Hong Kong has shown its resilience as a global financial center, retaining investment flows even as six months of protests dragged its economy into a technical recession.

The protests, which have often caused disruptions in the city’s business activity and affected transport links, are yet to dent investor sentiment or trigger a major flight of capital.

“The Hong Kong dollar (HKD) has generally been stronger since the start of the social events, and recent strength should suggest short-covering of HKD currency or assets, and limited capital outflows from the city,” said Becky Liu, a strategist with Standard Chartered.

The Hong Kong balance of payments data showed no alarming trend, though it includes just one month of the protests. And if indeed the protests led to further outflows, there would be larger, negative errors and omissions in the third quarter when the data is released this Friday.

Still, one has to be mindful there were more dominant factors that influence movements in the Hong Kong dollar, which is pegged to the US dollar and allowed to move in a narrow 7.75-7.85/dollar range.

“China is the 800-pound gorilla in the room and it is the main driver of flows to and from Hong Kong,” said Cliff Tan, East Asian head of Global Markets Research at MUFG Bank.

“There is a lot of interest on the equity side of Chinese fund-raising and the massive amount of debt that has to be refinanced in H1 next year – flows will be driven more by that than anything else.

“The capital needs of China will be key, although there is no denying some outflows will take place on account of protests and the recession. The question is about the scale and this won’t threaten the HKD peg.”

Hong Kong’s peg-linked exchange system was set up in 1983 by the Hong Kong Monetary Authority, the de facto central bank. It does not have a policy interest rate – but rates are determined by inflows and outflows from the territory.

Therefore, when demand for HK dollar assets falls and the HKD weakens to 7.85, the HKMA should purchase HKD, leading to a fall of HKD liquidity in the system. Interest rates then rise versus the US dollar, which should attract capital inflows and keep the exchange rate between 7.75 and 7.85.

“There’s no obvious quantifiable indicator suggesting capital outflows from Hong Kong, to Singapore or elsewhere, despite ongoing market chatter,” said Liu of Standard Chartered.

The most appropriate measure of liquidity would be the spread of the Hong Kong Interbank Offered Rate (HIBOR) over dollar LIBOR, analysts say.

The HIBOR-LIBOR spread was about 0 percentage points to -1 percentage point for most of the time since 2016. But this has moved from negative to positive since mid-June, when the protests began, ie, Hong Kong dollar interest rates have gone up, ING analysts said in a note.

Still, this spike is not alarming and certainly benign in comparison with the spike to 10 percentage points during the 1997 Asian financial crisis.

“Against this history, the swing to the current spread of around 0.6 percentage points, even though starting from a negative base, does not look particularly alarming. Though the rapidity with which previous spikes have taken hold cautions against complacency,” ING analysts said.

There were other factors such as the Alibaba IPO which were also driving these rates higher, therefore it did not appear money was leaving Hong Kong in any significant way. Other market indicators, such as HKD 6-month implied volatility and 12-month interest rate swaps, have picked up. But this too remains low relative to historical levels.

And Beijing would certainly not sit by idly, were there to be any panic-driven flows.

“Hong Kong may also serve as a conduit for technology flows as the incipient US-China Tech Cold War gets underway. So it would probably not be in the mainland’s own interests to allow Hong Kong to atrophy and lose its international financial center status. Hence, Chinese capital might reasonably be expected to act as a countervailing flow in the event of fright capital leaving Hong Kong. We think this could be a general rule of thumb,” said MUFG’s Tan.

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