Hong Kong's Monetary System after 1997

Introduction

It is a great pleasure to be here in Singapore to address the
distinguished members and guests of the Hong Kong-Singapore
Business Association.

1. Your Association has contributed much to strengthening the
   economic ties between Singapore and Hong Kong. Last year, Singapore
   was the sixth largest supplier of Hong Kong imports and also the
   sixth largest export market for Hong Kong. Taking Hong Kong's
   domestic exports alone, Singapore was Hong Kong's third largest
   market, after China and the United States. In the banking sector,
   Singapore has nine banking institutions in Hong Kong and three
   banks from Hong Kong are present in Singapore.
2. Your Commissioner in Hong Kong, in his recent message on the
   occasion of Singapore's National Day (9 August 1994) quite rightly
   pointed out that, whereas there is always a spirit of friendly and
   healthy competition between our two places, there are also great
   opportunities for co-operation. Indeed, we all benefit from the
   progress that comes with competition and the prosperity that comes
   with co-operation.
3. There are many things that we can learn from each other. Your
   Senior Minister, Mr. Lee Kuan Yew, has once said in Hong Kong that,
   over the past decades, he had formed a habit of visiting Hong Kong
   at least once a year, and each time he would learn something new.
   Well, we in Hong Kong have learnt from the Lion City too. For
   instance, we have modelled our Home Ownership Scheme on Singapore's
   and this Scheme has become a very important and popular element in
   our housing programme. On the central banking front, our newly
   created Hong Kong Monetary Authority (HKMA) has a lot to learn from
   the Monetary Authority of Singapore.

Political Transition

4. The subject of my speech this evening is Hong Kong's monetary
   system after 1997. An appropriate starting point is perhaps the
   political transition. 1 July 1997 is of course not far away. There
   are, in fact, 1,040 days to go. But do not take me wrong. I am not
   really counting the days, although I understand that somewhere in
   Beijing there is now a clock of some sort operating a count down.
   The date is of course an important one, particularly from a
   political point of view, for it will mark China's resumption of
   sovereignty over Hong Kong. But in many other respects, it would
   probably be just another day in which life of the majority of the
   people of Hong Kong goes on, in much the same way as in the
   past.
5. A few years back, in particular shortly after June 1989, there
   was quite widespread apprehension in Hong Kong about the approach
   of 1997, and understandably so. But now, I can sense that the
   people of Hong Kong are increasingly looking forward to 1997. This
   is perhaps particularly marked amongst businessmen, for two
   reasons. First, they hate uncertainties and are hoping that
   whatever residual uncertainties concerning the political transition
   could be removed by 1997. Secondly, and perhaps more importantly,
   they can see the business potential that will be open to them in
   China.
6. I am not privy to what exactly will happen on 1 July 1997.
   There will inevitably be the ceremonial events marking the
   historical occasion. But as the Chief Executive of the Hong Kong
   Monetary Authority today, responsible to the Financial Secretary
   for maintaining monetary and financial stability in Hong Kong, I
   would actually like the date of 1 July 1997, or the year 1997, or
   the whole of the transitional period, however defined, to be as
   dull as possible. Again, do not take me wrong. I have no wish to
   belittle the political significance of 1997. But I very much hope,
   and would wish to demonstrate to those interested, that the
   monetary significance of 1997 for Hong Kong is nil.
7. Public officers and community leaders in Hong Kong have often
   been asked the question as to what comes after 1997. One
   industrialist gave what I think is the best answer. What comes
   after 1997 must of course be 1997. This is, in fact, much more than
   just a punchy answer. The spirit of that answer is of course that
   life will go on as it has in the past. The monetary system of Hong
   Kong will after 1997 remain the same as before.

