year as low economic growth and expectations of yuan depreciation across the border led more people to switch yuan savings into Hong Kong and US dollar-denominated assets.

Banks access to wholesale funding from industry peers has also been robust. The Hong Kong Monetary Authority reported the aggregate balance of interbank liquidity is at HK$391.3 billion. The overnight Hong Kong Interbank Offered Rate, compiled from nine banks best offer daily at 11am, was at 0.43 per cent on Thursday.

Diana Cesar, Hong Kong chief executive at HSBC, said: The market widely anticipated the decision of the Federal Open Market Committee to raise the Federal fund rate by 0.25 per cent. As there is ample liquidity in the Hong Kong financial system, [HSBC] has decided to keep its best lending rate and Hong Kong dollar savings deposit rate unchanged. We will continue to monitor the condition of financial markets and review the deposit and lending rates when necessary.

(Source: South China Morning Post, 17 December 2015)

Answer the following questions.

(a) The Hong Kong dollar is said to be pegged to the US dollar. Critically discuss three prominent features of the currency peg in Hong Kong.

(b) As mentioned in the article, Hong Kong dollar interest rates normally follow that of the US. Describe the mechanism by which the currency peg will keep Hong Kong dollar interest rates in line with US rates.

(c) Banks in Hong Kong have the leverage not to follow the US Federal Reserve on its interest rate policy. Of course, there is still the chance that liquidity may leave the banking system. But banks have the flexibility to hike rates in their own pace when that happens. The rate hike cycle will be slow and limited in scale this time, said Tristan Zhuo, senior economist at Bank of China (Hong Kong). Please evaluate his statement.