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Kevin Li

In the summer of 1998, the usually placid air at the Hong Kong Monetary Authority’s headquarters in Citibank Tower suddenly evaporated as regional currencies collapsed like dominoes.
Rapacious speculators had shorted currencies such as the Thai baht, the Indonesian rupiah and the Korean won and had profited handsomely. The contagion looked like it would also bring the Hong Kong dollar to its knees. As storytellers from the era have recalled, that sweltering month of August, the wolves were at the gates.
International hedge funds had launched a lethal double play – simultaneously shorting the Hang Seng Index and dumping the Hong Kong dollar. They were betting that the de facto central bank’s rigid rules would force interest rates to stay so high that the stock market would collapse, handing them a billion-dollar payday.
For two weeks, the city’s financial leadership sat cloistered in a high-stakes war room. The decision they faced was an ideological heresy: should a laissez-faire government intervene directly in the stock market?
With absolute secrecy and the firepower of the Exchange Fund, they orchestrated a defensive manoeuvre. Three of the largest stockbrokers were invited to breakfast at the China Club in Central and sworn to secrecy as they were tasked to buy on the authority’s behalf.
The HKMA unleashed its spending power over 10 days. Finally, on a single Friday, it absorbed an avalanche of sell orders, spending HK$79 billion (US$10.1 billion) in five hours to break the speculators’ backs.
That “August war” cost HK$118 billion in total, but it bought something more valuable – a reputation for the Exchange Fund as the city’s ultimate, untouchable “war chest”.
Today, that chest is being opened again. This time, it is not to beat off a raid but to build a city – at least according to the financial secretary.
Landmark transfer
It was inevitable that the spectre of 1998 was raised last month when finance chief Paul Chan Mo-po announced a landmark HK$150 billion transfer from the Exchange Fund to the Capital Works Reserve Fund in his budget speech. The sum – to be withdrawn over two years – is to bankroll the Northern Metropolis and other critical infrastructure projects.
This will be the first such transfer in 42 years. The rarity of a move involving the Exchange Fund and the scale of the withdrawal sparked a fierce debate, with reminders of the ghosts of 1998 thrown in, never mind that the motivations are vastly different.
The Exchange Fund – the city’s de facto sovereign wealth fund and war chest to defend the Hong Kong dollar’s peg to the US dollar – has been the bedrock of the city’s open and internationalised economy. Hence, the fevered discussions of the past month.

At the heart of the debate lay two intertwined issues: the state of the city’s fiscal health and future fiscal discipline.
While the government officially reported a modest HK$2.9 billion surplus for the past financial year, that figure was boosted by bond proceeds, debt positions that are new to the administration.
Without them, Hong Kong would be staring at a HK$100.4 billion underlying deficit. To the city’s critics, tapping the “war chest” now looked less like a strategic investment and more like a tactical move to plug a hole.


The withdrawal from the Exchange Fund also elicited calls for a spending cap to ensure discipline and greater oversight, even as others warned that any dipping into it had to be done with extreme caution.
They argued that the current geopolitical uncertainties and the risk of being excluded from Swift – a secure financial messaging network that facilitates cross-border payments – made the protection of the “war chest” more vital than ever.
The system’s architect, however, has a different view.
Speaking to the South China Morning Post, John Greenwood, the economist who helped to design the dollar peg, known officially as the Linked Exchange Rate System, dismissed the current public outcry as a gross overreaction.
“I think it’s wrong to use the kind of language of [opening] a Pandora’s box,” he said. “There’s no great virtue in just having a pot of money sitting there if it isn’t going to be used for the benefit of Hong Kong citizens.”
He maintained that the current framework remained robust, cautioning that rigid caps could undermine the unmatched simplicity and global convertibility of the US dollar link.
The fund and the dollar peg
Historically, transfers out of the Exchange Fund are rare and significantly smaller in scope.
The first, in 1964, moved HK$150 million to the Development Loan Fund. This followed a 1963 audit showing the fund’s assets exceeded liabilities by 142 per cent, prompting an amendment to the Exchange Fund Ordinance to allow for the transfer of surplus capital.
The second and most recent transfer was in 1984, when HK$250 million was moved into general revenue to offset the abolition of interest tax on Hong Kong dollar deposits. At that time, the fund’s assets stood at HK$55.5 billion.
The latest transfer, however, was motivated by different impulses, analysts said. For a start, it departs from the previous “reactive” mode of accounting adjustments.
More significantly, the HK$150 billion proposal casts the city’s monetary bedrock in a new light – as a strategic instrument for underwriting Hong Kong’s long-term economic development, they said.