Constitutional Safeguards on the Monetary System

8. There are constitutional safeguards that this will be so. I am
   sure you have heard about the Sino-British Joint Declaration and
   the Basic Law. These are very important documents for anyone who
   wishes to look at any aspect of Hong Kong's future. They were
   constructed with the basic aim of maintaining the capitalist
   system, the way of life, the stability and prosperity of Hong Kong.
   The Joint Declaration elaborates the basic policies of the People's
   Republic of China regarding Hong Kong after 1997. And in order to
   ensure the implementation of such basic policies the Basic Law
   prescribes the systems to be practised in the Hong Kong Special
   Administrative Region (SAR) after 1997.
9. Some have played down the significance of these documents,
   saying rather cynically that they are merely pieces of paper,
   implying that they may not be observed by the parties that
   promulgated them. To these people, my personal advice to them is
   that they should forget about Hong Kong altogether. They should
   just pack up and go. But for the majority of us who have confidence
   in the sovereign states involved to stick by their words, there is
   I think a very clear framework and a very promising scenario.
   Afterall, where else in the world do you have pieces of paper
   safeguarding the continued stability and prosperity of a
   place?
10. Let me focus on the safeguards in respect of the monetary
    system. These are outlined in Section VII of Annex I of the Joint
    Declaration and Articles 109 to 113 of the Basic Law, and for your
    reference I have reproduced these as an appendix to the printed
    version of this speech. They are not very long but they are very
    clear. Those who have a serious interest in the monetary system of
    Hong Kong should examine them carefully. But let me first highlight
    the main provisions here before examining some of them in greater
    detail. The main provisions are as follows:
    • Hong Kong shall retain the status of an international financial
      centre
    • the monetary and financial systems of Hong Kong shall be
      maintained
    • Hong Kong to decide monetary and financial policies on its
      own
    • there shall continue to be free operation of financial
      business
    • there shall continue to be free flow of capital
    • the financial markets of Hong Kong shall continue to
      operate
    • the Hong Kong dollar, as legal tender, shall continue to
      circulate
    • the Hong Kong dollar shall remain freely convertible
    • the authority to issue, or designate banks to issue Hong Kong
      currency, is vested with the Hong Kong SAR Government
    • Hong Kong's reserves shall be managed and controlled by the
      Hong Kong SAR Government
11. These provisions are really quite comprehensive. They ensure
    that Hong Kong's monetary system will be the same after 1997 as
    before. Let me elaborate on a few of these. I have chosen those on
    which some doubts have understandably been expressed. The doubts
    were not so much on whether the provisions will be strictly adhered
    to, but on whether they can be realistically observed, having
    regard to recent economic developments in China and the likely
    trends in the foreseeable future.

