Hong Kong's Monetary System after 1997
Speeches
01 Aug 1994
Hong Kong's Monetary System after 1997
Joseph Yam, Chief Executive, Hong Kong Monetary Authority
(Speech to Hong Kong - Singapore Business Association)
Introduction
It is a great pleasure to be here in Singapore to address the
distinguished members and guests of the Hong Kong-Singapore
Business Association.
- Your Association has contributed much to strengthening the
economic ties between Singapore and Hong Kong. Last year, Singapore
was the sixth largest supplier of Hong Kong imports and also the
sixth largest export market for Hong Kong. Taking Hong Kong's
domestic exports alone, Singapore was Hong Kong's third largest
market, after China and the United States. In the banking sector,
Singapore has nine banking institutions in Hong Kong and three
banks from Hong Kong are present in Singapore.
- Your Commissioner in Hong Kong, in his recent message on the
occasion of Singapore's National Day (9 August 1994) quite rightly
pointed out that, whereas there is always a spirit of friendly and
healthy competition between our two places, there are also great
opportunities for co-operation. Indeed, we all benefit from the
progress that comes with competition and the prosperity that comes
with co-operation.
- There are many things that we can learn from each other. Your
Senior Minister, Mr. Lee Kuan Yew, has once said in Hong Kong that,
over the past decades, he had formed a habit of visiting Hong Kong
at least once a year, and each time he would learn something new.
Well, we in Hong Kong have learnt from the Lion City too. For
instance, we have modelled our Home Ownership Scheme on Singapore's
and this Scheme has become a very important and popular element in
our housing programme. On the central banking front, our newly
created Hong Kong Monetary Authority (HKMA) has a lot to learn from
the Monetary Authority of Singapore.
Political Transition
- The subject of my speech this evening is Hong Kong's monetary
system after 1997. An appropriate starting point is perhaps the
political transition. 1 July 1997 is of course not far away. There
are, in fact, 1,040 days to go. But do not take me wrong. I am not
really counting the days, although I understand that somewhere in
Beijing there is now a clock of some sort operating a count down.
The date is of course an important one, particularly from a
political point of view, for it will mark China's resumption of
sovereignty over Hong Kong. But in many other respects, it would
probably be just another day in which life of the majority of the
people of Hong Kong goes on, in much the same way as in the
past.
- A few years back, in particular shortly after June 1989, there
was quite widespread apprehension in Hong Kong about the approach
of 1997, and understandably so. But now, I can sense that the
people of Hong Kong are increasingly looking forward to 1997. This
is perhaps particularly marked amongst businessmen, for two
reasons. First, they hate uncertainties and are hoping that
whatever residual uncertainties concerning the political transition
could be removed by 1997. Secondly, and perhaps more importantly,
they can see the business potential that will be open to them in
China.
- I am not privy to what exactly will happen on 1 July 1997.
There will inevitably be the ceremonial events marking the
historical occasion. But as the Chief Executive of the Hong Kong
Monetary Authority today, responsible to the Financial Secretary
for maintaining monetary and financial stability in Hong Kong, I
would actually like the date of 1 July 1997, or the year 1997, or
the whole of the transitional period, however defined, to be as
dull as possible. Again, do not take me wrong. I have no wish to
belittle the political significance of 1997. But I very much hope,
and would wish to demonstrate to those interested, that the
monetary significance of 1997 for Hong Kong is nil.
- Public officers and community leaders in Hong Kong have often
been asked the question as to what comes after 1997. One
industrialist gave what I think is the best answer. What comes
after 1997 must of course be 1997. This is, in fact, much more than
just a punchy answer. The spirit of that answer is of course that
life will go on as it has in the past. The monetary system of Hong
Kong will after 1997 remain the same as before.
Constitutional Safeguards on the Monetary System
- There are constitutional safeguards that this will be so. I am
sure you have heard about the Sino-British Joint Declaration and
the Basic Law. These are very important documents for anyone who
wishes to look at any aspect of Hong Kong's future. They were
constructed with the basic aim of maintaining the capitalist
system, the way of life, the stability and prosperity of Hong Kong.
The Joint Declaration elaborates the basic policies of the People's
Republic of China regarding Hong Kong after 1997. And in order to
ensure the implementation of such basic policies the Basic Law
prescribes the systems to be practised in the Hong Kong Special
Administrative Region (SAR) after 1997.
- Some have played down the significance of these documents,
saying rather cynically that they are merely pieces of paper,
implying that they may not be observed by the parties that
promulgated them. To these people, my personal advice to them is
that they should forget about Hong Kong altogether. They should
just pack up and go. But for the majority of us who have confidence
in the sovereign states involved to stick by their words, there is
I think a very clear framework and a very promising scenario.
