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Record of Discussion of the Meeting of
the Exchange Fund Advisory Committee
Sub-Committee on Currency Board Operations held on 7 May 1999

(Approved for Issue by the Exchange Fund Advisory Committee on 27 May 1999)

Currency Board Operations for the Period 29 March - 28 April 1999

The Sub-Committee noted that changes in the monetary base during the review period from 29 March to 28 April 1999 had been fully matched by corresponding changes in foreign reserves in accordance with the rules of the Currency Board arrangements. The Sub-Committee also noted that the markets had adapted well to the movement of the convertibility rate by 1 pip per calendar day, which had commenced on 1 April 1999 in order to gradually bring the rate for the Aggregate Balance (originally at 7.75) in line with that applicable to Certificates of Indebtedness (fixed at 7.80). There had been some selling of Hong Kong dollars ahead of the Easter holidays, reflecting market expectations of a slight weakening of the exchange rate along with the movement of the convertibility rate. But the exchange rate strengthened soon after the Easter holidays and had remained firm for much of the rest of the month, despite a slight weakening towards the end of the reporting period. The report on Currency Board operations for the period under review is at Annex A.

Convertibility Undertaking in Respect of Banknotes

2. The Sub-Committee examined the desirability and feasibility of providing a convertibility undertaking through opening a facility to the general public, operated by the HKMA, for converting Hong Kong dollar banknotes into US dollar notes at a fixed rate of 7.80. Members considered that, while such a facility might be attractive in principle, a number of practical issues would be likely to arise were it to be implemented. These included the need to draw up new arrangements with the note-issuing banks to enable the HKMA to dispose of the Hong Kong dollar banknotes acquired through the facility in a way that would be consistent with the Currency Board arrangements. Additional problems would arise from the costs and problems associated with holding sufficient US dollar notes to accommodate any demands that might be made on such a facility. The Sub-Committee also noted that, in offering a direct exchange facility, the HKMA might be seen to be competing with banks for retail currency exchange business, particularly as the convertibility rate for banks' clearing balances approached 7.80.

3. The Sub-Committee concluded that the existing route for converting Hong Kong dollar banknotes through retail banks already supplied the general public with a convenient currency exchange service. The Sub-Committee further concluded that, given the high level of confidence in the existing arrangements for backing Hong Kong dollar banknotes with Certificates of Indebtedness, any additional assurance that might result from a direct convertibility undertaking for banknotes would probably be very limited. The Sub-Committee therefore agreed that the establishment of such a facility was not necessary.

Banks' Management of Clearing Balances

4. The Sub-Committee considered an analysis of banks' management of their clearing balances. The analysis found that the major determinants of banks' demand for clearing balance were the anticipated demand for liquidity to manage scheduled interbank transactions and the precautionary demand for liquidity to provide for unexpected events. The latter included late transfers of funds, a drawing down of overdrafts, or a sudden liquidity shortage in the money market arising from an outflow of funds from the Hong Kong dollar. Members noted that, while all banks sought to maintain as small a positive clearing balance as possible, since such a balance was non-interest bearing, the average clearing balance varied according to type of bank. For example, foreign banks generally kept much smaller clearing balances because their lack of extensive retail networks made their liquidity less vulnerable to unpredictable swings, and because their dependence on interbank funding implied a higher opportunity cost in holding surplus liquidity than was faced by banks with a sizeable retail deposit base. Members also noted that institutional changes over time (such as implementation of the Real Time Gross Settlement System in December 1996, the restrictions on repeated borrowers from the Liquidity Adjustment Facility between November 1997 and September 1998, and the introduction of the Discount Window in September 1998) had had important influences on the ways in which banks developed their liquidity management strategies.

5. Members noted that discrepancies between the target and actual levels of clearing balance occurred from time to time and that, at the close of market, banks sometimes found themselves sitting on idle clearing balances: they were generally unable to switch out into foreign currency assets because spot foreign exchange transactions were settled on a T+2 basis. Members considered whether there was a need to introduce a facility, such as reverse repo or special tap issues of Exchange Fund paper, to absorb excess transient liquidity of this kind. Such a facility, if introduced, could be on the basis of discretionary offers by the HKMA rather than a continuous facility. Members observed that any such transient increases in liquidity would be unlikely to undermine the normal functioning of the interest rate adjustment mechanism. They also expressed concern that any discretionary element in a facility of the kind under consideration might be seen as an attempt by the HKMA to control interest rates or as a policy of remunerating banks for holding clearing balances.

6. Members further considered that the various measures introduced since last September (such as the Discount Window, the Convertibility Undertaking in respect of the Aggregate Balance, and the movement of the convertibility rate for the Aggregate Balance by 1 pip per calendar day from 1 April 1999) had already stabilised the monetary system. To reduce further the scope for variability in the overnight interest rate could have the effect of making the system too rigid. The Sub-Committee therefore concluded that a facility for absorbing transient capital inflows was not necessary at present, but agreed that the matter should be kept under review.

Maturity Structure of Exchange Fund Paper Issuance

7. The Sub-Committee noted an information paper on the Maturity Structure of Exchange Fund Paper issuance.


Hong Kong Monetary Authority

31 May 1999

Last revision date: 1 August 2011
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