Hong Kong as an International Financial Centre

12. The first sentence of that section in the Joint Declaration
    concerning the monetary system specifies that the Hong Kong SAR
    "shall retain the status of an international financial centre". In
    this connection there have been comments made that whether Hong
    Kong is an international financial centre is not a matter for
    declaration by sovereign states, but is a matter for recognition by
    those who use Hong Kong as a financial centre. And so the Basic Law
    further specifies that the Government of the SAR "shall provide an
    appropriate economic and legal environment for the maintenance of
    the status of Hong Kong as an international financial centre".
13. But whatever wording is used, the spirit of the provisions is
    clear. And it sets a task for public officers like myself to
    provide that appropriate economic and legal environment. I believe
    that environment exists now, in a form which is quite familiar to
    Singapore because it is also practised here, although with varying
    emphasis in its elements. I shall therefore not bother to describe
    to you the elements that make up that environment. The task at hand
    is to ensure that this appropriate economic and legal environment
    is maintained and perhaps further enhanced. The world around us is
    changing. Hong Kong is itself changing too, perhaps even more so
    than other parts of the world. The task is therefore not a simple
    one. As someone who has responsibility to perform that task, I have
    identified four areas which we need to handle carefully.
14. First, although none of the factors contributing to the
    favourable economic and legal environment will change directly as a
    result of the resumption of sovereignty over Hong Kong by China in
    1997, Hong Kong does not remain static. Aspirations of an
    increasingly affluent society undergoing economic transformation
    and political transition are most complex. Meeting these
    aspirations involves costs and trade offs, and possibly risks of
    erosion of this favourable environment. Public officers will have
    to be vigilant in identifying such risks and persuasive in
    presenting them so that they could be properly taken into account
    in the decision making process. This seems to have become more
    difficult in recent years. Issues in Hong Kong, at least to me, now
    have a disturbing tendency to get politicized. Nevertheless, public
    officers are very adaptable and I have full confidence that the
    good sense of the people, politicians and civil servants alike, to
    act in the best interest of Hong Kong would in the end
    prevail.
15. Secondly, as some have pointed out, Hong Kong does not have a
    monopoly over that favourable economic and legal environment. To a
    varying degree other centres have it as well, notably Singapore.
    And as they do not have the type of political transition over the
    horizon as Hong Kong, when comparisons are made, an unfavourable
    perception arising from the fear of the unknown could well develop.
    This could undermine Hong Kong's position. There is therefore a
    much greater need for those concerned, including friends of Hong
    Kong, to explain to others objectively what is going on, so as to
    pre-empt that perception. Changes bring opportunities. The
    political transition that Hong Kong is experiencing are unique, and
    the opportunities are therefore also unique to Hong Kong.
16. I would say in this connection that there has perhaps been too
    much comparison between Singapore and Hong Kong; as if there is not
    enough room for both to play a meaningful role, or as if there is
    not enough business around to share. This Region has been the
    fastest growing area in the world for some years now, and it will
    continue to be the fastest growing area in the world for I think
    many more years to come. Intra-regional trade has, in recent years,
    developed quite a momentum of its own, with a corresponding
    reduction in the dependence of the Region upon the economies of the
    western world, which are themselves improving. My worry is in fact
    that there may be too much for us to handle.
17. Thirdly, the nature of the business carried out in
    international financial centres is itself changing. We have seen
    recently quite a rapid process of financial liberalization,
    particularly in the economies of this Region. As a result, domestic
    financial markets have emerged; and, supported by sound and open
    domestic economic policies, these markets are attracting increasing
    attention, and substantial funds, directly from outside,
    particularly from the developed economies of the West. Financial
    markets have also become globalized with the advance of
    telecommunications technology. And so it does not now matter where
    you are or what you want to deal in. As long as there is a
    telephone, and it can of course be a mobile one, you can buy a
