Transferability between Certificates of Indebtedness and the Aggregate Balance

inSight

09 Jun 2005

Transferability between Certificates of Indebtedness and the Aggregate Balance

Following the refinements to the Linked Exchange Rate system introduced last month, the outstanding issue now is the question of transferability between Certificates of Indebtedness and the Aggregate Balance.

Since we operate the Linked Exchange Rate system in a highly transparent manner, it should not be difficult for those with market, academic or other interests in the matter to monitor our activities and our thinking. There is a wealth of information in the published records of discussions in meetings of the Currency Board Sub-Committee (CBC) of the Exchange Fund Advisory Committee. Readers may wish to recall in particular the record published on 2 August 2000 concerning the discussion of the CBC in the meeting held on 5 July 2000, in which the scope for its continuing review of the Currency Board arrangement was outlined. As the latest record, published last Friday, shows, after the refinements introduced last month to the operation of the Linked Exchange Rate system, involving the introduction of the strong-side Convertibility Undertaking and the Convertibility Zone, the main issue outstanding is the transferability between Certificates of Indebtedness (CIs) and the Aggregate Balance.

In fact, this transferability, first raised in my paper "A Modern Day Currency Board  System" published at the end of 1998, was discussed at a Currency Board Sub-Committee meeting on 9 April 1999. The conclusion of that discussion, as the published record shows, is that "transferability was considered as a desirable long-run goal". However, as the convertibility arrangement for the Aggregate Balance was still being developed, the Sub-Committee felt that the issue should be re-visited only after "the convertibility rates for CIs and the Aggregate Balance were aligned".

I have never felt comfortable about different convertibility arrangements for different components of the Monetary Base. The Convertibility Undertaking for CIs was there right from the beginning, when the Linked Exchange Rate system was introduced on 17 October 1983. Indeed, this was the only feature that characterised the system then - the issue and redemption of CIs to and from the note-issuing banks against the US dollars at the fixed exchange rate of 7.80. Then our focus of attention in monetary management, as modern day finance dictated, shifted to the Aggregate Balance, in terms of putting it within the reach of the responsible authorities, creating a mechanism for controlling it and refining control in the light of experience. This started in 1988 with the introduction of the new "Accounting Arrangements", which were replaced at the end of 1996 by a requirement for all licensed banks to operate clearing accounts with the HKMA. From no control (before July 1988) we acquired indirect control (July 1988) and subsequently direct control (end-1996). This was followed in 1998, under the rather unusual circumstances of the Asian financial crisis, by the introduction of the one-sided (weak side) Convertibility Undertaking for the Aggregate Balance. And, with the latest refinements, we will, by 20 June this year, have a tidy two-way Convertibility Undertaking for the Aggregate Balance centred around 7.80, the Linked Exchange Rate.

As I have said many times, the crucial component of the Monetary Base, in terms of ensuring that monetary management is effective, is the Aggregate Balance, and not the other components, for example, the amount of banknotes in circulation. With the Aggregate Balance now enjoying a clear, two-way Convertibility Undertaking, there is theoretically no longer the need for separate convertibility undertakings for the other components of the Monetary Base, for as long as these other components are transferable with the Aggregate Balance. Exchange Fund paper is already transferable with the Aggregate Balance through automatic intra-day repos, which is an essential feature of our inter-bank payment system, and through over-night repos using the Discount Window. Furthermore, there is always the option to issue more Exchange Fund paper if there is a need to reduce the Aggregate Balance. The CIs can be made similarly transferable with the Aggregate Balance through issuing and redeeming them against the clearing balances of the three note-issuing banks.

I believe that it is time to revisit this matter. As the record of the Currency Board Sub-Committee meeting on 13 May 2005 shows, the Sub-Committee has considered the matter again and has recommended that discussions be held with the three note-issuing banks, as they may be affected by this technical change. As far as banknote holders - or members of the public - are concerned, they will be unaffected by any changes. The banknotes that they hold continue to be fully backed by the US dollars in that the CIs backing the banknotes are part of the Monetary Base, and, as the published Currency Board accounts show, the Monetary Base, using the Linked Exchange Rate of 7.80, is more than fully backed by the US dollars held in the Exchange Fund.

 

Joseph Yam

9 June 2005

 

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Last revision date : 09 June 2005