The Exchange Fund and the Government's Fiscal Reserves are managed and invested together. But they are two separate and distinct entities.
Last week, in concluding the debate on the budget, the Financial Secretary once again drew attention to the distinction between the fiscal reserves and the Exchange Fund. I hope what he said will provide a rational basis for whatever future discussion there may be on Hong Kong's reserves.
As the aspirations of our community increase along with economic progress, legislators and community leaders are understandably questioning the need for the Government to be holding on to such large reserves. This is particularly so when aberrations in the economy, for whatever reasons, are adversely affecting the well-being of the community, to such an extent that government relief of one kind or another, with significant financial implications, may seem justified. If these cannot be met through provisions in the annual budget, then naturally the very substantial reserves come to mind.
This is where confusion between the fiscal reserves and the Exchange Fund comes in. The fiscal reserves are accumulated from the budget surpluses run over the years. Currently standing at over HK$430 billion, the fiscal reserves are deposited with the Exchange Fund. This is done for two main reasons. The first is the centralisation in the investment management of public funds. There are obviously significant benefits in terms of the economies of scale in doing so, including the management of risks and liquidity, and, within those constraints, the maximisation of return. The monetary implications arising from such activity also have to be considered. The second reason is the need to enhance the resources available to the Exchange Fund in achieving the purposes for which the Fund is established. Although the fiscal reserves represent money borrowed for the account of the Exchange Fund and will have to be repaid on demand, the corresponding assets, managed along with other assets of the Fund, can be used for such purposes.
Monetary considerations notwithstanding, if it is considered appropriate that some of the HK$430 billion of fiscal reserves should be used to address the needs of the community, then the necessary amounts can, at any time, be withdrawn from the Exchange Fund. The HKMA, having responsibility for the day-to-day management of the Exchange Fund, will have to come up with the money. We can sell some of the foreign currency assets in the Exchange Fund for the Hong Kong dollars needed for the purpose, in which case the amount of foreign reserves held in the Exchange Fund, and the size of the Fund itself, will fall. Alternatively, if there are Hong Kong dollar assets in the Exchange Fund that can be deployed, these could be used, again involving a fall in the size of the Exchange Fund. And if, for monetary or other reasons, both are considered not desirable or not cost-effective, we could borrow Hong Kong dollars in the market to fund the repayment. In this case, there would be a change in the composition of the liabilities of the Exchange Fund and no change in its assets.
But this is not the end of the discussion. Questions have been raised about whether there is a need for so much money in the Exchange Fund and about whether money in excess of the requirements needed to achieve the purposes of the Fund could be used to provide more immediate benefits to the community. Last week in this column I addressed the question of the adequacy of foreign reserves. Although I did not draw any specific quantitative conclusions, my view was clearly that we could ill afford to be complacent. Nevertheless, Section 8 of the Exchange Fund Ordinance does provide a mechanism for the Financial Secretary, after satisfying certain conditions, to transfer money from the Exchange Fund to the general revenue. One condition is that the Financial Secretary should be "satisfied that such transfer is not likely to affect adversely his ability to fulfil any purpose for which the Exchange Fund is required to be or may be used under Section 3(1) or (1A)". These sections deal with "the exchange value of the currency of Hong Kong", "the stability and the integrity of the monetary and financial systems of Hong Kong" and "maintaining Hong Kong as an international financial centre". I cannot speak for the Financial Secretary, but, having regard to the risks to Hong Kong arising from international financial developments, I think it would be difficult for the Financial Secretary to be so satisfied.
Joseph Yam
12 April 2001
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More information on Foreign Currency Reserves can be found here.
More information on the Currency Board System can be found here.
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