In the first quarter of 2025, Hong Kong's capital and financial account surplus reached HKD 160.3 billion, an increase of approximately 20% compared to the previous quarter, marking the highest level since 1999. On the surface, it appears that Hong Kong has attracted a large inflow of capital, leading to the record-high account surplus. However, behind this surplus lies two diverging forces: one is the massive influx of Mainland China’s capital, and the other is the continued outflow of both local and international capital from Hong Kong. In reality, the capital structures of Hong Kong and the Mainland are increasingly becoming integrated. This shift is exerting deep, systemic pressure on Hong Kong’s linked exchange rate system, undermining the effectiveness of the currency peg to some extent.

As a bridge connecting the mainland with global markets, Hong Kong has attracted a large amount of Mainland capital this year. According to Bloomberg data, as of June 20, Mainland Chinese investors have injected nearly USD 90 billion into the Hong Kong stock market through the Shanghai-Hong Kong and Shenzhen-Hong Kong Stock Connects, nearly 90% of the total inflow for the entire year of 2024. HSBC expects the total for 2025 to reach a new high of USD 180 billion.

Why is the Hong Kong market so favored by Mainland capital? Behind this is clear policy guidance. Since the beginning of this year, Chinese regulators have continuously signaled a loosening of controls on cross-border capital flows through "window guidance". Although cross-border capital flows are still managed under a macroprudential framework, in the context of undervalued Hong Kong stocks and the relatively high risk of renminbi depreciation, some capital has been implicitly allowed to flow southward, operating more flexibly within compliance boundaries. In February 2024, the Guangdong-Hong Kong-Macau Greater Bay Area's "Cross-border Wealth Management Connect" was extended to the entire Guangdong province, with the quota raised to RMB 300 billion. The investment quota increased from RMB 150 billion to RMB 300 billion, and the number of mainland investors' accounts surged from 25,000 to 95,000.

In addition, the surge in Mainland companies listing in Hong Kong has further boosted capital inflows. In May 2025, Chinese EV battery maker CATL completed a USD 4.6 billion IPO in Hong Kong, becoming one of the largest IPOs globally and attracting significant mainland capital for follow-on investments. According to data from the Hong Kong Stock Exchange, in the first quarter of 2025, Hong Kong received 116 listing applications, with Mainland companies dominating. The wave of IPOs by industry leaders from the mainland is driving up Hong Kong’s IPO fundraising, helping the total amount of new equity raised in Hong Kong reach HKD 60 billion, reclaiming its position as the world’s top destination for IPOs.

The sluggish performance of the Mainland capital markets and geopolitical factors have also prompted high-net-worth individuals from the Mainland to diversify their asset allocation through investments in the Hong Kong market, aiming to hedge against the risk of renminbi depreciation. Compared to the strong rebound in the Hong Kong stock market, the Mainland stock market has recently shown signs of stagnation. As of June 16, the Hang Seng Index (HSI) has gained 22.61% year-to-date, leading all major global markets. In contrast, the return on the CSI 300 Index has been almost flat or even slightly declined during the same period.

However, despite the large inflow of Mainland capital, both local Hong Kong capital and foreign capital have continued to flow out. Data shows that in the second quarter of this year, Mainland funds flowing into Hong Kong through the Stock Connect exceeded HKD 150 billion. At the same time, local Hong Kong intermediaries, international intermediaries, and mainland intermediaries reduced their holdings by HKD 84.72 billion, HKD 18.04 billion, and HKD 8.42 billion, respectively. On one hand, hedge funds saw a temporary return between late April and mid-May. However, the persistently low Hong Kong interbank offered rates (HIBOR) have driven flexible funds to increase their positions in U.S. dollar assets via carry trades. On the other hand, according to EPFR data, long-term funds, represented by overseas active equity funds, have continued to show an outflow trend.

Due to the previous trend of stronger net inflows of Mainland capital compared to the outflows of both local and foreign capital from Hong Kong, under the linked exchange rate system, the inflow of Mainland capital pushed the Hong Kong dollar exchange rate to the strong-side convertibility level. As a result, the Hong Kong Monetary Authority (HKMA) was forced to sell Hong Kong dollars and buy U.S. dollars to release liquidity, causing Hong Kong dollar interest rates to drop significantly.

