Monetary Arrangements Under "One Country, Two Systems"

1. The resumption in the exercise of sovereignty over Hong Kong by China took place 82 days ago when the Hong Kong Special Administrative Region was formally established. It was a most important event for China as a whole and particularly for those of us in Hong Kong. As the flags of Britain and the Colonial Hong Kong Government were lowered and those of the People's Republic of China and the Hong Kong Special Administrative Region were raised within a minute or so at mid night on 30 June 1997, the impact on those of us at the ceremony, and many watching it on television, was intense.
2. There was, understandably, some nostalgia. This is to be expected at the end of any political era marked with economic success, regardless of the extent of the causal relationship between them. There was also, I think, much enthusiasm at the dawn of a new era which promises many opportunities, challenges and therefore even greater success. Then there were those of us, including myself, whilst greatly moved by the atmosphere, who quietly felt a sigh of relief that everything seemed to be going well and as planned, and that after all the celebrations we could all go back to our desks and continue to perform our respective roles so that Hong Kong could continue to prosper in much the same way as it had in the past.
3. You may be surprised to hear this: the past 82 days have been, to those of us at the Hong Kong Monetary Authority, a lot less demanding than any period in the ten years or so before the Handover. It is true that the preparations for the events on the occasion of the Annual Meetings of the International Monetary Fund and the World Bank have occupied quite a lot of our time. Recent turmoil in Asian financial markets and the ongoing discussions on strengthening Asian monetary cooperation also demanded our attention. But they are not as intellectually challenging as the preparatory work, undertaken well ahead of the Handover, for ensuring monetary and financial stability over a highly sensitive period of political transition.
4. Indeed, for the transition, a lot of low key, but elaborate and behind the scene efforts have been put in, which accounted for the excessively grey hair that I wear at this age. But with much support and cooperation from all those concerned, these efforts have proven to be very rewarding. This is evident in the rather uneventful transitional period on the monetary front. Currency stability has been maintained, notwithstanding an abundance of events which could have knocked our currency around - the 1987 stock market crash, the June 1989 events, the 1992 ERM crisis, the 1995 Mexican crisis and the attack on a number of currencies in Asia in the middle of this year, to name a few.
5. On the banking front, other than the unfortunate incident in which the Hong Kong subsidiary of BCCI had to be closed, triggering runs on a few banks, the transitional period has also been rather uneventful. The banking system has remained healthy with high capital adequacy ratios and low bad debt charges. Incidentally, all depositors of the BCCI subsidiary in Hong Kong have now received full repayment of their deposits.
6. Ahead of the Handover, I have in fact expressed the wish that, on the monetary and banking fronts, 1997 would, for Hong Kong, be a rather dull year. I am glad that this has, more or less, turned out to be the case. Even the volatility of Asian currencies did not affect the Hong Kong dollar.
7. Many will say of course that these are early days yet. I accept that and one must obviously not be complacent. But it is nevertheless pleasing to see that things are generally going well for Hong Kong. Economic growth continues to be robust. Inflation remains subdued. Unemployment remains very low. The fiscal position remains in substantial surplus. The balance of payments position looks healthy. Our foreign reserves remain among the highest in the world in absolute and in per capita terms. The exchange rate remains very stable. Our banks continue to be well capitalized. Although property prices look to new comers exceedingly high, that is the price of scarce land and prosperity.

"One Country, Two Systems"

