Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Currency Board Sub-Committee held on 14 September 2005

(Approved for Issue by the Exchange Fund Advisory Committee on 29 September 2005)

Report on Currency Board Operations (30 July - 30 August 2005)

1. The Sub-Committee noted that the Hong Kong dollar exchange rate had strengthened slightly to close at 7.7707 at the end of the reporting period. Hong Kong dollar interbank interest rates had increased and continued to be close to but slightly below their US dollar counterparts. The Monetary Base had decreased from HK$279.60 billion to HK$277.91 billion, largely reflecting a decline in Certificates of Indebtedness. The Aggregate Balance had remained relatively stable at around HK$1.3 billion.

2. The Sub-Committee noted that, in accordance with Currency Board principles, changes in the Monetary Base had been fully matched by corresponding changes in foreign reserves during the reporting period.

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

Monitoring of Risks and Vulnerabilities

4. Members noted that the global economy had been resilient to higher oil prices with robust growth in the US and Mainland China. There were signs of increased economic activity in Europe and Japan following a slowed expansion in the second quarter. Global inflation had increased, mainly due to higher oil prices, but core inflation remained low. Members noted that the Hong Kong economy had gathered further momentum in the second quarter but that the pace of expansion was likely to moderate. Headline inflation had increased in recent months. The rise in interest rates had had some dampening effect on the property market.

5. Members noted a special analysis in the report which suggested that, if oil prices stayed at current levels for a sustained period or increased further, the impact on global growth and Hong Kong could be more significant than that seen so far.

Transferability between Certificates of Indebtedness and the Aggregate Balance

6. The Sub-Committee considered a paper outlining the arguments for and against introducing transferability between CIs and the Aggregate Balance. This subject had previously been raised in May and the HKMA had, on the advice of the Sub-Committee, undertaken to carry out further research into the implications of such a change. While noting that such an arrangement would bring some advantages in terms of tidying up the Currency Board system, Members advised that the system should remain unchanged for the time being but that the issue might be revisited at a future date.

The New Renminbi Exchange Rate Regime and Its Implications for Hong Kong

7. Members noted a report on the new renminbi exchange rate regime announced by the People's Bank of China on 21 July 2005 and its implications for Hong Kong. Developments so far indicated a relatively smooth transition to the new regime. The change to the new regime had not induced speculative inflows into the Hong Kong dollar, helped by the three refinements to the Linked Exchange Rate system which had better anchored exchange rate expectations on the strong side. Members noted that the revaluation of the renminbi was likely to have a limited impact on Hong Kong's output growth and inflation.

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Hong Kong Monetary Authority
29 September 2005