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Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Currency Board Sub-Committee held on 7 January 2005

(Approved for Issue by the
Exchange Fund Advisory Committee on 20 January 2005)

Report on Currency Board Operations (24 November - 22 December 2004)

The Sub-Committee noted that the Hong Kong dollar exchange rate had strengthened in the middle of the period under review but had weakened towards the end of the period, closing at 7.7819. Since the end of the period the exchange rate had weakened further to below 7.79. Short-term Hong Kong dollar interbank interest rates had risen markedly in the middle of the period because of demand for liquidity associated with equity initial public offerings (IPOs). Members observed that the Currency Board system had accommodated the large IPO-related liquidity requirements without problems. In view of the ample liquidity in the system, banks had kept their Best Lending Rates unchanged at 5.0%, despite the 25-bp increase in the US fed funds arget rate on 14 December.

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

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

Monitoring of Risks and Vulnerabilities

4. The Sub-Committee noted that growth in the US and East Asian economies had continued to be solid, but it had been slower than expected in Japan and the euro area. Recent data suggested that growth on the Mainland was gradually decelerating. In Hong Kong, the latest indicators pointed to a slowdown in domestic demand growth but to continued robustness in external trade and inbound tourism.

5. Noting a general view among analysts that, given the size of the US current account deficit, the US dollar was likely to depreciate further against other major currencies, Members considered a special analysis of the risks for Hong Kong of a further decline in the US dollar. The analysis suggested that, with an orderly depreciation of the US dollar, growth in Hong Kong would probably be boosted by improved competitiveness and looser monetary conditions. Disorderly adjustment, on the other hand, could give rise to marked contractionary effects through financial channels in the short term, but this would probably be offset by positive trade effects over time.

A Monetary Conditions Index for Mainland China

6. Members considered a paper presenting an empirical framework for assessing monetary and financial conditions in Mainland China by estimating a monetary conditions index (MCI). The MCI consisted of a weighted sum of real interest rate, real exchange rate and real credit growth. Members noted that the estimated MCI suggested a sharp easing in monetary conditions in 2002-2003, reflecting a weaker US dollar, a relaxed credit stance among banks, and the easing of deflation, which reduced real interest rates. This had contributed to the acceleration in economic growth during that period. More recently, a rise in the MCI indicates a tightening of monetary conditions, reflecting primarily a sharp slowdown in credit growth.

7. While noting that the concept of an MCI was theoretically useful, there were caveats in its empirical implementation. Difficulties arose in measuring the real interest rate, the real effective exchange rate, and credit stance, as well as in estimating the relative weights of the component variables.

For further enquiries, please contact:

Jasmin Fung, Manager (Press), at 2878 8246 or
Kevin Ip, Manager (Press), at 2878 1687

Hong Kong Monetary Authority
28 January 2005

Last revision date: 1 August 2011
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