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08/07/1998 15:59:46 EMERGING MARKETS-Hong Kong peg raises concerns

By Diane Craft

LONDON, Aug 7 (Reuters) - The latest attack on the Hong Kong dollar has

raised concerns about emerging markets with currency board systems and analysts

said on Friday a number of countries would be in the firing line if authorities

abandoned the peg.

Obvious candidates that would come under attack in a worst case scenario --

a Chinese devaluation and removal or shifting of the Hong Kong dollar peg --

include Argentina, Bulgaria and the Baltics.

But analysts said other countries such as Russia and Brazil also would

surely suffer.

"Any time there is a new crisis or a deepening of a crisis, the market looks

around and says what other countries will be influenced by the same factors,"

said David Boren, emerging market strategist at Daiwa Securities in London.

"They did it after the peso crisis and one of the vulnerable countries was

Hungary on account of its current account deficit so they would do the same

thing with all the currency board countries," he said.

"The vulnerability to Argentina under a Hong Kong peg devaluation scenario

is the fact it is also a currency board and on that basis you would also have

pressure on Bulgaria and the Baltics."

Although Hong Kong's Financial Secretary Donald Tsang said the country's

dollar peg to the U.S. dollar would be maintained, analysts said the risk is

such that investors have fled emerging equity and bond markets en masse in

recent months.

Indeed, constant fears about a devaluation of the Chinese yuan and the Hong

Hong dollar has been an underlying theme in emerging markets, sparking capital

flight in emerging financial markets.

"There is a significant enough risk that it is a deterrent to investment in

the market at the current time and we are seeing that," said Boren.

Those concerns, along with domestic factors, have triggered fears of a

rouble devaluation and sharp drops in Russia's dollar-denominated debt

instruments.

"If you have a Hong Kong peg devaluation, which will trigger concerns over

renminbi devaluation, then I think the probability of Russian devaluation

increases significantly," said Boren.

Currency concerns among Hong Kong's neighbours this week suggest that

investors are growing ever more wary about the possibility of devaluations.

Standard Chartered said in a research note that the uncertain fate of the

Chinese renminbi remains a constant theme, with the Hong Kong dollar forward

contracts seen as a barometer of the pressure to devalue.

The Hong Kong dollar's six-month foward rate bid was at 2,650 against 2,300

on Thursday.

China's yuan closed at 8.2799 to the U.S. dollar after falling as low as

8.2850 and the Singapore dollar slipped to its lowest level since June to 1.75

to the dollar.

Neil Dougall, Latin American economist at Dresdner Kleinwort Benson, said

there would be a strong backlash in Latin America if the Hong Kong dollar peg

goes.

"The effect would be in terms of looking at particular currencies that have

come under very close scrutiny, and clearly the Argentine peso would be very

much in the firing line given the similarity with the currency board

arrangement."

But he added: "It's only in a worse case situation where we are talking

about currency contagion ripping right through Latin America and things going

badly wrong in terms of how the second or third stage of the Asian crisis was

handled that would bring the whole house of cards tumbling down," he added.

Under a currency board system, the fundamental requirement is that

international reserves held by the country have to be at least equal to or

higher than the monetary base.

Analysts said a key test in the worst case scenario would be whether

emerging market countries had the political will and resolve to take defensive

measures to ensure currency stability.

Two key defence mechanisms would be that central banks had enough reserves

to meet dollar demand and the ability to keep interest rates high at the expense

of the domestic economy.

Indeed, some said Brazil has already demonstrated it would defend its

currency at all costs rather than risk a maxi-devaluation and a return of

hyperinlation.

At the height of the Asian crisis last October, Brazil jacked up interest

rates and also tightened fiscally to stave off speculative attacks on the real.

They said Argentina would probably also pull out all stops to ensure

stability.

But even still, those currencies would come under speculative attack and

their financial markets would surely suffer further drops if the Hong Kong

dollar peg were abandoned.

"If it goes, that's it for emerging markets for the rest of the year at

least," said Boren.

((London Newsroom, 44 171 542 5110, fax 542 8688, uk.emering

markets.news@reuters.com))

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