    Euro-Yen bond issued, say, by a Mexican company while sailing in
    the South China Sea during our time zone.
18. In response to this, there is I think the need for a
    corresponding shift of policy emphasis in Hong Kong's development
    as an international financial centre. Greater attention should be
    given to the development of an efficient financial system with a
    robust market infrastructure. Funds are being attracted to this
    Region in view of the higher rate of return available compared with
    that of the rest of the world. But return is not all. Investors
    would want also to minimize the risks involved and, in particular
    for financial investments, retain a high degree of liquidity. Funds
    will gravitate to markets with high liquidity and a high degree of
    integrity, and to jurisdictions in which funds can be transferred
    in and out safely. These are matters currently of great interest to
    central bankers. If you have the privilege, or the burden, to
    listen in to discussions amongst central bankers nowadays, within
    five minutes you will hear them talking about derivatives and the
    management of risks arising therefrom, or payment systems and real
    time gross settlement, or the legal enforceability of netting and
    its treatment in relation to capital adequacy. Ensuring that there
    is an efficient and robust market infrastructure is now one of the
    main objectives of the HKMA.
19. Fourthly, Hong Kong has to take account of developments in
    other financial centres within China. That Hong Kong shall retain
    the status of an international financial centre is the basic policy
    of the People's Republic of China on Hong Kong after 1997, as
    elaborated by the Chinese Government in the Sino-British Joint
    Declaration. As far as I am aware there is no similar policy in
    respect of other centres in China, although it has been reported
    that the leaders in Beijing have expressed the wish that Shanghai
    should also play the role as an international financial centre.
    Whatever that has been said, I think there is scope for exploring
    objectively and jointly what roles should be played by the two
    centres after 1997 and the relationship between them. The aim
    should be to ensure that whatever roles are played, they should be
    complementary to ensure efficient use of scarce resources.
20. Insofar as Hong Kong is concerned, as an international
    financial centre it is ready made. Its unique position under the
    concept of "one country, two systems" makes it the most ideal place
    for facilitating foreign investments in China. Investors all over
    the world are attracted by the opportunities for a high rate of
    investment return in China. It is only realistic to expect that
    opportunities for high return carry high risks as well. And in
    terms of financial investments, the risks are familiar - exchange
    risk, counterparty or credit risk, liquidity risk, market risk,
    legal risk, systemic risk, etc. And, as I pointed out earlier,
    prudent investors all want to minimize and properly manage these
    risks. They find that they can do so more effectively in financial
    markets with a high degree of liquidity, a high degree of
    integrity, suitable regulation, etc. And where else can this be
    done with confidence and convenience than in Hong Kong, before or
    after 1997? For this reason, Hong Kong is increasingly serving as a
    window for China to access international capital, as the reform and
    liberalization of the economy of China intensify. There has been,
    for example, a significant number of Chinese enterprises, which
    satisfied the market requirements in Hong Kong, successfully
    listing their shares in the Stock Exchange of Hong Kong, attracting
    substantial foreign investment funds.
21. By contrast, I foresee Shanghai to be the main centre for RMB
    business, channelling domestic savings into productive investment.
    In this, Hong Kong will only have a limited role to play, at least
    for the time being, in view of the current restrictions in the flow
    of RMB to outside the mainland. But I have always held the view
    that, as Hong Kong will formally be a city in China after 1997,
    there really should not be any restriction in the flow of RMB to
    Hong Kong from then on, if not before. This would not lead to the
    migration of the wholesale or retail RMB business to Hong Kong. But
    it would have the advantage of facilitating the move of the RMB to
    full convertibility, as there are no, and will not be any, exchange
    controls in Hong Kong. This can be a managed process, whereby the
    mainland's restrictions on the flow of RMB to Hong Kong could be
    gradually relaxed in the light of market signals and for the pace
    to be closely monitored. With increased convertibility of the RMB,
    the prospects for international financial business to develop in
    Shanghai would in turn improve.

