The Monetary Base


10 Aug 2000

The Monetary Base

The convergence on Saturday of the Convertibility Undertakings for two of the three components of the Monetary Base marks the end of a 500-day process. With convergence out of the way, other possibilities for refining the Currency Board arrangements now present themselves. How desirable these refinements may be is a matter that requires careful consideration.

Readers will recall that in the Viewpoint article published on 4 May I drew attention to the impending convergence on 12 August 2000 of the Convertibility Undertakings, at 7.80, for two of the three components of the Monetary Base. These two components are, first, the Certificates of Indebtedness backing the issue of Hong Kong dollar bank notes and, second, the Aggregate Balance in the Hong Kong dollar clearing accounts that licensed banks hold at the HKMA. I pointed out that, after convergence, there will still be a few remaining, technical issues concerning the various components of our Monetary Base that need to be considered. These issues are not time-critical and will be dealt with as part of the continuous review being undertaken by the EFAC Sub-Committee on Currency Board Operations. If refinements are identified and considered appropriate, they will be introduced with the approval of the EFAC.

But many of our media friends specialising in finance have expressed a keen interest in this work. Their interest probably also reflects a similar interest among the financial community. I am very encouraged by this. After all, convertibility and transferability of the components of the Monetary Base are esoteric subjects even to some central bankers. In view of the level of interest, let me divulge more here about our thinking on these issues, particularly in respect of the constraints we face. I do so without pre-empting the necessary discussions in the various committees and the informal consultation that we are conducting with the banking sector, and without being too specific on the alternatives on grounds of market sensitivity.

Ignoring coins in circulation, which amount to only a small sum and have little bearing on monetary policy, there are three components in our Monetary Base, namely, the Certificates of Indebtedness, the Aggregate Balance and the Exchange Fund Paper that we have issued. The convertibility of each of the three components into US dollars, in accordance with the requirement of a Currency Board, and the transferability amongst them are the issues at hand. The present arrangements are as follows:

  • Certificates of Indebtedness: convertible with US dollars at 7.80, both ways, for same day value, but not transferable with other components of the Monetary Base.
  • Aggregate Balance: convertible into US dollars at 7.80 by 12 August 2000, convertible from US dollars at market exchange rate largely at the initiative of licensed banks, both for value spot (T+2), and transferable with Exchange Fund Paper.
  • Exchange Fund Paper: not directly but indirectly convertible into US dollars through being transferable with the Aggregate Balance, in real time using the intra-day repurchase facility or overnight using the Discount Window.

In tackling the issues at hand, we should all be conscious of five considerations. First, the current convertibility and transferability arrangements do look a little untidy. But, secondly, it is important at the same time to recognise that they work effectively at present in achieving our monetary policy objective of exchange rate stability. Thirdly, for tidiness sake, if that is considered beneficial, though I doubt whether tidiness alone is a sufficient reason for change, we should ideally have uniform convertibility arrangements for all the three components of the Monetary Base and they should also be freely transferable amongst themselves. Fourthly, however, for operational or other reasons, there may be merit for retaining technical differences between the convertibility undertakings of two different components of the Monetary Base. Where this is the case, transferability between the two components may have to be restricted, lest it create market activities that render the more restrictive convertibility undertaking of the two obsolete. Fifthly, alternatively, if for good reasons there ought to be transferability between two components of the Monetary Base, then it must be accepted that the convertibility undertakings of the two components would in practice become identical.

I hope this does not sound, to those interested in and trying to get to the bottom of this subject, to be too much of a riddle. But this is as clear as I can make it at this stage and in this column. Complex issues of notable monetary significance are involved in this work and we must handle them with the greatest care. Fortunately we do have the luxury of having all the time we need. We also have advice from knowledgeable people, including those in the markets, and we are still in the process of consulting them.


Joseph Yam
10 August 2000


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Last revision date : 10 August 2000