Greenwood said diversifying revenue was prudent given the volatility of traditional income streams.
“If land sales do not improve … then maybe the government has to rely on this kind of drawdown,” he said.
“My guess is they do not want the debt to continue to grow at the rate it’s grown in the last two or three years.”
Even as Greenwood and other business leaders have signalled support for the drawdown, public sensitivity regarding the Exchange Fund remains high, given its primary mandate to safeguard the Hong Kong dollar.
Established in 1935 to shift the city from a silver standard to a sterling peg, the fund’s assets have since grown to more than HK$4.2 trillion as of January 2026.
Stability was hard-won. In the 1970s, the currency briefly pivoted from sterling to a US dollar peg before a period of free-floating following the collapse of the gold-backed Bretton Woods system.
However, the lack of a clear monetary anchor, coupled with 1980s political uncertainty, triggered a 1983 currency crash that saw the exchange rate plummet to 9.60 against the US dollar.
To restore confidence, the government introduced the Linked Exchange Rate System in October that year, pegging the local dollar to the US dollar at 7.80. Since 1993, the authority has defended the link, refining it in 2005, into the current 7.75 to 7.85 trading band.
Beyond that infamous 1998 stand-off, the fund has repeatedly acted as the city’s ultimate financial backstop. During the height of the Asian financial crisis, it provided a HK$28 billion bank guarantee to stabilise the local lending market, and it later served as the backbone for full deposit guarantees during the 2008 global meltdown.
More unconventionally, HK$3.7 billion was diverted in 2001 to secure the HKMA’s permanent headquarters at Two IFC, anchoring the city’s financial authority in the heart of Central.

Professor Lawrence Lau Juen-yee, a noted economist and a former vice-chancellor of the Chinese University of Hong Kong (CUHK), suggested that public unease over tapping the fund stemmed from the trauma of the Asian financial crisis.
“There is always the worry that if the fund were ever perceived as inadequate for potential outflows, speculative attacks would come,” Lau said.
However, he dismissed these fears as misplaced, noting that in a true crisis, the sovereign reserves of mainland China “can and will be used”.
Lau also distinguished the Exchange Fund from sovereign wealth funds such as Singapore’s Temasek Holdings or Norway’s Norges Bank Investment Management, noting that Hong Kong’s reserves had to prioritise immediate US dollar liquidity.
Echoing the sentiment, Greenwood attributed public anxiety to a misunderstanding of the fund’s dual structure. He emphasised that of the HK$4.2 trillion portfolio, roughly half serves as monetary backing while the other half constitutes fiscal backing.
“Hong Kong’s structure is unique, with the monetary and fiscal sides under one roof,” Greenwood said.
“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.”
He pointed to the backing portfolio, which maintains a ratio of 105 to 112.5 per cent in liquid US dollar assets to defend the peg. This mechanism allows the authority to seek higher returns on excess assets while ensuring the currency remains secure.
“The fiscal backing is so great, it is as a result of the government’s conservatism and the HKMA’s investment track record,” Greenwood added. “You have an institution with substantial monetary reserves that will always exceed 105 per cent of the monetary base, but it also possesses this very strong fiscal component.”
Cap the reserves?
Still, some experts are calling for a fundamental shift in how the fund’s surplus is managed.
Terence Chong Tai-leung, an economics professor at CUHK, called for “capping” the fund’s size and diverting excess interest income to the treasury.
“There is an optimal reserve to defend the peg. Beyond that, it creates a social cost as the money could be better used for investing in infrastructure,” Chong said.
“It is certainly not ‘the more the better’. If all the money made is just put there to defend the peg, it is a waste. We do not need that much. Otherwise, there is no end.”
Lau echoed the need to define an “optimal” size, suggesting Hong Kong could separate its liquid reserves from a dedicated wealth fund.
“Hong Kong could simultaneously maintain a high-liquidity Exchange Fund dedicated to defending the peg, alongside a separate wealth fund tasked with maximising returns for the treasury,” Lau said.
Such a model would mirror the approach of the China Investment Corporation and Singapore’s Temasek and GIC, he said, noting they operated independently of their respective central banks to serve as substantial revenue contributors.
Lau cited the Hong Kong Investment Corporation (HKIC), established in 2022, as a local analogy, although he noted it was still a new experiment.
“HKIC is actually the closest to that kind of fund, but it’s very small and just getting started. It will be years before it can be a significant revenue source.”
Greenwood, however, cautioned that imposing a rigid “cap” on the fund could prove to be a mistake.
“Introducing that kind of rigidity might make things more awkward in a future crisis,” he warned, stressing that the system already provided a balanced “dividend” mechanism.
Since 2007, the government has received a steady payout from the fund based on a six-year average investment return, allowing for precise fiscal planning despite market volatility.
This resilience was famously tested in 2022, when the fund recorded a record HK$202.4 billion investment loss. Despite a negative 8.6 per cent return in the investment portfolio that year, the fund’s payout mechanism remained resilient, distributing more than HK$50 billion to the government at a fixed rate of 5.6 per cent.