The Hong Kong Dollar

22. This is a convenient point to turn to the Hong Kong dollar.
    Here again, both the Joint Declaration and the Basic Law are
    crystal clear. The Hong Kong dollar, as the legal tender in the
    Hong Kong SAR, shall continue to circulate and remain freely
    convertible. The free flow of capital shall be safeguarded and no
    exchange control policies shall be applied.
23. Nevertheless, pointing to the fact that the economies of China
    and Hong Kong are becoming increasingly integrated, there have been
    queries as to whether the Hong Kong dollar would eventually be
    replaced or displaced by the RMB. I quite understand that Hong Kong
    is small and China is big, and that this could mislead one to think
    that the economy of Hong Kong, its currency and its financial
    markets, might somehow be absorbed by those of China. With a
    population of about 6 million, Hong Kong is indeed small when you
    look at the corresponding figure of 1.2 billion in China. It is
    only half a percent of China's. But as an economy Hong Kong is not
    small. As a currency the Hong Kong dollar is not small. And
    certainly Hong Kong dollar based financial markets are not small.
    You will I think be surprised to learn that the total money supply
    (in domestic and foreign currencies) in Hong Kong is equivalent to
    about two-thirds of the money supply in the mainland. (The Hong
    Kong dollar money supply is about a third of the RMB money supply.)
    The market capitalization of the Hong Kong Stock Exchange is in
    fact 13 times that of the Shanghai Stock Exchange (of which only 6%
    is open to foreign investors in the form of B-shares). And the
    foreign reserves of Hong Kong are almost twice as large as that of
    China at the end of last year.
24. What has in fact been happening, along with the increasingly
    close economic ties between Hong Kong and China, particularly the
    southern part of China, is that the Hong Kong dollar is becoming
    more and more popular as a currency in China. A rough estimate
    shows that about 20 to 25% of the Hong Kong dollar bank notes
    issued are circulating in China. The amount had been increasing
    fairly rapidly in recent years, but appeared to have stabilized
    somewhat in the first half of this year. This I believe is a
    response to the re-iteration by China at the beginning of this
    year, in relation to the measures taken to unify the RMB exchange
    rates, of a long standing policy prohibiting the circulation of
    foreign currencies in China. But I understand that this policy is
    being pragmatically applied in respect of the Hong Kong dollar, in
    order that the full benefits of the closer economic ties between
    Hong Kong and China could be realized. There must be about three
    million workers employed now in the Guangdong Province by Hong Kong
    businesses. This is equivalent to the size of the labour force in
    Hong Kong and about the population of Singapore. It would be
    difficult for the prohibition of the circulation of foreign
    currencies to be strictly enforced. Furthermore, the Hong Kong
    dollar will no longer be a "foreign" currency after 1997. The
    concept of "one country, two systems" also means "one country, two
    currencies". And for the wisdom underlying this forward looking
    concept to be transformed into tangible benefits for the country,
    and for these benefits to be maximized, it can be convincingly
    argued that limitations on the convertibility between the two
    currencies and the currency flows between the two systems should be
    minimized and eventually eliminated.
25. In any case, money flows around obstacles created to restrict
    its movement. Restricting the wider use of the Hong Kong dollar in
    the southern part of China might, I fear, lead to the re-emergence
    of the currency black market that China has just successfully
    eliminated. I think the Chinese authorities are well aware of this
    risk. At the same time, it seems obvious that the use of the Hong
    Kong dollar there has led to the economy of Guangdong being a lot
    more prosperous than other provinces. The best policy in the
    circumstances is indeed one of pragmatism.
26. And how about the role of the RMB in Hong Kong? There are no
    exchange controls in Hong Kong. So the RMB is, and will continue to
    be, just another currency that can be freely traded in Hong Kong
    like the US dollar. Tendering a currency which is not legal tender
    is in fact not illegal. It is up to the payee whether or not to
    accept it. At the retail level, there would understandably be
    increasing acceptance by shops wishing to attract consumers from
    the mainland, particularly if the RMB exchange rate remains stable
    and the RMB can be readily converted into the Hong Kong dollar,
    just as the shops are happy to accept US dollars and other freely
    convertible currencies from tourists. But this is not to say that
    the RMB would gain popularity generally as a medium of exchange, as
    a store of wealth or as a unit of accounting in Hong Kong. This did
    not happen in the case of the US dollar, even though by virtue of
    our exchange rate policy the Hong Kong dollar is really an
    extension of it. There is no reason why this would become the case
    for the RMB. At the wholesale level, the RMB may also increasingly
    be used for the settlement of external trade transactions involving
    China, as China's trade relations with Hong Kong, and through Hong
    Kong with the rest of the world, grow. Again, as with the case of
    the US dollar being the main currency used for trade transactions,
    this would not undermine the position of the Hong Kong dollar as
    the currency of Hong Kong.

