Monetary conditions

inSight

08 Apr 2004

Monetary conditions

Six months after its sudden strengthening in September last year, the market exchange rate of the Hong Kong dollar has returned to something nearer the official rate of HK$7.80 to one US dollar.

Readers may remember the sudden strengthening of the exchange rate of the Hong Kong dollar in the spot market at the end of September and beginning of October last year. The change of sentiment was so rapid that it took quite a lot of people by surprise. From worrying about pressures on the exchange rate to weaken as a result of the potent combination of economic problems of high unemployment, sharp deflation and a large budget deficit, sentiment shifted towards the exchange rate appreciating. Political pressures to allow the exchange rate of the renminbi to appreciate, weakness of the US dollar, and improving economic conditions, including a large current account balance of payments surplus, unnerved those who had maintained a short position in the Hong Kong dollar. As they quickly reduced that short position, the exchange rate in the spot market moved sharply at that time to 7.70. Although this is just a little over one per cent away from 7.80 - hardly a significant deviation for many - to those shorting the Hong Kong dollar the effect, for example, on trading profits can be quite big.

But the deviation, small as it was, signified a degree of instability, particularly to financial market participants. Our strategy since then has been to nurse the exchange rate back over time nearer to 7.80. This involved, as recorded in the published minutes of the Currency Board Sub-Committee of the Exchange Fund Advisory Committee, ourselves passively taking in US dollars when these were put to us at the market exchange rate and correspondingly creating Hong Kong dollar liquidity in the inter-bank system. The strategy has been successful. Six months on, the exchange rate is now very near to 7.80, but the Aggregate Balance in the clearing accounts of licensed banks has grown to over HK$54 billion. This is some 100 times the usual amount required to oil Hong Kong's efficient real time inter-bank payment system. Correspondingly, interest rates in the inter-bank market, particularly those for short-term money, have fallen to near zero. Concerns have consequently been expressed about the conditions in the inter-bank market, which was obviously making it difficult for banks with Hong Kong dollar liquidity to earn a return. These concerns have also taken the form of suggestions for us to issue additional Exchange Fund paper to tighten conditions in the inter-bank market. We have considered the suggestion and concluded that there was no need in present circumstances to do so. The record of the discussion of this matter at a recent meeting of the Currency Board Sub-Committee has just been published.

Thus we continue to wait for the interest rate differential against the holding of Hong Kong dollars to generate, in the fullness of time, the outflow necessary for the Aggregate Balance to be reduced back to a more normal level. This may take a little more time, given the significant current account balance of payments surplus that Hong Kong is running and the continuing international focus on renminbi exchange rate policy. Easy monetary conditions are for the time being also helpful to sustaining the economic recovery in Hong Kong, which is now supported by favourable global economic conditions, and there are no signs of any inflationary pressures or overheating (economy-wide or sector-specific) developing. Indeed, with the problems of negative equity and bankruptcy rapidly dissipating, financial and economic conditions now present much less risk than before to monetary and banking stability in Hong Kong.

However, outside of the purely economic and financial spheres, there are always the events and processes of a political and social nature that need to be watched. And, in an age of globalisation, these too can move rapidly from the local to the global. So far this year we have seen outbreaks of avian flu in our own region and appalling acts of terrorism in the Middle East and in Spain. Disturbing and disruptive though these events may have been, they have not had much of an impact on the generally positive economic trends or on financial stability. Much the same can be said for the political issues closer to home. The disputed Taiwan presidential election, although a cause of some uncertainty and perhaps a factor in recent stock market movements, must be set against the very positive growth figures coming out of Taiwan and the other developed Asian economies. The debate within Hong Kong on political reform has been received by the markets for what it is: a reasoned and for the most part polite discussion of how to develop Hong Kong's constitutional arrangements in the best interests of Hong Kong. The recent interpretation by the Standing Committee of the National People's Congress of the relevant provisions in the Basic Law should help provide a clear set of procedures for carrying out this development in a calm and orderly manner.

Overall, the risks and vulnerabilities to monetary and financial stability appear to have substantially reduced from the situation we have been facing since the Asian financial crisis and the bursting of the property bubble in 1998. I hope this benign environment can be sustained in the years to come, although we obviously should remain vigilant.

 

Joseph Yam

8 April 2004

 

Related Viewpoint Article:

Related Information:

Click here for previous articles in this column.

 

Document in Word format

Latest inSight
Last revision date : 08 April 2004