8. The Hong Kong Special Administrative Region of the People's Republic of China has therefore made a very good start. This is an encouraging indication that the principle of "one country, two systems", which is enshrined in the many provisions in the Basic Law, prescribing the systems to be practised in Hong Kong, is entirely appropriate for our circumstances.
9. There has, nevertheless, been much skepticism about the practicality of the principle of "one country, two systems" ever since it was first laid down by the late Deng Xiaoping for dealing with the question about Hong Kong. This is understandable as the principle is untried and goes against the traditional understanding of what goes on in any one country.
10. For example, one would expect there to be free mobility of labour within a country, but this is not the case under "one country, two systems". One would expect a high degree of uniformity in social and economic policies for different regions in a country, but this is not the case under "one country, two systems". One would also expect any region within a country, however autonomous, to have to contribute to the public finances of the State and therefore be subject to some fiscal influence of the State, but this is again not the case under "one country, two systems".
11. And one would expect macro monetary policy and other currency matters to be determined by the central government and applied to all regions within a country. So when one hears of the idea of having two separate currencies in one country to be separately managed, particularly against the background of the very sharp focus in international monetary affairs on EMU, where it is intended there should be one currency for a number of countries, a skeptical reaction is indeed likely.
12. But the principle of "one country, two systems" is one that breaks away from tradition and cannot therefore be assessed against traditional understanding. As with all innovative ideas, one needs a fairly open mind, the time and patience, and understanding of the totality of the situation that one faces, to be able to appreciate the grandeur of that idea.
13. There is much difference between Hong Kong and the Mainland of China, in terms of quite a lot of things - anything that one cares to think of. For example, they are not exactly the most likely candidates for a successful economic and monetary union. I have often asked the skeptics to try and apply the Maastricht criteria to Hong Kong and the Mainland of China, and recommend a way forward. They invariably would come to the view that, if there is to be a smooth resumption of sovereignty by China over Hong Kong, then there should be as much segregation between the legal, social, economic, fiscal and monetary systems of Hong Kong and those of the Mainland as is politically acceptable. The "one country, two systems" principle is precisely designed for this purpose. Other than in defence and foreign affairs, Hong Kong has autonomy. Hong Kong people are to run Hong Kong on their own.
14. Another aspect which I often like to alert skeptics to is the fact that constitutionally, Hong Kong's autonomy as a Special Administrative Region of the People's Republic of China is higher, I repeat, higher than as a British Colony before the Handover. This is particularly the case in the monetary area and is evident when one compares carefully the relevant provisions in the Basic Law applicable after the Handover with those in the Royal Instructions from the Queen to the Governor of Hong Kong under the Colonial Administration before 1 July 1997. Furthermore, in order that our monetary legislation is consistent with the Basic Law, quite a number of amendments had been introduced, much ahead of 1 July 1997 to remove the need to refer matters to London before the Handover and to have the relevant powers in that monetary legislation localized. This in effect removed the implied need in the legislation to refer matters to Beijing after the Handover, which is consistent with the autonomy promised for Hong Kong and enshrined in the Basic Law.

The Basic Law

15. Perhaps you will be interested in knowing a little more about the monetary arrangements for Hong Kong under "one country, two systems". The starting point is naturally the Basic Law which contains five articles in the monetary area.
    • First, the Government of the Hong Kong Special Administrative Region shall provide an appropriate economic and legal environment for the maintenance of its status as an international financial centre (Article 109).
      
      Second, the Government of the Hong Kong Special Administrative Region shall, on its own, formulate monetary and financial policies, safeguard the free operation of financial business and financial markets, and regulate and supervise them in accordance with law (Article 110).
      
      Third, the Hong Kong dollar, as the only legal tender in Hong Kong, shall continue to circulate, and the existing currency issue mechanism shall continue (Article 111).
      
      Fourth, the Hong Kong dollar shall remain freely convertible, with free flow of capital and no exchange control (Article 112).
      
      Fifth, the Exchange Fund, which holds the bulk of Hong Kong's foreign reserves, shall be managed and controlled by the Government of the Hong Kong Special Administrative Region, primarily for regulating the exchange value of the Hong Kong dollar (Article 113).
16. These monetary provisions in the Basic Law are clearly designed to safeguard the continuing development of Hong Kong as an international financial centre, the maintenance of Hong Kong's monetary autonomy, its supervisory framework of internationally accepted standards, its freely convertible currency and its control over its own foreign reserves. Supplementing this constitutional framework is of course our own local monetary legislation with localized powers equivalent in nature and effectiveness to those of other central banks. This includes the Exchange Fund Ordinance which gives the necessary powers for operations to ensure currency stability, for the development of financial markets and their infrastructure, and for facilitating the further development of Hong Kong as an international financial centre. There is also the Banking Ordinance which gives the necessary powers to me, as Monetary Authority, to promote the stability and integrity of the banking system.

