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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 January 2002

(Approved for Issue by the Exchange Fund Advisory Committee on 24 January 2002)

Currency Board Operations for the Period 29 November - 19 December 2001

The Sub-Committee noted that the Hong Kong dollar had been generally stable during the period under review. Amid tightening interbank liquidity, the HKMA had, in response to banks' offers, sold a total of HK$0.23 bn, resulting in an expansion of the Aggregate Balance and a consequent softening of interbank interest rates. Interbank interest rates had further eased in the second week of December, following the 25 bps cut in the US Fed Funds Target Rate. Towards the end of the period, there had, as usual, been an increased demand for the Hong Kong dollar, partly reflecting market anticipation of higher local interest rates during the year-end period: the exchange rate had, as a result, strengthened. The Sub-Committee observed that, largely as a result of net interest income on backing assets and an increase in the outstanding amount of Certificates of Indebtedness, the backing ratio had increased during the period, although, at 111.60% at the end of the period, it was still some distance away from the trigger point of 112.5%, at which assets would be transferred from the Backing Portfolio to the Investment portfolio sufficient to reduce the backing ratio to 110%.

2. Members noted that neither the crisis in Argentina nor concerns about the depreciation of the yen had had much impact on the Hong Kong dollar exchange and money markets. With reference in particular to the Argentinian situation, it appeared that the markets were clearly differentiating between Hong Kong's currency board system and that in Argentina.

3. The Sub-Committee noted that, in accordance with Currency Board principles, changes in the monetary base continued to be fully matched by 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 the regular information on external and internal risks facing Hong Kong. Members observed that, externally, the situation in the major economies was continuing to evolve very slowly. There had been little hard evidence of any improvement in the indicators for the fourth quarter of 2001. More recently, however, some indicators suggested the beginnings of an upturn in the US economy, though it was too early to say whether these would be sustained. A particular concern was the deterioration in the labour markets of both the US and Japan, which could have a negative impact on consumer confidence and spending. Members noted the depreciation of the yen during the period under review. This was, in a sense, a two-edged sword: it raised concerns about pressures on other currencies in the region; yet if it helped stimulate Japanese economic growth this would generally be of benefit to the region. Members also noted that, so far, there had been little contagion from the Argentinian crisis into other markets. If, however, the peso devalued, the risk of contagion could increase.

6. The Sub-Committee noted that, for Hong Kong, the indicators continued to point to a slowdown in economic activity, despite an increase in the transaction volume of residential properties in November. The slowdown was expected to continue well into 2002, although there continued to be uncertainty about the prospects for growth for the year as a whole. Members noted that a particular concern was the continuing difficult fiscal situation.

Estimating Hong Kong's Output Gap and its Impact on Inflation

7. The Sub-Committee noted an information paper on Hong Kong's output gap and its relationship with inflation, with particular reference to the deceleration in Hong Kong's growth from an annual average of 7% in the period 1977-1994 to 3.5% in 1995-2000. The analysis in the paper suggested that, although Hong Kong's potential growth had moderated since the Asian financial crisis, it was still above the average of the G-7 countries. The negative output gap, which had emerged in 1998-9, had virtually vanished following the strong recovery in 2000, although a negative output gap was likely to re-emerge in 2001. The analysis suggested that the output gap had a significant impact on inflation both in the short run and the long run. A change in the import price had a significant contemporaneous effect on inflation, and was fully passed through to the domestic price over the long run. According to the research, the current deflation process was more a cyclical than a structural phenomenon, and was likely to continue in the immediate future as a result of the possible re-emergence of a negative output gap in 2001 and the long-run effect of the negative gaps of 1998-2000.

For further enquiries, please contact:

 

Jasmin Fung, Manager (Press), at 2878 8246 or
Sylvia Yip, Manager (Press), at 2878 1687

Hong Kong Monetary Authority
28 January 2002

Last revision date: 1 August 2011
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