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Record of Discussion of the Meeting of
the Exchange Fund Advisory Committee
Currency Board Sub-Committee held on 7 December 2007

(Approved for Issue by the Exchange Fund Advisory Committee by circulation on 4 January 2008)

Report on Currency Board Operations (6 November - 23 November 2007)

The Sub-Committee noted that the Hong Kong dollar exchange rate had weakened during the reporting period. Interbank interest rates had eased, while their negative spreads against US dollar interest rates had widened. The Monetary Base had declined slightly from HK$313.95 billion to HK$313.20 billion.

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.

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 there was a high degree of uncertainty facing the global economy. Although most forecasts indicated only a modest slowing of the global economy in 2008, this appeared to depend on the resilience of demand outside the US, which was likely to see an extended period of below-trend growth as a result of problems in the credit markets and a housing-market correction.

5. East Asian economies had experienced strong capital inflows in the recent months as global investors had rebalanced portfolios away from US-dollar assets. The Hong Kong dollar had been strengthening against the US dollar since late July. Following the HKMA's operations within the Convertibility Zone and the triggering of the strong-side Convertibility Undertaking in late October, the Aggregate Balance had expanded from $1.3 billion to $10.6 billion, leading short-term interbank interest rates to fall to very low levels.

6. The yield spreads between Exchange Fund papers and HIBOR had widened since August and the yields on short-dated Exchange Fund Bills had even turned negative for a period in November. The increased demand for the short-dated Exchange Fund bills might reflect in part the credit concerns arising from the sub-prime problem. Another, perhaps more important, contributing factor was related to the strong demand for the paper for intra-day liquidity to meet settlement obligations, alongside the increase in equity-market transactions. The Sub-Committee agreed that there might therefore be a need to increase the supply of Exchange Fund paper through tap issues. The Sub-Committee noted that this would be in line with the principles for operations within the Convertibility Zone laid down when the three refinements to the Linked Exchange Rate system were adopted in 2005.

7. Economic expansion in Hong Kong had continued in the third quarter supported by expansion in private consumption and business spending. Underlying inflationary pressure had increased with CCPI inflation reaching 3.2% year on year in October. Inflationary pressure was likely to persist reflecting strong domestic demand and a tight labour market, a weakening US dollar, rising global food prices and the likely pass-through of property prices to rents. However, rapid labour-productivity growth and a weaker global economy were likely to mitigate the pressure.

 

Is the Hong Kong Dollar Real Exchange Rate Misaligned?

8. The Sub-Committee noted a paper applying International Monetary Fund (IMF) methodologies to estimate the equilibrium path of the Hong Kong dollar real effective exchange rate and comparing it with the actual path. The study concluded that there is no obvious evidence of exchange-rate misalignment for the Hong Kong dollar in 2006. This was consistent with the observation that there were no obvious signs of macroeconomic imbalances in the Hong Kong economy. Similar conclusions were reached by the IMF in its recent Article IV report on Hong Kong.

 

A Leading Indicator Model of Banking distress - Developing an Early Warning System for Hong Kong and Other EMEAP Economies

9. The Sub-Committee noted a paper that identified a set of leading indicators of episodes of banking-system distress based on quarterly panel data from the 11 EMEAP economies. The predictive power of the resulting economic model was assessed to be reasonably good. The model suggested that weakening macroeconomic fundamentals; an increase in money supply relative to foreign reserves; deteriorating credit-worthiness of banks and companies; and significant asset-price misalignments, especially if fuelled by strong credit growth, were useful leading indicators of problems. Stress-testing using a number of stress scenarios suggested that the Hong Kong banking sector was healthy and well able to withstand the simulated shocks.

 

For further enquiries, please contact:
Thomas Chan, Senior Manager (Press), at 2878 1480 or
Hing-fung Wong, Officer (Press), at 2878 1802

Hong Kong Monetary Authority
11 January 2008

Last revision date: 1 August 2011
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