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Record of Discussion of the Meeting of
the Exchange Fund Advisory Committee Sub-Committee
on Currency Board Operations held on 5 January 2001

(Approved for Issue by the Exchange Fund Advisory Committee on 18 January 2001)

Currency Board Operations for the Period 26 November - 20 December 2000

1. The Sub-Committee observed that markets had been generally quiet during the period under review. The Hong Kong dollar exchange rate had stayed very close to 7.8000 for most of the period. In early December the Aggregate Balance had fallen to a negative level following a triggering of the Convertibility Undertaking on 6 December. Subsequently in response to bank offers, the HKMA had sold Hong Kong dollars to restore the Aggregate Balance to positive.
2. Members noted the substantial increase in the backing ratio during the period under review. At 112.35% on the last day of the period, it had come very near to the upper trigger level of 112.5%, upon which assets from the backing portfolio would be transferred to the investment portfolio sufficient to reduce the backing ratio to 110%. A large part of the increase in December was attributable to net interest income on the backing portfolio, helped by a favourable interest differential. Although the backing ratio had continued to be close to the upper trigger level in late December and early January, the experience of past years suggested that it could be substantially reduced in the weeks leading up to Chinese New Year as the number of outstanding Certificates of Indebtedness would increase to cover additional banknote issue. It was unlikely, therefore, that the upper trigger would be reached in the near future. The HKMA would continue to monitor the movements of the backing ratio and take action as necessary.
3. The Sub-Committee noted that, in accordance with the currency board principles, changes in the monetary base during the reporting period had been fully matched by corresponding changes in foreign reserves.
4. The report on Currency Board operations for the period under review is at Annex A.

Monitoring of Risks and Vulnerabilities

5. The Sub-Committee noted an information paper assessing risks and vulnerabilities in the domestic and external environment relevant to Hong Kong's financial stability. The paper examined, among other topics, the general slowdown in economic activity in the US, Europe and Japan and the continuing growth momentum in East Asia, qualified by an expected slowdown in external demand and continuing political problems in some countries. For the purpose of comparison, the paper focused in particular on the recent financial crisis in Argentina, which, like Hong Kong, operated a currency board system. The paper noted that the crisis in Argentina was induced more by public finance problems (such as extensive external debt and a weak fiscal position) than by any weakness in the monetary system. Members observed that, in contrast, Hong Kong enjoyed strong fundamentals: it had been unaffected by the crisis in Argentina partly because trade links between the two economies were limited and partly because financial market participants were increasingly able to differentiate the two currency board systems, which rested on very different fundamentals.

HKAB Rules on Deposit Charges

6. Members considered a paper on the Hong Kong Association of Banks (HKAB) Rules on Deposit Charges. These rules had been made by HKAB in 1988, after consultation with the Financial Secretary, to allow for the imposition of charges on large Hong Kong dollar deposit balances at a time when the Hong Kong dollar was under significant upward pressure. The rules had not been applied at that time: the mere possibility that they might be imposed was sufficient to deter speculation. They had not been needed since.
7. The Sub-Committee noted that the full deregulation of the Interest Rate Rules was expected to take place in July 2001. Members recommended that this would also be an appropriate time to remove the Rules on Deposit Charges. They observed that considerable improvements to the currency board system since 1988 had provided the potential for unlimited creation of Hong Kong dollars against US dollars, which would be a potent tool against speculative inflows. They also considered that, should circumstances warrant, this potential could be made more explicit by setting a convertibility undertaking on the strong side of the link. Members noted that, as a last resort, the Financial Secretary had powers under section 3A of the Exchange Fund Ordinance which would allow him to levy charges on Hong Kong dollar balances in clearing accounts maintained by banks with the HKMA. Even in the absence of the HKAB rules on deposit charges, banks could, at their discretion, pass those charges on to their customers.

Balance of Payments Statistics: Examining Some Received Wisdom

8. Members noted an information paper questioning the conventional view that a fall in foreign exchange reserve assets necessarily reflected a deterioration in an economy's external position. The paper argued that, in the case of Hong Kong in particular, changes in reserve assets were mainly caused by changes in the demand for banknotes, or in Exchange Fund holdings of US dollars due to, for example, fiscal transfers. The paper pointed out that the deficit in the overall BoP account in the first quarter of 2000 was largely due to a decline in the demand for banknotes, rather than to a decrease in portfolio demand for Hong Kong dollar assets, as some analysis had suggested.

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Last revision date: 1 August 2011
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