Currency stability brings great benefits but there are implications for risk management across economic cycles.
Readers may have noticed a surge in the growth rate of the Hong Kong-dollar money supply in the second half of last year, especially in the three months from September to November. For example, at the end of October 2007, broad money (M3) had increased by 40% compared with a year earlier. Narrow money (M1) was 37% higher at the end of November than a year earlier.
We in the HKMA have been watching these numbers closely and trying to discern their significance. One quick answer, and probably the principal explanation, is the effect of IPO activities. At the month-ends of September, October and November, there were large IPOs which had closed but the refunds of the over-subscription monies were only scheduled for the beginning of the following months. The one at the end of October, for example, involved subscription monies of $452 billion. This is equivalent to 86% of M1 and 12% of M3. Many investors borrowed from banks to finance IPO subscriptions and used cheques to transfer the funds to the receiving banks. This initially swelled both the loan and monetary aggregates as demand deposits are a component of both M1 and M3. And as the subscription monies are temporarily placed as time deposits with banks to earn interest while waiting for the refund, M3, almost half of which is time deposits, remained high even when demand deposits subsequently declined.
But, even when the effect of IPO activities is excluded, growth in money supply has been increasing, and this is confirmed by the rising demand for Hong Kong-dollar loans to finance non-IPO related stock-market activities, property transactions and other economic activities during the last two to three years. In terms of Hong Kong-dollar loan growth, an accelerating trend seems to be developing. From single-digit growth in 2005 and 2006, the growth rate increased to double digits in the second half of 2007, when activity in the property market and inflation also picked up, possibly encouraged by the outlook for interest rates in the United States and therefore in Hong Kong. Different measures of the money multiplier also confirmed the increased demand for loans. The M3 money multiplier (the ratio of M3 to the Monetary Base) increased to over 10 for the first time in the second half of 2007, having stood at about 8 or 9 for many years.
While these trends bear close watching, let me stress that they are not causing us any serious concern from a monetary-policy perspective. The occurrence of these trends is a feature of our monetary system and a result of having a stable exchange rate. Under this system the changes in monetary aggregates and interest rates are not determined by our own policy actions, but rather by those in the United States, taking into account the reactions of the participants in our financial markets. It is thus inevitable that when the monetary policy in the United States (currently manifested in low interest rates) is temporarily not entirely suitable for our economic circumstances, cyclicality in our domestic economy may be exacerbated. If this happens, it is necessary for us (all economic units, but most importantly those in the financial system) to prudently manage the risks associated with economic cycles that might be larger than we would like. I am confident that our banks are capable of this very fundamental task of banking - taking risks and managing them - through economic cycles, with or without encouragement from the banking supervisor.
This is of course not to say that extensive cyclicality is something that we welcome. Public policies designed to assist those who are financially disadvantaged by or unable to cope with economic cyclicality can be pursued, if the state of the public finances allows the Government to do so. But there is a limit to what we can pursue to limit cyclicality in a highly externally oriented economy. The policies also need to be carefully targeted. For example, additional government spending may be inflationary. Whether we like it or not, economic cyclicality is something we have to live with, and Hong Kong has done so in the past with flying colours.
Joseph Yam
17 January 2008
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