Afterall, where else in the world do you have pieces of paper
safeguarding the continued stability and prosperity of a
place?
- Let me focus on the safeguards in respect of the monetary
system. These are outlined in Section VII of Annex I of the Joint
Declaration and Articles 109 to 113 of the Basic Law, and for your
reference I have reproduced these as an appendix to the printed
version of this speech. They are not very long but they are very
clear. Those who have a serious interest in the monetary system of
Hong Kong should examine them carefully. But let me first highlight
the main provisions here before examining some of them in greater
detail. The main provisions are as follows:
- Hong Kong shall retain the status of an international financial
centre
- the monetary and financial systems of Hong Kong shall be
maintained
- Hong Kong to decide monetary and financial policies on its
own
- there shall continue to be free operation of financial
business
- there shall continue to be free flow of capital
- the financial markets of Hong Kong shall continue to
operate
- the Hong Kong dollar, as legal tender, shall continue to
circulate
- the Hong Kong dollar shall remain freely convertible
- the authority to issue, or designate banks to issue Hong Kong
currency, is vested with the Hong Kong SAR Government
- Hong Kong's reserves shall be managed and controlled by the
Hong Kong SAR Government
- These provisions are really quite comprehensive. They ensure
that Hong Kong's monetary system will be the same after 1997 as
before. Let me elaborate on a few of these. I have chosen those on
which some doubts have understandably been expressed. The doubts
were not so much on whether the provisions will be strictly adhered
to, but on whether they can be realistically observed, having
regard to recent economic developments in China and the likely
trends in the foreseeable future.
Hong Kong as an International Financial Centre
- The first sentence of that section in the Joint Declaration
concerning the monetary system specifies that the Hong Kong SAR
"shall retain the status of an international financial centre". In
this connection there have been comments made that whether Hong
Kong is an international financial centre is not a matter for
declaration by sovereign states, but is a matter for recognition by
those who use Hong Kong as a financial centre. And so the Basic Law
further specifies that the Government of the SAR "shall provide an
appropriate economic and legal environment for the maintenance of
the status of Hong Kong as an international financial centre".
- But whatever wording is used, the spirit of the provisions is
clear. And it sets a task for public officers like myself to
provide that appropriate economic and legal environment. I believe
that environment exists now, in a form which is quite familiar to
Singapore because it is also practised here, although with varying
emphasis in its elements. I shall therefore not bother to describe
to you the elements that make up that environment. The task at hand
is to ensure that this appropriate economic and legal environment
is maintained and perhaps further enhanced. The world around us is
changing. Hong Kong is itself changing too, perhaps even more so
than other parts of the world. The task is therefore not a simple
one. As someone who has responsibility to perform that task, I have
identified four areas which we need to handle carefully.
- First, although none of the factors contributing to the
favourable economic and legal environment will change directly as a
result of the resumption of sovereignty over Hong Kong by China in
1997, Hong Kong does not remain static. Aspirations of an
increasingly affluent society undergoing economic transformation
and political transition are most complex. Meeting these
aspirations involves costs and trade offs, and possibly risks of
erosion of this favourable environment. Public officers will have
to be vigilant in identifying such risks and persuasive in
presenting them so that they could be properly taken into account
in the decision making process. This seems to have become more
difficult in recent years. Issues in Hong Kong, at least to me, now
have a disturbing tendency to get politicized. Nevertheless, public
officers are very adaptable and I have full confidence that the
good sense of the people, politicians and civil servants alike, to
act in the best interest of Hong Kong would in the end
prevail.
- Secondly, as some have pointed out, Hong Kong does not have a
monopoly over that favourable economic and legal environment. To a
varying degree other centres have it as well, notably Singapore.
And as they do not have the type of political transition over the
horizon as Hong Kong, when comparisons are made, an unfavourable
perception arising from the fear of the unknown could well develop.
This could undermine Hong Kong's position. There is therefore a
much greater need for those concerned, including friends of Hong
Kong, to explain to others objectively what is going on, so as to
pre-empt that perception. Changes bring opportunities. The
political transition that Hong Kong is experiencing are unique, and
the opportunities are therefore also unique to Hong Kong.
- I would say in this connection that there has perhaps been too
much comparison between Singapore and Hong Kong; as if there is not
enough room for both to play a meaningful role, or as if there is
not enough business around to share. This Region has been the
fastest growing area in the world for some years now, and it will
continue to be the fastest growing area in the world for I think
many more years to come. Intra-regional trade has, in recent years,
developed quite a momentum of its own, with a corresponding
reduction in the dependence of the Region upon the economies of the
western world, which are themselves improving. My worry is in fact
that there may be too much for us to handle.
