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Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Sub-Committee on Currency Board Operations held on 3 September 2004

(Approved for Issue by the Exchange Fund Advisory Committee on 30 September 2004)

Report on Currency Board Operations (2 August - 20 August 2004)

The Sub-Committee noted that the Hong Kong dollar exchange rate had stayed close to the linked rate during the reporting period. The Convertibility Undertaking had been triggered on 4 August and the Aggregate Balance had fallen to HK$7.54 billion at the end of the period. Nevertheless, Hong Kong dollar interest rates had eased and had continued to stay below US dollar rates during the period.

Members observed that, subsequent to the period under review, there had been some further outflows of funds as a result of interest arbitrage trades, leading to further reduction of the Aggregate Balance to $4.4 billion on 3 September 2004. It was expected that these interest arbitrage trades would lead to further reductions in the size of the Aggregate Balance. Along with this, interbank interest rates could rise further. Members further noted that the loans for use in Hong Kong had grown significantly in the second quarter of this year. But given the abundance of liquidity in the banking system, reflected by the relatively low loan-to-deposit ratio, this should not cause a significant tightening in monetary conditions in the near term.

The Sub-Committee noted that, in accordance with Currency Board principles, changes in the Monetary Base during the reporting period had been fully matched by changes in the foreign reserves.

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

Monitoring of Risks and Vulnerabilities

The Sub-Committee noted that there had been a greater-than-expected slowdown in global growth in the second quarter, particularly in the US and Japan. While this had helped to reduce market expectations about interest rate increases in the near term, there had been renewed concern about surge in oil prices. Economic developments in Hong Kong continued to be encouraging: the Government had revised upwards its growth forecast for 2004 to 7.5% following the better-than-expected growth rate of 12.1% recorded in the second quarter. The main risks to the outlook of Hong Kong's economy remained (i) the pace of interest rate increases; (ii) the persistent rise in oil prices; and (iii) the magnitude of the slowdown of the Mainland economy.

In connection with the third risk, Members noted that, while the administrative macro-economic adjustment measures had moderated growth in GDP and investment in the Mainland, the inflationary and domestic demand pressures did not seem to have abated partly because of the loose monetary and financial conditions. The slowdown of the Mainland economy could present risks to Hong Kong, particularly in the financial markets, which had been used for hedging risks in the Mainland. However judged at this stage, these risks were unlikely to be so large as to threaten monetary and financial stability in Hong Kong.


Intra-regional Trade and the Role of Mainland China

Noting the concern about the potential impact of a slowdown of Mainland economy on the Asian economies through the trade channel, the Sub-Committee considered an information paper on developments in intra-regional trade and the role of Mainland China. Members noted that there had been a significant growth in the intra-regional trade over the past two decades. Some of this expansion in intra-regional trade represented a redirection of trade flows, consistent with greater production sharing among Asian economies and reflecting the comparative advantage of China in processing and assembly operations. Thus, China had played a crucial role in the expansion of intra-regional trade and its slowdown could have an impact on other regional economies, in particular, Taiwan, South Korea, Hong Kong and Japan. The impact would likely be limited provided that the slowdown remained concentrated in domestic demand components, but it could be more pronounced in the event of a credit crunch that affected exporting firms on the Mainland as well.


International Reserve Holdings - Are Financial Centres Different?

Noting that there had been discussions about the size of the foreign reserves in Hong Kong, the Sub-Committee considered an information paper on the demand for international reserves by considering the financial centre status of an economy as well as factors such as the size of an economy, trade openness and the exchange rate regime. Members noted that international financial centres (IFC), which were often confronted with substantial and volatile international capital flows, might seek to hold a higher level of foreign reserves. The results of the HKMA study confirmed that, after controlling for important variables such as the size of the economy, trade openness and IFC status, the level of foreign reserves in Hong Kong did not appear to be unusually high by international standards.


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
4 October 2004

Last revision date: 1 August 2011
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