Hong Kong’s Northern Metropolis: War Chest or Waste?

Landmark HK$150 Billion Transfer from Exchange Fund Ignites Fierce Debate

A significant withdrawal of HK$150 billion from Hong Kong’s Exchange Fund, earmarked for crucial infrastructure projects, has ignited a fervent debate among financial experts and the public. This unprecedented move, the first of its kind in 42 years, has stirred memories of past financial crises and prompted discussions about the city’s fiscal health, future discipline, and the very nature of its financial bedrock.

The Exchange Fund, often referred to as Hong Kong’s de facto sovereign wealth fund and its “war chest” for defending the Hong Kong dollar’s peg to the US dollar, has long been the cornerstone of the city’s open and internationalized economy. Therefore, any substantial action involving this fund naturally draws intense scrutiny.

The Specter of 1998: A Ghost of Financial Battles Past

The current debate is inextricably linked to the dramatic events of the summer of 1998. During the Asian Financial Crisis, Hong Kong faced a formidable challenge from international hedge funds that launched a “double play” – simultaneously shorting the Hang Seng Index and dumping the Hong Kong dollar. Their strategy gambled on the Hong Kong Monetary Authority (HKMA) being forced to maintain prohibitively high interest rates to defend the currency, thereby collapsing the stock market and delivering them a massive profit.

In response, Hong Kong’s financial leadership, after intense deliberation, made the controversial decision to intervene directly in the stock market. Utilizing the substantial “firepower” of the Exchange Fund, they orchestrated a covert defensive maneuver. Over ten days, HK$118 billion was spent in a fierce battle against speculators, culminating in a single Friday where HK$79 billion was deployed in just five hours to absorb sell orders and break the speculators’ resolve. This “August war” secured not only the Hong Kong dollar but also cemented the Exchange Fund’s reputation as an ultimate, untouchable “war chest.”

A New Era: Funding the Future

Today, the Exchange Fund’s “war chest” is being opened again, but this time, the objective is not defense against external attack but rather the ambitious project of nation-building – specifically, funding critical infrastructure and the development of the Northern Metropolis. Financial Secretary Paul Chan Mo-po announced the HK$150 billion transfer, to be drawn down over two years, in his budget speech, marking a historic departure from decades of conservative practice.

The Core of the Controversy: Fiscal Health and Discipline

At the heart of the current controversy lie two interconnected issues: the state of Hong Kong’s fiscal health and the imperative of future fiscal discipline. While the government reported a modest surplus for the past financial year, this figure was significantly bolstered by bond proceeds and new debt instruments. Without these, the underlying deficit would have been a substantial HK$100.4 billion. Critics argue that tapping the Exchange Fund now appears less like a strategic investment and more like a tactical maneuver to mask a fiscal shortfall.

This withdrawal has also amplified calls for stricter spending controls and greater oversight of the Exchange Fund. Some warn that in the current climate of geopolitical uncertainty and the potential risk of exclusion from financial messaging networks like SWIFT, the fund’s protective role is more critical than ever.

A Different Perspective: The Architect’s View

However, John Greenwood, the economist credited with designing Hong Kong’s Linked Exchange Rate System (LERS), dismisses the public outcry as an overreaction. He argues that hoarding a large sum of money is not inherently virtuous if it does not benefit Hong Kong citizens. Greenwood contends that the existing framework remains robust and that rigid caps could compromise the simplicity and global convertibility of the US dollar peg.

A History of Prudence: Past Transfers from the Exchange Fund

Transfers from the Exchange Fund have historically been rare and considerably smaller in scale.

• 1964: HK$150 million was transferred to the Development Loan Fund, following an audit that revealed the fund’s assets significantly exceeded its liabilities.
• 1984: HK$250 million was moved to general revenue to offset the abolition of interest tax on Hong Kong dollar deposits. At this time, the fund’s assets stood at HK$55.5 billion.

The current HK$150 billion transfer, however, is seen by analysts as a departure from previous “reactive” accounting adjustments. It signals a new perspective, viewing the Exchange Fund not just as a shield but as a strategic instrument for underwriting Hong Kong’s long-term economic development.

Safeguarding the Peg: The Fund’s Dual Role

Established in 1935, the Exchange Fund’s primary mandate has always been to safeguard the Hong Kong dollar’s peg to the US dollar. Its assets have grown exponentially, reaching over HK$4.2 trillion as of January 2026. The stability of this peg has been hard-won, surviving periods of currency volatility and crises.