- Thirdly, the nature of the business carried out in
international financial centres is itself changing. We have seen
recently quite a rapid process of financial liberalization,
particularly in the economies of this Region. As a result, domestic
financial markets have emerged; and, supported by sound and open
domestic economic policies, these markets are attracting increasing
attention, and substantial funds, directly from outside,
particularly from the developed economies of the West. Financial
markets have also become globalized with the advance of
telecommunications technology. And so it does not now matter where
you are or what you want to deal in. As long as there is a
telephone, and it can of course be a mobile one, you can buy a
Euro-Yen bond issued, say, by a Mexican company while sailing in
the South China Sea during our time zone.
- In response to this, there is I think the need for a
corresponding shift of policy emphasis in Hong Kong's development
as an international financial centre. Greater attention should be
given to the development of an efficient financial system with a
robust market infrastructure. Funds are being attracted to this
Region in view of the higher rate of return available compared with
that of the rest of the world. But return is not all. Investors
would want also to minimize the risks involved and, in particular
for financial investments, retain a high degree of liquidity. Funds
will gravitate to markets with high liquidity and a high degree of
integrity, and to jurisdictions in which funds can be transferred
in and out safely. These are matters currently of great interest to
central bankers. If you have the privilege, or the burden, to
listen in to discussions amongst central bankers nowadays, within
five minutes you will hear them talking about derivatives and the
management of risks arising therefrom, or payment systems and real
time gross settlement, or the legal enforceability of netting and
its treatment in relation to capital adequacy. Ensuring that there
is an efficient and robust market infrastructure is now one of the
main objectives of the HKMA.
- Fourthly, Hong Kong has to take account of developments in
other financial centres within China. That Hong Kong shall retain
the status of an international financial centre is the basic policy
of the People's Republic of China on Hong Kong after 1997, as
elaborated by the Chinese Government in the Sino-British Joint
Declaration. As far as I am aware there is no similar policy in
respect of other centres in China, although it has been reported
that the leaders in Beijing have expressed the wish that Shanghai
should also play the role as an international financial centre.
Whatever that has been said, I think there is scope for exploring
objectively and jointly what roles should be played by the two
centres after 1997 and the relationship between them. The aim
should be to ensure that whatever roles are played, they should be
complementary to ensure efficient use of scarce resources.
- Insofar as Hong Kong is concerned, as an international
financial centre it is ready made. Its unique position under the
concept of "one country, two systems" makes it the most ideal place
for facilitating foreign investments in China. Investors all over
the world are attracted by the opportunities for a high rate of
investment return in China. It is only realistic to expect that
opportunities for high return carry high risks as well. And in
terms of financial investments, the risks are familiar - exchange
risk, counterparty or credit risk, liquidity risk, market risk,
legal risk, systemic risk, etc. And, as I pointed out earlier,
prudent investors all want to minimize and properly manage these
risks. They find that they can do so more effectively in financial
markets with a high degree of liquidity, a high degree of
integrity, suitable regulation, etc. And where else can this be
done with confidence and convenience than in Hong Kong, before or
after 1997? For this reason, Hong Kong is increasingly serving as a
window for China to access international capital, as the reform and
liberalization of the economy of China intensify. There has been,
for example, a significant number of Chinese enterprises, which
satisfied the market requirements in Hong Kong, successfully
listing their shares in the Stock Exchange of Hong Kong, attracting
substantial foreign investment funds.
- By contrast, I foresee Shanghai to be the main centre for RMB
business, channelling domestic savings into productive investment.
In this, Hong Kong will only have a limited role to play, at least
for the time being, in view of the current restrictions in the flow
of RMB to outside the mainland. But I have always held the view
that, as Hong Kong will formally be a city in China after 1997,
there really should not be any restriction in the flow of RMB to
Hong Kong from then on, if not before. This would not lead to the
migration of the wholesale or retail RMB business to Hong Kong. But
it would have the advantage of facilitating the move of the RMB to
full convertibility, as there are no, and will not be any, exchange
controls in Hong Kong. This can be a managed process, whereby the
mainland's restrictions on the flow of RMB to Hong Kong could be
gradually relaxed in the light of market signals and for the pace
to be closely monitored. With increased convertibility of the RMB,
the prospects for international financial business to develop in
Shanghai would in turn improve.
The Hong Kong Dollar
- This is a convenient point to turn to the Hong Kong dollar.