Hong Kong adopts a linked exchange rate system pegged to the U.S. dollar, with a trading band set between HKD 7.75 and 7.85 per USD 1. When the Hong Kong dollar appreciates and hits the strong-side limit of 7.75, the Hong Kong Monetary Authority (HKMA) is required to automatically sell Hong Kong dollars and buy U.S. dollars to maintain the peg. In May 2025, Mainland capital inflows pushed up demand for the Hong Kong dollar, causing the exchange rate to reach the strong-side level of 7.75. The HKMA triggered the strong-side convertibility guarantee, selling HKD 46.54 billion to buy USD 6 billion, thus increasing the supply of Hong Kong dollars in the market and alleviating the liquidity pressure on the Hong Kong dollar.

The direct consequence of this intervention was a sharp decline in Hong Kong dollar interest rates. The one-month HIBOR was still at around 4% at the end of April, but by June 20, it had dropped to 0.52845%. Similarly, the overnight HIBOR also fell sharply. On May 26, the rate for this term had dropped to 0.02336%, the lowest level on record since 2006, and by June 20, it had further decreased to 0.01%.

Meanwhile, the U.S. federal funds rate remained between 4.25% and 4.5%, creating a significant interest rate differential between Hong Kong and the U.S., which opened up substantial arbitrage opportunities. This stimulated local capital to flow aggressively into U.S. dollar assets, further exacerbating capital outflows. In June 2025, the Hong Kong dollar’s exchange rate shifted dramatically within just one month, from reaching the strong-side limit (7.75) to approaching the weak-side limit (7.85). After selling Hong Kong dollars in May, the HKMA was forced to buy HKD 9.42 billion on June 26 for the first time. This rapid shift from the strong side to the weak side exposed the inherent vulnerability of the linked exchange rate system.

The current risk is that Hong Kong's market is becoming overly dependent on Mainland capital. Driven by policy and macroeconomic factors, a large amount of capital has flowed southward, while local and international capital continues to exit, resulting in an increasingly concentrated base of participants in Hong Kong’s capital market. If this trend persists, the market will become systematically reliant on the policy and economic stability of the Mainland. Should Mainland China’s regulatory policies tighten or the attractiveness of Hong Kong dollar assets decline, southbound flows could shrink, leading to a sharp drop in demand for the Hong Kong dollar.

Furthermore, excessive reliance on Mainland capital could undermine the independence and openness of the market’s pricing mechanisms, making it harder for Hong Kong to attract long-term diversified capital, which could further accelerate the outflow of foreign capital. The Hong Kong dollar exchange rate would then face a new round of volatility pressure, and the linked exchange rate system would bear a more complex intervention burden. These interventions come at a cost and require continuous injection of fund. Once the fund runs out, there is little that can be done unless the central government steps in to provide support.

The stability of the linked exchange rate system essentially depends on the diversity of market participants and the balance of capital flows. When the market relies solely on a single pool of capital, the HKMA's mechanism for strong- and weak-side convertibility is more likely to be triggered frequently, undermining the stability and credibility of the system. This creates a long-term hidden risk for the linked exchange rate system, leading to liquidity mismatches and the concentration of risks.

Therefore, although the current net capital inflows and the temporary stability of the exchange rate have provided Hong Kong with a brief window of relief, the capital structure issue driven by the dominance of Mainland capital has clearly emerged and is exerting unprecedented systemic pressure on the linked exchange rate mechanism. This is not a short-term issue that can be alleviated by monetary policy or foreign exchange interventions by the HKMA; rather, it represents a substantial challenge to the very framework of the linked exchange rate system.

Final analysis conclusion:

As the trend of integration between Hong Kong and the Mainland deepens, Hong Kong's capital market is showing an increasingly clear trend of structural uniformity. The southbound funds have become the primary "buyer", while local and international capital continue to flow out. This imbalance has begun to exert a systemic impact on the linked exchange rate system, increasing exchange rate volatility and the frequency of interventions.

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Chen Li is an Economic Research Fellow at ANBOUND, an independent think tank.