Cooperation and Consultation

17. I hope you are satisfied with these monetary arrangements for Hong Kong under "one country, two systems". If so, then I am glad; but I must confess that I did myself have some hesitation when I was first exposed to these various provisions in the Basic Law. Not that there is anything that I did not like. My initial hesitation arose from the recognition, on the one hand, that nothing is absolutely black and white, and that the different shades of grey that in practice we all see could conceivably be subject to different interpretations. I also recognized, on the other hand, the risk of overly elaborate legal provisions presenting Hong Kong's monetary and financial system with a rigid strait jacket.
18. It is obviously a difficult balance to strike and so in practice one must accept that there is always a need for close cooperation and consultation. I have full confidence that all those concerned would always bear in mind the spirit of the underlying principle of "one country, two systems" when approaching the occasional issues where there might be an element of doubt, and for such issues, as and when they arise, to be effectively and expeditiously resolved.
19. Indeed, this has always been the case, insofar as the monetary and financial areas are concerned, ever since the enactment of the Basic Law. The close cooperation and consultation have yielded pleasing results, with the monetary and financial system of Hong Kong going from strength to strength, even against a background of volatile international financial conditions, and notwithstanding the rather sensitive period of political transition where differences of opinion in other areas often hit the news headlines. Furthermore, for the benefit of those with a business interest in Hong Kong, and having regard to the fact that we are dealing with the very new concept of "one country, two systems", there is a willingness to lay down additional principles and policies consistent with the Basic Law whenever it is felt that grey areas may present unhelpful uncertainties.

Mutually Independent Relationship

20. There have, for example, been concerns about the exact relationship between the two monetary systems under the principle of "one country, two systems", notwithstanding the autonomy defined for the monetary system of Hong Kong in the Basic Law. Some felt that if the relationship between the two monetary systems is not clearly defined, there is risk that the rather more politically minded might wish to apply the otherwise "Natural" political relationship between the Central Government and the Special Administrative Region Government, thus subordinating Hong Kong's monetary system to that of the Mainland.
21. This would be a pity. It would clearly not be in the interest of Hong Kong as an international financial centre, and indeed for the continuing reform and liberalization of China, for there to be the slightest possibility that the Hong Kong dollar might be considered to be of less importance to China than the Renminbi, or the monetary system of the Mainland to have precedence over that of Hong Kong, or the Hong Kong Monetary Authority to be taking instructions from the People's Bank of China.
22. The relationship between the two currencies, the two monetary systems and the two monetary authorities has now been described as a mutually independent one, which is entirely sensible given the significance of Hong Kong's currency and other financial markets, in terms of their relative size to those of the Mainland and their level of sophistication. In this connection, the Mainland authorities have also confirmed in no uncertain terms that monetary legislation and regulations of the Mainland shall not be applicable to Hong Kong.
23. There have also been concerns, more so on the part of the Mainland authorities, about the extent to which Mainland entities of all dimensions, in pursuing their own interests, would wish to get involved in the monetary and financial affairs of Hong Kong, cutting special deals and making special arrangements, in a totally uncoordinated manner, which may in the end undermine the stability and prosperity of Hong Kong, the integrity of its financial markets and its development as an international financial centre.
24. This concern is not unjustified, given the size and complexity of the Mainland, and the stage of economic development that it is going through. It was felt, therefore, that there was a need for administrative discipline to be exercised on the part of the Mainland, through laying down principles and policies to be observed by Ministries, Departments and Provinces in the Mainland. As far as Hong Kong is concerned, it can be argued that the free market philosophy of Hong Kong and the clear rules of the game could be relied upon to impose the necessary discipline. But on balance a regulated and coordinated approach on the part of Mainland interests seems beneficial to Hong Kong, particularly in respect of dealings at the official level.
25. Yet another grey area which has been the focus of internal attention is the extent to which the international financial affairs of Hong Kong involve foreign affairs in which Hong Kong does not have autonomy, and how issues of this nature are to be dealt with in order that Hong Kong's development as an international financial centre would not be undermined.

Monetary Arrangements - Principles and Policies

26. With close cooperation and consultation, a number of basic principles and policies addressing these concerns have been emerging recently, although they are still subject to the final endorsement of the State Council. Let me attempt to outline my understanding of what they are to you.

27. First, all monetary legislation, regulations, policies and management directives enacted and practised in the Mainland shall not be applicable to the Hong Kong Special Administrative Region. The Hong Kong Special Administrative Region shall on its own lay down monetary legislation and regulations, and on its own determine and implement monetary policies.
    
