The stable Aggregate Balance, which reflects licensed banks' foreign exchange transactions with the HKMA, indicates that there have been no outflows of funds from the Hong Kong dollar. The materialisation of any outflows will be determined by the market under the non-discretionary Currency Board system.
I have written on the subject of inflows and outflows of funds before, but since there is continuing interest in it and different views expressed on it, particularly on what seems currently to be a considerable outflow of funds, let me say a little more.
What seems clear is that there has been greater ex ante demand to exchange Hong Kong dollars into foreign currencies than the other way round. That explains why the exchange rate has weakened, but only very lightly, from about 7.77 to nearly, but not quite, 7.80 over a period of about two months - a process that is necessary to equalise demand and supply ex post. It is necessary to realise that for every seller of Hong Kong dollars there must be a buyer, so somebody is holding onto those Hong Kong dollars sold.
To examine the matter in greater detail it is also useful to identify the three categories of players in the foreign exchange market - the non-bank sector, the banking sector and the HKMA - and the effects of foreign exchange transactions undertaken by them. When the buying and selling of Hong Kong dollars are conducted among the non-bank and banking sectors, it is really a zero-sum game, in which the Hong Kong dollars only change hands from the seller to the buyer. It is only when Hong Kong dollars are sold to the HKMA that the transaction should be considered as a genuine outflow of funds from the Hong Kong dollar. This is because, as the HKMA is the settlement institution for Hong Kong dollar inter-bank transactions, the selling of Hong Kong dollars by licensed banks to the HKMA involves the HKMA debiting the Hong Kong dollar amounts from the clearing accounts of the banks concerned. This is reflected in a decrease in the Aggregate Balance. As readers are aware, the HKMA is entirely transparent on the size of the Aggregate Balance and reasons for changes in it. There has not been any change in the Aggregate Balance arising from any purchase of Hong Kong dollars (sale of US dollars) by the HKMA for some time. It has remained at around HK$15.8 billion since 10 December 2004.
We closely monitor the foreign exchange positions in the banking sector. The information we have suggests that the long position in foreign exchange that the banking system holds has slightly declined in the past month. This means that the banking system has been a net seller of foreign exchange and a net buyer of Hong Kong dollars recently. This also means that the non-bank sector has in fact been a net seller of Hong Kong dollars during the same period.
We do not know who has sold these Hong Kong dollars - other banks or the non-bank sector. In any case, there are many different entities in the non-bank sector participating in the foreign exchange market, including foreign investors, domestic investors, importers, exporters and currency speculators. But this seems to tally well with the recent fall in the stock market, probably with foreign investors selling their Hong Kong stocks and consequently the Hong Kong dollar. I have no information to confirm this. And I really do not mind much. Markets go up and down. There are those who sell and there are those who buy, and if there is any significant difference in the dynamics in the interaction of these two groups constituting the market, the market price will adjust to equilibrate them. But there has been no outflow of funds from the Hong Kong dollar. The HKMA has not sold a single US dollar recently for the account of the Exchange Fund. And, in case readers forget, the HKMA will not sell US dollars until the Hong Kong dollar exchange rate touches 7.80 and until licensed banks express an interest to sell Hong Kong dollars at that exchange rate.
Since the stance of US monetary policy is expected to tighten further this year, interest rate arbitrage activity will likely trigger outflows. This would normalise our monetary conditions and allow Hong Kong dollar interest rate to move closer to those of the US dollar. Easy monetary conditions, with short-term interest rates at nearly zero, while beneficial to economic recovery for the time being, should preferably not be sustained for too long, to the extent of risking inflationary consequences in consumer prices or asset prices. But I should also add quickly that what I would like to see may not necessarily be how the market will behave under the non-discretionary Currency Board system that we adhere to. Market sentiment is influenced by a lot of things: the economic fundamentals, the (increasing) interest rate differential between the Hong Kong dollar and the US dollar and perception about the effect of a change in the renminbi exchange rate system. The market will decide when the outflow materialises.
Joseph Yam
27 January 2005
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