Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Currency Board Sub-Committee held on 18 January 2010

(Approved for Issue by the Exchange Fund Advisory Committee on 29 January 2010)

Report on Currency Board Operations (1 October 2009 - 29 December 2009)

The Sub-Committee noted that the Hong Kong-dollar exchange rate against the US dollar had stayed close to the strong-side Convertibility Undertaking of 7.75 between October and early December, but weakened slightly thereafter due to the repatriation of proceeds from initial public offerings. The strong-side Convertibility Undertaking had been triggered repeatedly during the reporting period, resulting in an inflow of about HK$199 billion. Hong Kong-dollar interbank interest rates had remained at near zero and their negative spreads against US-dollar interest rates had been roughly stable.

2. The Sub-Committee noted that the Monetary Base had expanded during the period from HK$806.17 billion to HK$1,009.04 reflecting an increase in the Aggregate Balance and additional issuance of Exchange Fund Bills.

3. 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.

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 that major economies had continued to recover slowly with non-farm payrolls and housing sales in the US being better than expected and business sentiment remaining positive. The US dollar had rebounded from a 14-month low against the euro as the encouraging news on the US economy helped convince investors the recovery might be stronger than expected. The euro area had emerged from recession in the third quarter, with sentiment indicators reaching their highest levels since the summer of 2008. In Japan, industrial recovery had been mainly driven by the growing strength of trading partners, but the strong yen was a threat to further improvements in exports.

6. The Mainland economy had maintained its robust momentum, while the authorities had announced measures to contain rising house prices, which would help to avoid financial instability arising from a housing bubble.

7. In Hong Kong, economic activity had continued to improve with the latest data indicating that activities would be stronger in the fourth quarter of 2009 than in the third quarter. The Hong Kong dollar-US dollar exchange rate had weakened slightly but remained close to the strong side of the Convertibility Zone. The residential property market had cooled somewhat in the fourth quarter of 2009.

8. While the economic recovery was expected to continue in 2010 and inflation to remain subdued, the Sub-Committee noted that growth might be stronger if the recovery in global financial markets and the performance of asset prices in Hong Kong turned out to be stronger than expected. On the other hand, there remained a risk of a double-dip recession in the global economy or an abrupt reversal of fund flows, which might affect market confidence and disrupt economic activity in Hong Kong.

The Renminbi Exchange Rate and its Implications for Inflation in Hong Kong

9. The Sub-Committee noted a paper discussing the likely implications for inflation in Hong Kong if the renminbi were to appreciate. The study concluded that, given Hong Kong's particular economic structure, the effects of an appreciation, or the expectation of an appreciation, in the renminbi on inflation in Hong Kong through changes in import prices and aggregate demand were likely to be modest. However, there might be more significant effects through changes in liquidity conditions and asset prices.

Annex A

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Hong Kong Monetary Authority
3 February 2010