Question

1. Hong Kong is has a “currency board” system. This means they have a fixed exchange rate regime with free flows of capital. In fact, the Hong Kong dollar has been pegged to the U.S. dollar at an exchange rate of HK$7.80 = US$1 (unlike mainland China, which has a different currency).   In 2017, Hong Kong had a more than US$32 billion trade deficit with the United States. Thinking about the balance of payments structure, discuss three different ways that this exchange rate could remain stable in spite of this deficit.

Answer 1

Following are three ways that shows that exchange rate could remain stable:

• Trade deficit causes fall in value of currency and it induces export and reduces import. Such outcomes help to tame over the trade deficit and help further to stabilize the exchange rate.
• When currency depreciates marginally, inflow of more capital from foreign market is witnessed. It also helps to stabilize the currency depreciation.
• Government keeps certain reserve currency and such reserve are released when trade deficit is predominant. Release of foreign exchange keeps the exchange rate stable.