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Record of Discussion of the Meeting of
the Exchange Fund Advisory Committee
Sub-Committee on Currency Board Operations held on 4 May 2000

(Approved for Issue by the Exchange Fund Advisory Committee on 25 May 2000)

Currency Board Operations for the Period 1 - 20 April 2000

1. The Sub-Committee noted that during the period under review the Hong Kong dollar exchange rate had eased slightly from 7.7864 to 7.7886, following closely the movement of the convertibility rate in respect of the Aggregate Balance. The Currency Board system had operated smoothly during a period of sharp corrections in the local stock market, with periodic outflows of funds. The Aggregate Balance had been volatile, reflecting market activity, and the Convertibility Undertaking had been triggered on a number of occasions. Members observed, however, that the volatility in the Aggregate Balance had not had a destabilising effect on the money market. Short-term interest rates had edged up slightly, but this appeared to be due more to a reversal of unusually liquid conditions in March than to any decline in market confidence. The twelve-month HIBOR remained very stable, which suggested that the markets were accepting the frequent flows into and out of the Aggregate Balance very well.

2. Members observed that there had been a general downward trend in the level of the Aggregate Balance since the introduction of the technical measures in September 1998, and agreed that further research into the dynamics of the Aggregate Balance and the usage of the Discount Window over the past 20 months would be of interest to the Sub-Committee.

3. The Sub-Committee noted that changes in the monetary base during the period under review had been fully matched by changes in foreign reserves in accordance with the Currency Board arrangements.

4. The report on Currency Board operations for the period under review is at Annex A.

Currency Board Arrangements in Argentina and their Relevance for Hong Kong

5. The Sub-Committee considered a paper on aspects of Argentina's currency board system, which focused in particular on the core of that system, the dollarisation of banks' clearing balances. Members noted that the dollarisation of these balances with the Banco Central de la Republica Argentina (BCRA) had been introduced at a time of crisis in 1995 as a confidence boosting measure, rather than as a technical measure to improve liquidity management. The measure had three main implications for the monetary system in Argentina. First, it reduced any incentive the BCRA might have had to devalue the peso by converting its liabilities into US dollars (a measure of greater significance for Argentina than for Hong Kong, since banks' clearing balances in the former also include statutory liquidity deposits). Secondly, it decoupled the impact of liquidity management from the asset demand factors determining peso interest rates, so that sudden shocks to liquidity in the clearing system did not affect the determination of peso interest rates. Thirdly, it marked a very significant step towards dollarisation, in that it denominated an important component of Argentina's monetary base in US dollars.

6. The Sub-Committee considered what uses, if any, dollarisation of the Aggregate Balance along the lines of the Argentinian model might have for Hong Kong. Members observed that the theoretical technical advantages of such a measure included the removal of exchange rate, settlement and portfolio risks currently entailed in the switching between US dollars and Hong Kong dollars in the Aggregate Balance. Members noted, however, that these risks could be removed, or at least mitigated, by measures other than dollarisation of the Aggregate Balance. For example, exchange rate risk could be removed by constraining movements in the exchange rate for the Convertibility Undertaking to an even narrower range, settlement risk could be removed by changing the settlement convention from T+2 to T+0, and portfolio risk had already become less of an issue following the technical measures introduced in September 1998.

7. Members concluded that, while the dollarisation of the Aggregate Balance had some technical merits, these advantages could not be achieved without generating the unintended signaling effect that a substantial step towards dollarisation of the currency as a whole had been taken. Since the Sub-Committee had already advised against dollarisation as a policy, and, in view of the fact that any of the technical difficulties addressed by dollarisation of the Aggregate Balance could be dealt with by other measures, Members advised that the measure was not appropriate for Hong Kong. Members advised, however, that dollarisation of the Aggregate Balance might be held in reserve as a possible contingency measure. Its desirability would depend on whether a step towards dollarisation would be appropriate to alleviate the difficulties that Hong Kong's currency board system might face, without unpalatable side effects.

Budget for Financial Year 2000: a Preliminary Assessment

8. The Sub-Committee considered an information paper assessing the implications of the 2000 Budget.


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Last revision date: 1 August 2011
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