Record of Discussion of the Meeting of the Exchange Fund Advisory Committee Currency Board Sub-Committee held on 27 July 2010

(Approved for Issue by the Exchange Fund Advisory Committee by circulation on 18 August 2010)

Report on Currency Board Operations (10 April 2010 - 8 July 2010)

The Sub-Committee noted that the Hong Kong dollar exchange rate had stayed at around 7.76 to 7.80 in the reporting period. The exchange rate had softened in May after the European sovereign debt crisis intensified and had remained calm after the People's Bank of China's announcement on 19 June 2010 of increasing the flexibility of the renminbi exchange rate. The Hong Kong dollar interbank interest rates had increased, reflecting upward movements in their US dollar counterparts and buoyant IPO activities in Hong Kong in mid-June and early July.

2. The Sub-Committee noted that the Monetary Base had remained steady at around HK$1,020 billion during the period under review.

3. 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.

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 that financial strains in Europe were likely to continue, with a confluence of sovereign and bank risks weighing further on global financial stability.

6. Economic recovery in the US had slowed. The austerity measures introduced by the governments in Japan, the UK and some European countries had added uncertainties to the economic outlook. Europe's financial problems could also dampen global demand.

7. Growth momentum on the Mainland was likely to moderate in the coming months. While inflationary pressures were expected to ease, the current macroeconomic policy stance was likely to be maintained. In Hong Kong, economic growth had likely slowed in the second quarter. Downward pressures on external demand would persist, and concerns about sovereign risks in the euro area would continue to threaten financial market stability.

8. Looking ahead, the sovereign debt problems in the euro area and Mainland's policy tightening might cause some slowdowns in the economic growth in 2010. As the dust settled, inflationary pressure might surface on renewed capital inflows into the Asian region in view of its better growth prospect relative to the advanced economies.

Analysing External Demand for the Hong Kong Dollar Currency

9. The Sub-Committee noted a paper estimating that the amount of Hong Kong dollar currency, mostly in the form of high-denomination banknotes, circulating in Mainland China and Macau had reached HK$100-140 billion, mainly reflecting increased economic integration between the Mainland and Hong Kong. The paper concluded that a gradual and orderly appreciation of the renminbi might reduce the external demand for the Hong Kong dollar banknotes but the magnitude would not be large. In the event that the continued appreciation of the renminbi led to a repatriation of the banknotes back to Hong Kong, the effect on the Hong Kong dollar exchange rate and interest rates would be minimal.

Review of the Formula for the Determination of the Base Rate

10. The Sub-Committee noted a paper reviewing the suitability of the existing formula for determining the Base Rate against the backdrop of potential changes to the long-term framework for monetary policy implementation in the US. The paper concluded that the formula for determining the Base Rate continued to be appropriate.

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Hong Kong Monetary Authority
23 August 2010