Here again, both the Joint Declaration and the Basic Law are
crystal clear. The Hong Kong dollar, as the legal tender in the
Hong Kong SAR, shall continue to circulate and remain freely
convertible. The free flow of capital shall be safeguarded and no
exchange control policies shall be applied.
- Nevertheless, pointing to the fact that the economies of China
and Hong Kong are becoming increasingly integrated, there have been
queries as to whether the Hong Kong dollar would eventually be
replaced or displaced by the RMB. I quite understand that Hong Kong
is small and China is big, and that this could mislead one to think
that the economy of Hong Kong, its currency and its financial
markets, might somehow be absorbed by those of China. With a
population of about 6 million, Hong Kong is indeed small when you
look at the corresponding figure of 1.2 billion in China. It is
only half a percent of China's. But as an economy Hong Kong is not
small. As a currency the Hong Kong dollar is not small. And
certainly Hong Kong dollar based financial markets are not small.
You will I think be surprised to learn that the total money supply
(in domestic and foreign currencies) in Hong Kong is equivalent to
about two-thirds of the money supply in the mainland. (The Hong
Kong dollar money supply is about a third of the RMB money supply.)
The market capitalization of the Hong Kong Stock Exchange is in
fact 13 times that of the Shanghai Stock Exchange (of which only 6%
is open to foreign investors in the form of B-shares). And the
foreign reserves of Hong Kong are almost twice as large as that of
China at the end of last year.
- What has in fact been happening, along with the increasingly
close economic ties between Hong Kong and China, particularly the
southern part of China, is that the Hong Kong dollar is becoming
more and more popular as a currency in China. A rough estimate
shows that about 20 to 25% of the Hong Kong dollar bank notes
issued are circulating in China. The amount had been increasing
fairly rapidly in recent years, but appeared to have stabilized
somewhat in the first half of this year. This I believe is a
response to the re-iteration by China at the beginning of this
year, in relation to the measures taken to unify the RMB exchange
rates, of a long standing policy prohibiting the circulation of
foreign currencies in China. But I understand that this policy is
being pragmatically applied in respect of the Hong Kong dollar, in
order that the full benefits of the closer economic ties between
Hong Kong and China could be realized. There must be about three
million workers employed now in the Guangdong Province by Hong Kong
businesses. This is equivalent to the size of the labour force in
Hong Kong and about the population of Singapore. It would be
difficult for the prohibition of the circulation of foreign
currencies to be strictly enforced. Furthermore, the Hong Kong
dollar will no longer be a "foreign" currency after 1997. The
concept of "one country, two systems" also means "one country, two
currencies". And for the wisdom underlying this forward looking
concept to be transformed into tangible benefits for the country,
and for these benefits to be maximized, it can be convincingly
argued that limitations on the convertibility between the two
currencies and the currency flows between the two systems should be
minimized and eventually eliminated.
- In any case, money flows around obstacles created to restrict
its movement. Restricting the wider use of the Hong Kong dollar in
the southern part of China might, I fear, lead to the re-emergence
of the currency black market that China has just successfully
eliminated. I think the Chinese authorities are well aware of this
risk. At the same time, it seems obvious that the use of the Hong
Kong dollar there has led to the economy of Guangdong being a lot
more prosperous than other provinces. The best policy in the
circumstances is indeed one of pragmatism.
- And how about the role of the RMB in Hong Kong? There are no
exchange controls in Hong Kong. So the RMB is, and will continue to
be, just another currency that can be freely traded in Hong Kong
like the US dollar. Tendering a currency which is not legal tender
is in fact not illegal. It is up to the payee whether or not to
accept it. At the retail level, there would understandably be
increasing acceptance by shops wishing to attract consumers from
the mainland, particularly if the RMB exchange rate remains stable
and the RMB can be readily converted into the Hong Kong dollar,
just as the shops are happy to accept US dollars and other freely
convertible currencies from tourists. But this is not to say that
the RMB would gain popularity generally as a medium of exchange, as
a store of wealth or as a unit of accounting in Hong Kong. This did
not happen in the case of the US dollar, even though by virtue of
our exchange rate policy the Hong Kong dollar is really an
extension of it. There is no reason why this would become the case
for the RMB. At the wholesale level, the RMB may also increasingly
be used for the settlement of external trade transactions involving
China, as China's trade relations with Hong Kong, and through Hong
Kong with the rest of the world, grow. Again, as with the case of
the US dollar being the main currency used for trade transactions,
this would not undermine the position of the Hong Kong dollar as
the currency of Hong Kong.