Greenwood also highlighted that technical reforms since 1998 have significantly bolstered the fund’s resilience.
He noted that during the 1997-98 crisis, banks often faced uncertainty regarding their end-of-day Hong Kong dollar balances. Today, the Real-Time Gross Settlement (RTGS) system and the use of Exchange Fund Bills and Notes (EFBNs) provide a critical liquidity buffer.
“Banks now can use their portfolios of EFBNs issued by the HKMA to top up their settlement balances,” Greenwood said. “Transactions have moved to a real-time basis, so shorting of the Hong Kong dollar will immediately show up in the balances at the HKMA.”
He said the framework prevented “settlement surprises” that previously fuelled volatility. By discounting EFBN holdings, banks maintain positive balances throughout the day, ensuring that if the currency were attacked, “it is very unlikely that interest rates would spike so drastically”.
‘Plan B’ needed?
Lau warned not to rule out the risk that shifting global geopolitics could eventually force a “decoupling” from the US dollar.
He cautioned that if US-China relations deteriorated to the point where Washington weaponised the financial system, Hong Kong could be barred from the Swift network.
“The US may do anything to preserve its hegemony. That is one scenario where Hong Kong would be forced off the peg,” Lau said, noting that the city remained largely “passive” in the face of such external shocks.
Rather than a new single-currency link, he proposed a strategic shift towards the yuan.
“Hong Kong should try to use the yuan in parallel with Hong Kong dollars within the Greater Bay Area,” Lau said. “If mainland China and Hong Kong cannot use Swift any more, the People’s Bank of China can offer to exchange yuan for Hong Kong dollars at the average exchange rate during the previous, say, 10 business days.”
Businessman Allan Zeman also called for a similar review, noting the global trend of diversification away from the US dollar.
“Many countries are now getting rid of the US dollar in treasury holdings. That is why gold has gone through the roof,” said Zeman, chairman of the Lan Kwai Fong Group.

He suggested a shift towards a currency basket if the dollar’s value continued to erode, though he warned any transition had to be handled delicately.
“The HKMA needs to be careful. If people think we are making the peg less important, you’ll have attackers from all over the world.”
Others, such as Greenwood, dismissed the need to have a “Plan B”, arguing that the US dollar remained the most practical anchor due to its simplicity and full convertibility throughout Asia.
“If another currency like the yuan was introduced … the interest rate would not be that simple,” Greenwood said. “Also, the yuan is not convertible and it’s not so widely traded.”
Despite ongoing doubts about the greenback’s role, he expressed confidence in its resilience.
“I don’t see that its position will be drastically changed going forward. That may change – and you can never say never – but for the moment, the US dollar is the most appropriate currency to which [to peg] Hong Kong’s currency.”
The Exchange Fund debate would continue when the actual drawdown occurred, analysts noted. The debate over the HK$150 billion transfer is ultimately a contest between two visions of security – traditional “vault of cash” defences versus a more proactive approach of maximising the use of the reserves.
As to the fears that the fund might be weaker over time and might face tough challenges akin to 1998, Lau said that a private hedge fund attack was now highly improbable, given that Hong Kong’s defences were bolstered by the mainland’s reserves.
He noted that the mainland’s reserves had reached US$3.816 trillion, including gold, as of last month – the world’s largest stockpile. This includes around US$700 billion in US Treasury securities, creating a liquidity buffer that he believed dwarfed any potential speculative threat to the Hong Kong dollar.
“I think it’s hopeless for a private hedge fund to attack the combined foreign exchange reserves of China and Hong Kong,” Lau said.


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Rare HK$150 billion transfer from the Exchange Fund has sparked fierce debate


Rare HK$150 billion transfer from the Exchange Fund has sparked fierce debate.


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Should Hong Kong be using ‘war chest’ firepower for Northern Metropolis?

.css-1c6uqr6{color:inherit;font-weight:inherit;font-size:inherit;font-family:inherit;line-height:inherit;overflow-wrap:break-word;}Rare HK$150 billion transfer from the Exchange Fund has sparked fierce debate

Rare HK$150 billion transfer from the Exchange Fund has sparked fierce debate