Recent rating upgrades for Hong Kong given by international agencies have rightly stressed the importance of sound monetary management.
Like many people in Hong Kong, I am very pleased to see the recent upgrades given by various international rating agencies on Hong Kong. As one of these agencies pointed out, when upgrading Hong Kong's foreign currency rating, Hong Kong's creditworthiness is supported by a sound policy framework.
The statements announcing these rating upgrades have all included favourable comments on Hong Kong's monetary management. We in the Hong Kong Monetary Authority have indeed put in quite a lot of effort in this important area of work. Some may think that this is not necessary for a system based on a simple rule that the monetary base should be fully backed by foreign reserves. But, while the theory behind the currency board system may be simple, the reality is inevitably a lot more complicated. This is particularly so for a currency board system operating in a highly externally oriented economy that is also an international financial centre where there are often huge inflows and outflows of funds. That is why we monitor how the system functions closely - on a virtually 24-hour basis - passing on that responsibility from Hong Kong when we close shop here to our two overseas offices in London and then New York. We also review this, including the structure of the system, periodically, both internally and through the Currency Board Sub-Committee of the Exchange Fund Advisory Committee. And we do so transparently, with the notes of the meetings of the Sub-Committee published. Such a high degree of transparency is necessary, given the scope for misunderstanding when theoretically simple issues are rendered more complex in actual practice. Further, when we take actions to strengthen the system, these can be - and often have been - misinterpreted as a departure from the important rule on which the system is based. Transparency in the operation of the system enhances its credibility and I am glad that the rating upgrades for Hong Kong were partly given on the basis of the sustained credibility of the currency board arrangement of Hong Kong.
In the published statements and reports of these upgrades, there are two other themes concerning our monetary system that are often mentioned. The first is that the system has come through several stress tests in recent years, including most obviously the events of the Asian financial turmoil of 1997 and 1998, and has gained in credibility as a result. The statements and reports also endorse our continuing efforts to strengthen the system. While we are pleased with this endorsement of our work, we are acutely conscious of one thing. The stress tests have been severe and the discipline of our system is such that the pain of adjustment when coping with the stress had to be borne by an adaptable economy and an understanding community. Very clearly, they are the true heroes behind the success of the currency board system in maintaining exchange rate stability in Hong Kong. As one rating agency puts it: "Flexible factor and goods markets, supportive but non-interventionist macroeconomic policies, fiscal restraint, and a resilient private sector have provided the economy with a high degree of adaptability." Long may this continue.
The second theme, as we also have been keen to point out, is that the rating agencies have now clearly differentiated between the currency board system of Hong Kong and those of other economies, in particular that of Argentina, the other significant economy with a currency board system. One rating agency has pointed out that "Hong Kong's currency board appears not to have experienced any adverse effects from Argentina's recent economic crisis". This sentiment is in fact reflected quite clearly in recent behaviour of financial markets. We in the HKMA watch the forward premium (or discount) in the Hong Kong dollar's exchange rate quite closely. The premium of, for example, the one-year forward exchange rate over the spot exchange rate is one that at least I look at everyday. Whenever there is an event that is perceived by the market to be relevant to confidence in the Hong Kong dollar, unusual movements may be detected. Earlier this year, tension in the Sino-US relationship over the spy plane affair led to a jump in the one-year forward exchange rate of about two to three hundred points. (A premium of one hundred points is one cent in the exchange rate. This means that for a one-year forward, the market is prepared to buy US dollars at 7.81 instead of 7.80 in the spot market.) But economic crisis in Argentina merely caused a blip of less than a hundred points that lasted for a few days. By contrast, at the height of the Asian financial crisis, the forward premium hit nearly 6000 points.
Joseph Yam
5 July 2001
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