Monetary Policy
- Let me say a few words on monetary policy after 1997. The Basic
Law specifies that the Government of the HKSAR shall, on its own,
formulate monetary and financial policies. This again is very
clear, and of course reflects present practice. I am in no position
to speak for the future SAR Government. But if I were asked for an
opinion, I would emphasize the need for the objective of monetary
policy always to be clearly defined and firmly adhered to. This is
necessary if the policy is to have credibility and therefore be
achievable.
- The objective of monetary policy in Hong Kong is currency
stability, in terms of the external value of the Hong Kong dollar
against the US dollar at the fixed rate of 7.80 and within the
framework of the linked exchange rate system. Exchange rate
stability and therefore confidence in the currency is of course
important to Hong Kong in the sensitive period of political
transition. Furthermore, for a highly externally oriented economy,
the maintenance of a stable external value of the currency is I
believe a correct policy to pursue. This policy has served Hong
Kong well since its establishment in October 198
- It is a policy that the present Government has no intention
whatsoever of changing and has the full support of the Chinese
Government. This therefore is a clear indication that the policy
will be firmly adhered to after 1997.
- I am sure many of you are aware of the higher rate of inflation
that Hong Kong has been experiencing in recent years. Some have
attributed this to the link with the US dollar. This is I would say
a very superficial comment. Hong Kong is going through an economic
transformation that is more rapid than anyone could have predicted
ten years ago. This is the result of the equally rapid
liberalization of the economy of China, unleashing very strong and
sustained demand on the services industry in Hong Kong, in
particular on financial services. There has therefore been
inflationary pressures on what economists called the non-traded
goods sector. Indeed, inflation in the traded goods sector, as
measured by the rate of increase in the prices of goods either
imported into or exported from Hong Kong, has been moderate. This
is what one would expect given the exchange rate is fixed against
the currency of an economy with moderate inflation. The fixed
exchange rate does, however, constrain our ability to use interest
rates to curb inflation. But this is a constraint that Hong Kong
accepts as a price to pay for stability in the external value of
the currency. I should point out that as US interest rates have
been raised in recent months, this has helped to curb inflationary
pressures domestically.
- Given the importance of exchange rate stability to Hong Kong in
transition, we have over the past few years been strengthening our
monetary system to enhance our ability to deliver that stability.
There were a number of important reform measures introduced,
basically putting ourselves in a position effectively to influence
money market conditions so as to assist in the maintenance of
exchange rate stability. These are nothing new to other established
monetary systems. In a way we are merely catching up with others. I
shall therefore skip the details.
Institutional Safeguard
- This series of monetary reform measures led last year to the
establishment of the HKMA, which has more or less the same
functions as the Monetary Authority of Singapore. I am sure you
will agree with me that there are important tasks to be performed
in the monetary area in any economy. These tasks need to be
performed with a high level of professionalism and continuity, and
in a manner that commands the confidence of the people and the
international financial community. In Hong Kong, these tasks were
becoming increasingly inappropriate for civil servants to carry,
hence the establishment of the HKMA, with its own terms and
conditions of employment.
- The establishment of the HKMA had the clear blessings of both
the British and the Chinese governments. There is therefore a
so-called "through train" for monetary affairs in Hong Kong. In
this connection, let me quote Chen Yuan, the Deputy Governor of the
People's Bank of China (PBOC). He said at a conference organized by
the HKMA last year in Hong Kong that he welcomes "the further
development of the good co-operative relationship between the two
monetary authorities" and that after 1997 the PBOC "will not take
the place of the Hong Kong Monetary Authority". This assurance of
good co-operative relationship and institutional and functional
separation is very clear. It is of course an unequivocal
demonstration of the application of the "one country, two systems"
principle in the practice of central banking in Hong Kong. After
1997, there will be one country, two currencies, two monetary
systems and two separate monetary authorities.
Closing Remarks
- Before closing and taking questions from you, let me thank you
again for giving me this opportunity to speak about Hong Kong's
monetary system after 1997. Although there are still one or two
transitional issues, mainly in the area of the relevant
legislation, to sort out before 1997, and I do not expect these to
be controversial, the monetary system of Hong Kong is well on track
for a smooth train ride through 1997. I very much look forward to
riding on that train.
- I hope that I shall have an opportunity of welcoming you to
Hong Kong, before or after 1997. In case you wish to do so in 1997,
do be aware that bookings of many hotels are already full for the
night of 30 June 1997, for obvious reasons, and for the end of
September 1997 when the Annual Meetings of the World Bank and the
International Monetary Fund will be held in Hong Kong. Perhaps 1997
will not be a dull year afterall. Thank you.