Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Sub-Committee on Currency Board Operations held on 9 January 2004

(Approved for Issue by the Exchange Fund Advisory Committee on 29 January 2004)

Report on Currency Board Operations (2 December - 22 December 2003)

The Sub-Committee noted that funds had continued to flow into the Hong Kong dollar, bringing the Aggregate Balance to over $28 billion at the end of the report period, and to a level forecast to be around $44 billion on 12 January. Interbank interest rates had in consequence eased, and the negative spreads between the Hong Kong dollar and US dollar interest rates had widened. Members noted that, despite the strong inflows, the Hong Kong dollar had remained stable throughout the report period. Members also noted that the increase in the size of the Aggregate Balance, as well as the sale of Hong Kong dollars by the HKMA, had been in accordance with Currency Board principles.

2. Members observed that the ratio between the Backing Assets and the Monetary Base, the Backing Ratio, had decreased from 110.93% to 110.21% during the reporting period. The increases in the Aggregate Balance and outstanding amount of Certificates of Indebtedness had been matched by the increase in the Backing Assets in magnitude, rather than by proportion. Members noted that, with the Backing Assets being larger than the Monetary Base, a rise in the Monetary Base had led to a lower Backing Ratio. This factor had outweighed the positive effect of net interest income, thus leading to a decline in the Backing Ratio.

3. 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.

4. The report on Currency Board operations for the period under review is at Annex A.

Monitoring of Risks and Vulnerabilities

5. The Sub-Committee noted the regular report on risks and vulnerabilities, both international and domestic, relevant to monetary stability in Hong Kong. Internationally, economic data from the major economies continued to be generally favourable. In the US in particular consumer confidence continued to be high, and the manufacturing sector had expanded further in December, with the manufacturing Purchasing Managers' Index reaching the highest level since 1983. Members noted, however, that the picture in Japan and the euro area was a mixed one.

6. Members noted that in Hong Kong the latest retail sales figures showed a further improvement, and the Purchasing Managers' Index suggested that the economy had continued to expand in December, although the pace of expansion might have eased somewhat. In general, the latest data indicated continued improvements in both the domestic and external environments, which were helpful to Hong Kong's economic recovery and conducive to monetary stability.

Personal Renminbi Business: Will the Hong Kong Dollar be Marginalised?

The Sub-Committee considered a paper addressing the question of whether the expected introduction of personal renminbi business by banks in Hong Kong in the near future would lead to a marginalisation of the Hong Kong dollar. The conclusion of the paper was that it was unlikely, in the foreseeable future, that the renminbi would replace the Hong Kong dollar to any significant extent in domestic transactions. In the longer run, when the renminbi became fully convertible, the degree of renminbisation in Hong Kong was likely to grow. Even then, however, the role of the Hong Kong dollar was likely to remain significant, not least because of its legal tender status and its use for tax and other official payments.

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Hong Kong Monetary Authority

2 February 2004