(Approved for Issue by the Exchange Fund Advisory Committee on 3 December 2003)
Report on Currency Board Operations (29 September - 24 October 2003)
The Sub-Committee noted that, following the sharp strengthening of the Hong Kong dollar on 23 September, the dollar had continued to strengthen into the period under review, reaching a recent high of 7.7094 against the US dollar on 7 October as a result of strong capital inflows. The dollar had, since the end of the period under review, stabilised to around 7.77. Members noted that during the period short-term interbank interest rates had dropped to close to zero, and the HKMA had sold a total of HK$3.29 bn under the Currency Board Account. Reflecting the inflow of funds, Hong Kong dollar forward points had continued to be at a considerable discount, and the negative spreads between Hong Kong dollar interbank interest rates and their US dollar counterparts had widened during the period.
The Sub-Committee noted that, in accordance with Currency Board principles, changes in the Monetary Base during the reporting period had been fully matched by changes in the foreign reserves.
The report on Currency Board operations for the period under review is at Annex A.
Monitoring of Risks and Vulnerabilities
The Sub-Committee noted that the economic recovery now in progress in the major economies had become more balanced and robust. The Asian economies had also showed signs of acceleration in growth. There were, however, concerns that the pace of recovery could moderate in some economies, including the US. In Hong Kong the Government had revised upwards its growth projection for 2003 to 3% in the light of the reviving economy. Most indicators pointed to a broadening of the economic recovery.
Members noted that financial markets in Hong Kong continued to be strong, driven by the brighter economic prospects and increased fund flows. Sentiment towards the Hong Kong currency had changed markedly in the light of these developments and against the background of a weakening US dollar and political pressure for a revaluation of the renminbi. It appeared that the concerns in the market about deflation, the budget deficit and unemployment had for the time being subsided.
Recent Developments in Hong Kong Dollar Exchange and Money Markets
The Sub-Committee considered a report on the recent sharp strengthening of the Hong Kong dollar. Members noted that among the factors behind this strengthening were improved economic prospects, helped by the rebound from the SARS outbreak, policy measures to facilitate further economic co-operation between Hong Kong and the Mainland, and the background of a depreciating US dollar. Other factors, such as speculations about the revaluation of the renminbi and market dynamics, had played a role in triggering and magnifying the process. The limited room for further falls in interest rates appeared to be a further factor in the adjustment of the exchange rate.
Members observed that the impact of the strengthening of the dollar on the real economy had been minimal. They noted that the Hong Kong dollar had in fact depreciated in effective terms by 0.5% between 23 September and 23 October because other currencies had appreciated more against the US dollar.
In the light of the recent strengthening of the Hong Kong dollar and of the discussions at the meetings held in October 1999 and July 2000, the Sub-Committee considered the question of whether or not it was desirable for a convertibility undertaking to be introduced on the strong side of the Linked Exchange Rate. The Sub-Committee was supportive of the actions taken by the Hong Kong Monetary Authority to dampen excessive market volatility during the recent strengthening of the Hong Kong dollar: Members considered that these actions were appropriate in the circumstances and that they were in accordance with Currency Board principles. The Sub-Committee concluded that the current system was working effectively and that it was not necessary to introduce a strong-side convertibility undertaking for the time being.
Macroeconomic Conditions and Banking Performance in Hong Kong: A Panel Data Study
The Sub-Committee noted a paper reporting on research using supervisory data to examine the determinants of banking performance in Hong Kong. The main findings of the paper suggested that the reduced profitability of banks in recent years was related to the difficult macroeconomic conditions and increased competition. The paper also noted that, while the bursting of the property bubble had placed banks under stress, property-related loans remained relatively safe assets compared with other types of bank lending during the study period.
The Prospects of a Return of Inflation in Hong Kong
The Sub-Committee noted a paper discussing factors affecting the prospects of a return of inflation in Hong Kong. Members noted that projections about inflation were subject to considerable uncertainties.
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Hong Kong Monetary Authority
4 December 2003
