64 Finance & economics The EconomistFebruary 8th 2020
21ment or home purchases). And many of the
deposits on the other side of its balance-
sheet are held by non-residents, who might
prove flighty in a crisis.
According to its defenders, Hong Kong’s
currency peg is “virtually impregnable”.
The hkma’s foreign-exchange reserves
amount to $440bn, twice as much as the
money supply, narrowly defined to include
banknotes and the banks’ claims on the
monetary authority. The banks would run
out of Hong Kong dollars before it ran out
of American ones.
Why then is it only “virtually” impreg-
nable? For one thing, there are broader de-
finitions of money supply. A war chest of
$440bn may be large compared with
banks’ deposits at the hkma. But it is small
compared with customers’ deposits with
banks (hk$6.9trn, equivalent to $880bn). If
every depositor wanted to convert their
holdings into American dollars, there
would not be enough to go around.
Such conversions would also have
broader economic implications. Every
Hong Kong dollar sold to the monetary au-
thority disappears. All else equal, it then
becomes dearer for the banks to borrow the
diminishing number of Hong Kong dollars
that remain. These high interest rates
make holding the currency more lucrative
and short-selling it more costly. But insofar
as households and firms still need to bor-
row in Hong Kong dollars, these high inter-
est rates also hurt the economy. How much
pain would Hong Kong be willing to take?
The peg’s downfall may be imaginable.
But is it probable? One place to look is the
options market, where investors can hedge
against the risk of the currency moving
outside the band. For about 40% of the per-
iod from June 2005 to July 2018, option
prices implied that the odds of the peg
breaking were above 10%, suggests a recent
study by Samuel Drapeau, Tan Wang and
Tao Wang of Shanghai Jiao Tong University.
But for most of that time markets were bet-
ting on the currency strengthening past
hk$7.75 to the dollar, not weakening past
hk$7.85.
Bearish bets became more popular last
year during the worst of the protests. But
the speculation was not as fierce as it had
been in 2016, after China clumsily devalued
the yuan. Capital outflows picked up in the
third quarter of last year, diminishing
Hong Kong’s foreign-exchange reserves.
But reserves have stabilised since, helped
by a truce in the trade war between America
and China. Hong-Kong dollar deposits are
lower than they were six months ago, but
still higher than they were a year ago.
Any signs of sustained capital outflows
are, then, “embryonic”, says Alicia Garcia
Herrero of Natixis, a bank. If capital is leav-
ing, its speed of departure is reminiscent of
one of Hong Kong’s quaint trams, not one
of its bullet trains. 7R
arely haveplans in China fallen apart
so swiftly and so publicly. On January
12th the leaders of Hubei declared that the
province’s gdpwould grow by 7.5% this
year. They made no mention of a new virus
fast spreading through its towns and cities.
But less than two weeks later it could not be
ignored. They placed the province under
quarantine, hemming in over 50m people
and rendering this year’s flashy growth tar-
get almost certainly unreachable.
The lurch from confidence to anxiety
has echoed throughout China. In the
months before the coronavirus outbreak,
the stockmarket had rallied and businesses
had been upbeat, not least because China
and America had struck a trade deal. But
optimism has crumbled as officials have
begun to fight the epidemic.
The Chinese stockmarket has fallen by
10% since January 20th. Factories and of-
fices were supposed to reopen in recent
days after the new-year holiday. Most prov-
inces have ordered them to stay shut until
at least February 10th. Farmers have
warned that their chickens might starve
because roadblocks have snarled their feed
supplies. Few people dare venture out, hit-
ting restaurants and hotels especially hard.
In an interview that attracted much atten-
tion before being censored, the founder of
Xibei, a restaurant chain, said that if the
lockdown persisted for a few months, vast
numbers could lose their jobs. “Wouldn’tthat be an economic crisis?” he asked.
Analysts have rushed to lower their eco-
nomic forecasts. The consensus had been
thatgdpwould expand about by 6% year-
on-year in the first quarter. Now several ex-
pect a 4% pace, the slowest since China be-
gan publishing quarterly figures in 1992.
Usually, the further into the future you
peer, the greater the uncertainty. But as
past epidemics have shown, China’s offi-
cials can be fairly confident that growth
will rebound to its pre-virus trajectory next
year. It is the next couple of months that are
the black hole. Three unknowns cloud the
outlook: how long it takes to contain the vi-
rus; when the government relaxes its
heavy-handed restrictions on daily life;
and how long after that people resume the
whirl of activity that normally makes the
Chinese economy so vibrant.
This near-term uncertainty presents a
challenge for economic policy. Even if
growth plummets, a big stimulus package
might be dangerous medicine. Given the
lag in spending, the boost from projects an-
nounced today could kick in just as the
economy gathers steam of its own, leading
to overheating. Instead, measures to help
people and firms through the rough patch
are more sensible. These can be pared back
when the recovery eventually arrives. Get-
ting them right, though, is not easy.
Officials are combining temporary cash
support with market interventions and
forbearance. On February 3rd the central
bank injected 1.2trn yuan ($172bn) into the
financial system by purchasing treasury
bonds from banks that promise to buy
them back within 14 days. Banks will prob-
ably suffer from rising loan defaults in the
coming weeks; this gives them more cash
to work with in the near term. The central
bank can extend the support if needed.
Officials are also meddling in the stock-
market (or, as they would say, managing it).
Regulators have told brokers to bar clients
from short selling, so as to limit downward
pressure, according to Reuters. State media
have also played cheerleader, saying that
big state-owned insurance companies
were primed to scoop up undervalued
stocks. Share prices still dropped by 8% on
February 3rd. But that was largely a
catch-up with the Hong Kong market,
which had been open the previous week.
Trading has since stabilised, suggesting
that the tactics are working.
Finally, officials have been orchestrat-SHANGHAI
Companies warn of an economic crisis as China battles an epidemicChina’s economyViral injections
Awaiting a cure