    Second, all departments of the Mainland authorities shall not interfere with the monetary affairs of the Hong Kong Special Administrative Region. The monetary authorities of the Mainland and Hong Kong shall be mutually independent. The Mainland authorities shall not establish any organization that undertakes the roles of monetary management in Hong Kong.
    
    Third, financial businesses between the Mainland and Hong Kong are considered in the Mainland as external transactions and, where applicable, supervised as such within the framework of the relevant laws and regulations of the Mainland, and the Basic Law. Should any department in any province in the Mainland intend to promulgate policies and regulations which have a bearing on monetary affairs in Hong Kong or the monetary relationship between the Mainland and Hong Kong it shall first seek approval from the monetary authorities in the Mainland and the Hong Kong and Macau Affairs Office of the State Council. Important issues shall be referred to the State Council. All departments and provinces shall not sign any monetary agreement with the Hong Kong Special Administrative Region without approval.
    
    Fourth, The Hong Kong Special Administrative Region shall continue to maintain current arrangements for the issue and management of its currency. The Renminbi and the Hong Kong dollar shall circulate as legal tender in the Mainland and Hong Kong respectively. The Renminbi shall be considered as a foreign currency in Hong Kong and the Hong Kong dollar shall be considered as a foreign currency in the Mainland.
    
    Fifth, the monetary authorities of Hong Kong and the Mainland shall independently exercise their own authority in approving the establishment and the supervision of each other's financial institutions in each other's territory, and for this purpose shall continue to strengthen links and cooperation. The monetary authority of the Hong Kong Special Administrative Region shall independently conduct supervision and regulation in accordance with the laws of Hong Kong. Mainland financial institutions establishing and operating in Hong Kong shall be subject to the approval and supervision of the monetary authority of Hong Kong in accordance with the uniform standards applied in Hong Kong. Hong Kong financial institutions established in the Mainland shall be considered as foreign financial institutions.
    
    Sixth, financial transactions between the Mainland and Hong Kong shall be dealt with in accordance with internationally accepted rules and practices. Claims and liabilities between the Mainland and Hong Kong shall be regarded as external claims and liabilities. Disputes arising from financial transactions of the two sides shall be dealt with by reference to international standards. In respect of cases presented in the Mainland for arbitration or litigation, the relevant provisions in the laws of the Mainland concerning external issues shall apply.
    
    Seventh, Mainland enterprises listing in the Hong Kong Stock Exchange shall be considered as an overseas listing. Mainland companies listed in Hong Kong shall observe the relevant securities legislation of Hong Kong and be supervised by the relevant supervisory authorities of Hong Kong.
    
    Eighth, the Hong Kong Special Administrative Region may, in accordance with the provisions of the Basic Law and under delegated authority of the Central People's Government, on its own, using the name "Hong Kong, China", maintain and develop financial and monetary relations with foreign states and regions and relevant international organizations, including the conclusion and implementation of multilateral and bilateral financial and monetary agreements, the establishment of official and semi-official representative organizations in foreign countries, and the handling of matters concerning external monetary relations. For activities of international financial organizations, the participation of which is limited to sovereign countries, the Central People's Government shall, having regard to the circumstances, appropriately involve participation from the Hong Kong Special Administrative Region. China shall positively protect Hong Kong's interest in multilateral and bilateral financial activities conducted in international forums, with a view to maintaining and developing Hong Kong's status as an international financial centre.

27. These principles and policies are very clear and helpful. They are entirely consistent with the guiding principle of "one country, two systems" and with the relevant provisions in the Basic Law concerning financial and monetary affairs in Hong Kong. As Monetary Authority I feel very comfortable working within this framework. As I mentioned earlier, this framework gives us a higher degree of autonomy than before the Handover. Its clarity will also enable us robustly to defend our autonomy in the unlikely event that this is in any way challenged. I am hopeful that the international financial community, many of whom are members of your Institute, will also feel as comfortable as I am, operating from Hong Kong, contributing to and benefiting from the economic prosperity of this Region, particularly China. I look forward to your continued presence in Hong Kong. Thank you for listening to me.