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Hong Kong's Monetary System after 1997

by Joseph Yam, Chief Executive, Hong Kong Monetary Authority

(Speech to Hong Kong - Singapore Business Association)

August 1994


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

  1. 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.
  2. 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.
  3. 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.
  4. 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

  1. 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.
  2. 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?
  3. 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
  4. 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

  1. 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".
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. 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.
  8. 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.
  9. 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.
  10. 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

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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

  1. 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.
  2. 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
  3. 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.
  4. 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.
  5. 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

  1. 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.
  2. 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

  1. 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.
  2. 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.
Last revision date: 1 August 2011
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