Fiscal Drawdowns


22 Jul 2004

Fiscal Drawdowns

The Government will need to draw on its fiscal reserves to meet expenditure in the next few months: the HKMA will make arrangements to fund these drawdowns in the most economical manner.

Although we are now in the wet season, when Hong Kong gets a lot of rain, in terms of the flow of government revenues we are entering the dry months. Even counting the HK$20 billion proceeds from the issue of government bonds, expenditure will greatly exceed revenue in the next few months. This means that the Treasury will need to draw on the fiscal reserves deposited with the Exchange Fund. As readers are aware, the assets of the Exchange Fund are mostly foreign assets, with the exception of the Hong Kong equities that we are committed to hold on a long-term basis. To fund the (partly seasonal) drawing down of fiscal reserves by the Treasury we have therefore to find the necessary Hong Kong dollars.

What we will not do, of course, is "print" the money, or, more accurately, create the money by crediting the required amounts to accounts the Treasury is maintaining with commercial banks through crediting the clearing accounts that those banks are maintaining with the Exchange Fund. This would amount to increasing the Aggregate Balance of the banking system without increasing correspondingly the US dollar assets backing it. This is not allowed under the rules of the Currency Board System.

There are less controversial ways of funding the drawdown of fiscal reserves. Two come readily to mind. Both have been used, quite satisfactorily, in the past for this purpose, and those interested in our affairs may wish to be reminded of them. The first is to sell US dollars to raise the Hong Kong dollars required by the Treasury and the second is to borrow Hong Kong dollars from the market.

The choice between them is principally a matter of dollars and cents. Currently the investment return of the US dollar assets we are holding, for example US dollar deposits, is significantly higher than the cost of borrowing Hong Kong dollars. Hong Kong dollar interest rates in the interbank market are very low because of the large size of the Aggregate Balance. For overnight money, the interest rate is near zero, while we are earning over one per cent for liquid US dollar assets. Our current strategy is therefore to borrow Hong Kong dollars in the interbank market to fund the drawdown of fiscal reserves while continuing to enjoy a higher return for those US dollar assets. To maintain flexibility and minimise the cost of borrowing, we would tap the short end of the market while being careful in the management of the maturity mismatch.

If, however, the cost of borrowing Hong Kong dollars is higher than the rate of return on the US dollar assets in the Exchange Fund, the preference will be to sell US dollars instead. Indeed, we would do so for the purpose of repaying previous Hong Kong dollar borrowing that has become relatively expensive, even if there were no new requirements to draw down the fiscal reserves. Chances are that when there is an interest rate premium for the Hong Kong dollar over the US dollar, the exchange rate will already have exhibited a tendency to weaken and possibly trading at or close to the rate of the Convertibility Undertaking. So we would also be selling US dollars at a favourable exchange rate, thus further contributing to minimising the cost, including the opportunity cost, for funding the drawdown of fiscal reserves.

Our transparent activity in this area, in the past few years in which there have been substantial drawdowns of fiscal reserves due to the budget deficits, has led to such borrowings standing at around HK$44 billion at the end of 2003. If domestic money market conditions continue to be favourable, the amount will increase: indeed, it now stands at about HK$60 billion, and could reach HK$80 billion by the end of 2004. For those who wish to keep track of this activity, the amount borrowed is shown in the annual accounts as "placements by banks and other financial institutions".


Joseph Yam

22 July 2004


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Last revision date : 22 July 2004