The HKMA stands ready to meet any withdrawls of fiscal reserves placed with the Exchange Fund for the purpose of funding the fiscal deficit. Depending on financial market conditions, two main options for meeting such withdrawls are available to the Exchange Fund: borrowing, or realising assets.
Last month Hong Kong slipped in its international ranking in the size of its foreign reserves from third to fourth place, as shown in the figures for the end of September. This should not give cause for alarm or concern. At well over US$100 billion (US$113.4 billion at the end of September), the foreign reserves of Hong Kong are very substantial by any standards. In any case, such rankings are not particularly meaningful. But for those who like them, to be fourth in the world is very good indeed, particularly when we think of ourselves as having more foreign reserves than any developed economy in Europe or America. Furthermore, in terms of per capita holding of foreign reserves, we continue to rank second in the world, next to Singapore.
Similarly, the fall in the total assets of the Exchange Fund to below HK$1 trillion is a matter of some temporary regret, but it need not be a cause for concern. There is nothing magic about the HK$1 trillion mark. The valuation of the assets in the Exchange Fund goes up and down, reflecting volatility in financial markets in which we have investments. Such volatility has increased in recent years, partly as a consequence of globalisation. And our exposure to the particularly volatile Hong Kong equity market is still higher than our neutral allocation, notwithstanding the good progress, up until the third quarter of this year, of disposal through the Tracker Fund. But I am sure that, as day follows night, the relevant markets will recover and assume the familiar long-term upward trend. So let us not be unnerved by the short-term deviations from that trend, however substantial they may be. We are not leveraged and we have the staying power to see through the short-term market cycles.
There is, nevertheless, one aspect behind these changes that is noteworthy. We are of course aware of the state of our public finances this year being adversely affected by a whole host of unexpected factors. It is now quite clear that the fiscal deficit for the financial year 2001-2002 will be much larger than originally budgeted. With our substantial fiscal reserves, an occasionally large deficit should not present too much of a problem for Hong Kong, although the situation would be different if this became a sustained phenomenon. The management of the Exchange Fund, in which the fiscal reserves are deposited, is organised always to enable liquidity to be raised to meet withdrawals by the Treasury to fund shortfalls in cash flow.
So far in this financial year (for the six months from April to September), withdrawals of fiscal reserves from the Exchange Fund totalled HK$58 billion. In meeting such withdrawals, we have the choice of borrowing or of realising our assets. The former would have the effect of replacing some of our liabilities to the Treasury by liabilities to those from whom we have borrowed, and would not affect the size of the Exchange Fund. But when we realise our assets (including the withdrawal of our deposits with banks) to fund the withdrawal of fiscal reserves, the size of the Exchange Fund comes down. And when those assets are foreign currency assets, the amount of foreign reserves held in the Exchange Fund also comes down. The choice of funding mechanisms depends very much on market conditions, and, in deciding which to use we look at, among other things, the cost effectiveness of each.
Thus the falls observed in Hong Kong's foreign reserves and in the size of the Exchange Fund reflect, apart from the net downward valuation of the assets held, the manner in which we have been funding the withdrawal of fiscal reserves. This would include, for example, the selling of US dollars for Hong Kong dollars, withdrawl of deposits or borrowings from banks, and the use of proceeds from the sale of equities through the Tracker Fund. The effects of such activities were hardly noticeable in the money and foreign exchange markets. As usual, there was considerable care exercised to ensure that their impact on monetary conditions was as far as possible neutral, and certainly in strict accordance with the rules dictated by the Currency Board system.
Whether or not further fiscal deficits should be funded through the use of fiscal reserves is a matter that will be addressed thoroughly by the Financial Secretary when appropriate. We stand ready to meet any withdrawals of fiscal reserves placed with the Exchange Fund, making use of the most cost-effective arrangements, having regard to conditions in the financial markets.
Joseph Yam
1 November 2001
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