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Joseph Yam reiterates no change on the Linked Exchange Rate System

There is no intention or plan to change or abandon the Linked Exchange Rate System, said Joseph Yam, Chief Executive of the Hong Kong Monetary Authority (HKMA), in a luncheon address to the Hong Kong Institute of Bankers today (Wednesday).

In a speech entitled "Building Stability in Unstable Times", Mr Yam said that although not perfect, the Link has served Hong Kong well, and there is no better or less risky alternative.

"A stable exchange rate provides a predictable and conducive business environment for an economy that imports practically everything that it consumes, processes or re-exports. And, for a financial centre with strong international capital flows but no capital controls, linking our currency to a strong international currency provides stability and strength," Mr Yam said.

The stability provided by the Link was of crucial importance during the current economic slowdown. "At this time of great global uncertainty and local distress, our efforts should be directed towards building stability, not destroying or undermining it," Mr Yam said.

Noting recent claims that the Link had been a drag on Hong Kong's competitiveness, particularly when compared with economies that had devalued their currencies, Mr Yam said that Hong Kong's real effective exchange rate (REER), which was a more appropriate measure of competitiveness than the nominal exchange rate had depreciated by around 13% since the crisis period in 1998. During the same period, the REERs for other Asian currencies had appreciated by various degrees, reflecting both a rebound in nominal exchange rates as well as high domestic inflation. He added that the sharp deceleration in growth of Hong Kong this year was due mainly to the slowdown in the major industrial economies outside the region, and not to any deterioration in its competitive position, and certainly not to the strength of the currency.

Mr Yam said that although the Link meant in effect that Hong Kong's monetary policy was determined by the US Federal Reserve and the US and Hong Kong economies may not be in sync at all times, "the misalignments are one of the trade-offs that we have to accept from time to time in return for exchange rate stability." He doubted if Hong Kong would be able to avoid importing US monetary policy even in the absence of the Link.

On the question of internal price deflation, Mr Yam pointed out that this was a necessary part of the process of adjustment imposed on the economy under the Link when there is a fall off in external demand. It was also incidentally, a feature of Hong Kong's longer-term economic integration with the Mainland.

He expressed doubt about claims that price deflation, as part of the adjustment process under the Link, might turn into the kind of spiralling deflation that inhibited investment and fueled recession. "At present, and despite nearly three years of steady price deflation, this does not appear to be happening. Indeed, the experience last year of robust growth and moderate price decline underlines the point that price deflation and economic expansion are quite compatible under a linked exchange rate system."

Mr Yam warned that depegging would bring problems even in the best of times. "The outcome, even with the most benign conditions and the best-judged strategy, can be summarised in two words, "uncertainty" and "instability". Uncertainty, because the Hong Kong dollar would become a magnet to speculators eager to test the limits and the weaknesses of the new regime, with all the instability that would bring. Uncertainty in the effects on business and on daily life, if, as a result of that instability or of a general fall in confidence, the value of the Hong Kong dollar depreciated dramatically and, in consequence, the price of our imports increased sharply. Uncertainty and instability, because if imported inflation was high, and if monetary policy were to be targeted towards stable domestic prices, it may not be possible to keep interest rates low."

Mr Yam said that carrying out depegging in the conditions facing Hong Kong now could result in catastrophe, since the worst possible time to change a fundamental monetary policy was when the economy was weak and the outlook full of risk. "In its banking system and financial infrastructure, and in its currency, Hong Kong enjoys a position of great strength. It is from this position of strength, and not through any sudden and destabilising gimmickry, that we will best be able to weather the difficulties that now face us, and to embrace the opportunities to come."

In addition to the discussion of the Link, Mr Yam examined Hong Kong's financial settlement arrangements and banking system in the wake of the September 11 incident. The HKMA has launched its own US dollar clearing system and greater use of the Hong Kong system for real-time settlement of Hong Kong dollar versus US dollar transactions would bring real benefits in terms of reduction and diversification of risk. The banking sector remains remarkably strong, despite declining profits at a time of increasing competition. The HKMA will continue the reform programme to remove barriers to competition with the aim of driving efficiency and energy in the banking sector.

"Sustained recovery will come only when the external situation improves. In the meantime, we should take what measures we can to control the damage, maintain stability and strength in our financial and banking systems, and position ourselves as best we can to get the best advantage out of recovery," said Mr Yam.

The full speech of Mr Yam is available on the HKMA website (


For further enquiries, please contact:

Jasmin Fung, Manager (Press) at 2878 8246, or
Thomas Chan, Senior Manager (Press) at 2878 1480


Hong Kong Monetary Authority
24 October 2001

Last revision date: 1 August 2011
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