• 1970s: A shift from a sterling peg to a US dollar peg, followed by a period of free-floating.
• 1983: A currency crash spurred by political uncertainty led to the introduction of the Linked Exchange Rate System, pegging the Hong Kong dollar to the US dollar at 7.80.
• 1998: The infamous stand-off where the fund’s intervention prevented a currency collapse.
• Asian Financial Crisis: A HK$28 billion bank guarantee was provided to stabilize the local lending market.
• 2008 Global Meltdown: The fund served as the backbone for full deposit guarantees.
• 2001: HK$3.7 billion was diverted to secure the HKMA’s permanent headquarters.

Addressing Public Anxiety: The Fund’s Structure

Economist Professor Lawrence Lau Juen-yee suggests that public unease stems from the trauma of past crises. He argues, however, that fears of the fund being inadequate are misplaced, especially given the substantial reserves of mainland China which can be deployed if necessary. Lau also distinguishes Hong Kong’s Exchange Fund from typical sovereign wealth funds, emphasizing its critical need for immediate US dollar liquidity.

Greenwood echoes this sentiment, attributing public anxiety to a misunderstanding of the fund’s dual structure. He clarifies that of the HK$4.2 trillion portfolio, approximately half serves as monetary backing for the peg, while the other half acts as fiscal backing.

“Hong Kong’s structure is unique, with the monetary and fiscal sides under one roof,” Greenwood explained. “The idea that all money is to support the peg is an overstatement. In practice, only half of the assets are needed to cover full convertibility.”

The backing portfolio maintains a ratio of 105% to 112.5% in liquid US dollar assets to defend the peg, allowing for higher returns on excess assets. Greenwood adds, “The fiscal backing is so great, it is as a result of the government’s conservatism and the HKMA’s investment track record.”

The Debate Over Caps and Optimal Reserves

Despite assurances, some experts advocate for a fundamental shift in managing the fund’s surplus. Professor Terence Chong Tai-leung proposes “capping” the fund’s size and diverting excess interest income to the treasury, arguing that beyond an optimal reserve level for defending the peg, the money could be better utilized for infrastructure investment.

Lau supports the idea of defining an “optimal” size and suggests Hong Kong could separate its liquid reserves from a dedicated wealth fund, similar to models in Singapore and China. He sees the recently established Hong Kong Investment Corporation (HKIC) as a nascent local analogy, though still in its early stages.

Greenwood, however, cautions against rigid caps, warning they could hinder responses to future crises. He highlights the existing “dividend” mechanism, established in 2007, which provides the government with a steady payout based on a six-year average investment return, allowing for stable fiscal planning. This system proved resilient even in 2022, when the fund recorded a significant investment loss but still distributed over HK$50 billion to the government.

Fortified Defenses: Reforms Since 1998

Greenwood also points to technical reforms that have significantly bolstered the fund’s resilience since 1998. The introduction of the Real-Time Gross Settlement (RTGS) system and the use of Exchange Fund Bills and Notes (EFBNs) provide a critical liquidity buffer. Banks can now use EFBNs to top up settlement balances, ensuring that shorting the Hong Kong dollar is immediately reflected in HKMA balances, thus preventing the drastic interest rate spikes that fueled past volatility.

Contingency Planning: A “Plan B” for a Shifting World?

Concerns about shifting global geopolitics have also prompted discussions about a potential “decoupling” from the US dollar. Lau warns that deteriorating US-China relations could lead to Hong Kong being barred from SWIFT, potentially forcing it off the peg. He proposes a strategic shift towards the yuan, suggesting parallel usage within the Greater Bay Area and mechanisms for exchanging yuan for Hong Kong dollars if SWIFT access is compromised.

Businessman Allan Zeman also calls for a review, noting the global trend of diversification away from the US dollar. He suggests a gradual shift towards a currency basket, emphasizing the need for delicate handling to avoid triggering speculative attacks.

Conversely, Greenwood dismisses the need for a “Plan B,” asserting that the US dollar remains the most practical anchor due to its simplicity and convertibility. He argues that introducing another currency like the yuan would introduce complexities and that the yuan’s convertibility and trading volume are not comparable. He remains confident in the US dollar’s resilience.

The debate surrounding the HK$150 billion transfer underscores a fundamental tension between traditional “vault of cash” defense strategies and a more proactive approach to utilizing reserves for long-term development. While fears of a repeat of 1998 may be diminished by Hong Kong’s fortified defenses and the backing of mainland China’s vast reserves, the discussion about the Exchange Fund’s role and management is far from over. The sheer scale of the withdrawal and its unprecedented nature ensure that this conversation will continue to shape Hong Kong’s financial future.