Monetary Policy

27. Let me say a few words on monetary policy after 1997. The Basic
    Law specifies that the Government of the HKSAR shall, on its own,
    formulate monetary and financial policies. This again is very
    clear, and of course reflects present practice. I am in no position
    to speak for the future SAR Government. But if I were asked for an
    opinion, I would emphasize the need for the objective of monetary
    policy always to be clearly defined and firmly adhered to. This is
    necessary if the policy is to have credibility and therefore be
    achievable.
28. The objective of monetary policy in Hong Kong is currency
    stability, in terms of the external value of the Hong Kong dollar
    against the US dollar at the fixed rate of 7.80 and within the
    framework of the linked exchange rate system. Exchange rate
    stability and therefore confidence in the currency is of course
    important to Hong Kong in the sensitive period of political
    transition. Furthermore, for a highly externally oriented economy,
    the maintenance of a stable external value of the currency is I
    believe a correct policy to pursue. This policy has served Hong
    Kong well since its establishment in October 198
29. It is a policy that the present Government has no intention
    whatsoever of changing and has the full support of the Chinese
    Government. This therefore is a clear indication that the policy
    will be firmly adhered to after 1997.
30. I am sure many of you are aware of the higher rate of inflation
    that Hong Kong has been experiencing in recent years. Some have
    attributed this to the link with the US dollar. This is I would say
    a very superficial comment. Hong Kong is going through an economic
    transformation that is more rapid than anyone could have predicted
    ten years ago. This is the result of the equally rapid
    liberalization of the economy of China, unleashing very strong and
    sustained demand on the services industry in Hong Kong, in
    particular on financial services. There has therefore been
    inflationary pressures on what economists called the non-traded
    goods sector. Indeed, inflation in the traded goods sector, as
    measured by the rate of increase in the prices of goods either
    imported into or exported from Hong Kong, has been moderate. This
    is what one would expect given the exchange rate is fixed against
    the currency of an economy with moderate inflation. The fixed
    exchange rate does, however, constrain our ability to use interest
    rates to curb inflation. But this is a constraint that Hong Kong
    accepts as a price to pay for stability in the external value of
    the currency. I should point out that as US interest rates have
    been raised in recent months, this has helped to curb inflationary
    pressures domestically.
31. Given the importance of exchange rate stability to Hong Kong in
    transition, we have over the past few years been strengthening our
    monetary system to enhance our ability to deliver that stability.
    There were a number of important reform measures introduced,
    basically putting ourselves in a position effectively to influence
    money market conditions so as to assist in the maintenance of
    exchange rate stability. These are nothing new to other established
    monetary systems. In a way we are merely catching up with others. I
    shall therefore skip the details.

Institutional Safeguard

32. This series of monetary reform measures led last year to the
    establishment of the HKMA, which has more or less the same
    functions as the Monetary Authority of Singapore. I am sure you
    will agree with me that there are important tasks to be performed
    in the monetary area in any economy. These tasks need to be
    performed with a high level of professionalism and continuity, and
    in a manner that commands the confidence of the people and the
    international financial community. In Hong Kong, these tasks were
    becoming increasingly inappropriate for civil servants to carry,
    hence the establishment of the HKMA, with its own terms and
    conditions of employment.
33. The establishment of the HKMA had the clear blessings of both
    the British and the Chinese governments. There is therefore a
    so-called "through train" for monetary affairs in Hong Kong. In
    this connection, let me quote Chen Yuan, the Deputy Governor of the
    People's Bank of China (PBOC). He said at a conference organized by
    the HKMA last year in Hong Kong that he welcomes "the further
    development of the good co-operative relationship between the two
    monetary authorities" and that after 1997 the PBOC "will not take
    the place of the Hong Kong Monetary Authority". This assurance of
    good co-operative relationship and institutional and functional
    separation is very clear. It is of course an unequivocal
    demonstration of the application of the "one country, two systems"
    principle in the practice of central banking in Hong Kong. After
    1997, there will be one country, two currencies, two monetary
    systems and two separate monetary authorities.

Closing Remarks

34. Before closing and taking questions from you, let me thank you
    again for giving me this opportunity to speak about Hong Kong's
    monetary system after 1997. Although there are still one or two
    transitional issues, mainly in the area of the relevant
    legislation, to sort out before 1997, and I do not expect these to
    be controversial, the monetary system of Hong Kong is well on track
    for a smooth train ride through 1997. I very much look forward to
    riding on that train.
35. I hope that I shall have an opportunity of welcoming you to
    Hong Kong, before or after 1997. In case you wish to do so in 1997,
    do be aware that bookings of many hotels are already full for the
    night of 30 June 1997, for obvious reasons, and for the end of
    September 1997 when the Annual Meetings of the World Bank and the
    International Monetary Fund will be held in Hong Kong. Perhaps 1997
    will not be a dull year afterall. Thank you.