Following the endorsement by the Exchange Fund Advisory Committee (EFAC), the HKMA announced today three measures to further enhance the transparency and fine-tune the operations of the Currency Board arrangements in Hong Kong. These include the scheduled plan to move the exchange rate under the Convertibility Undertaking in respect of the Aggregate Balance from 7.75 to 7.80, the methodology for determining the Base Rate under the Discount Window and the publication of the minutes of the EFAC Sub-committee on Currency Board Operations.
Exchange Rate Under Convertibility Undertaking
As from 1 April 1999, the exchange rate under the Convertibility Undertaking in respect of the Aggregate Balance will move from the present level of 7.75 to 7.80 by 1 pip (i.e. HK$ 0.0001) per calendar day. It will then take 500 calendar days to complete the move of the rate to 7.80, where it will stay thereafter. The gradual move of the exchange rate over a 500*day period enables a convergence of the convertibility rate with the exchange rate applicable to the issue and redemption of Certificates of Indebtedness while minimizing disruptions to the foreign exchange and money markets.
Determination of the Base Rate
Balancing the objectives of ensuring that interest rates are adequately responsive to capital flows and allowing excessive and destabilizing interest rate movement to be dampened, the HKMA will adopt the following framework in setting the Base Rate under the Discount Window :
- floor - the floor to the Base Rate will be set by reference to the US Fed Funds Target Rate, adjusted by a factor which is to be a premium of 150 basis points. The EFAC Sub-committee on Currency Board Operations will review the adjustment factor from time to time, and where appropriate, recommend any change to the EFAC for approval;
- reference rate - subject to the floor stipulated in (a), the Base Rate will be derived by taking the simple average of the 5-day moving averages of overnight and 1-month Hong Kong Interbank Interest Rates (HIBORs);
- exceptions - the HKMA reserves the right, in exceptional cases, to apply a different Base Rate to individual banks, for example, banks believed to be facilitating market manipulation. The HKMA will report exceptions to the EFAC Sub-committee on Currency Board Operations and the EFAC; and
- review - this methodology for determining the Base Rate will be reviewed by the EFAC Sub-committee on Currency Board Operations from time to time or as and when circumstances dictate.
The Base Rate will be set in accordance with the above methodology starting from 27 November (Friday).
Publication of Minutes of the EFAC Sub-committee on Currency Board Operations
As a further step to enhance the transparency of the operations of the Currency Board arrangements in Hong Kong, a record of each meeting of the EFAC Sub-committee on Currency Board Operations will be published as soon as it has been endorsed by EFAC. A record of the last meeting held on 13 November is attached at Annex A.
Commenting on the disclosure of the minutes of the Sub-committee meeting, Mr Donald Tsang, the Financial Secretary, said "This is another step forward to improve the transparency of the operations of the Hong Kong monetary system. We started to disclose the forecast change in the Aggregate Balance on a real time basis in June and yesterday we began to publish details of the Monetary Base on a daily basis. Disclosing the records of the Sub-committee meetings will enhance public confidence in our discipline further."
Turning to the other two measures, Mr. Joseph Yam, Chief Executive of the HKMA, said, "We have consulted the relevant industry associations and academics on these measures. There is broad support for our scheme to move the exchange rate under the Convertibility Undertaking gradually over a long period to avoid disruptions to the market. On the setting of the Base Rate, we have received a number of proposals. We believe the methodology we adopt will enable the interest rate adjustment to kick in when there is a significant outflow of funds, while giving us some scope to smooth interest rate fluctuations."
The Convertibility Undertaking in respect of the Aggregate Balance was introduced in September 1998 as part of the seven technical measures to strengthen the Currency Board arrangements in Hong Kong. The rate of 7.75 was chosen at that time because it was then the intervention rate of the HKMA. However, the HKMA clearly indicated its intention to move the convertibility rate to 7.80, which is the fixed exchange rate applicable to the issue and redemption of Certificates of Indebtedness backing the bank notes, when market conditions permit. To further allay market uncertainty over the move, the HKMA issued a statement on 14 September stating that the rate under the Convertibility Undertaking would remain unchanged at 7.75 for at least six months.
Also as part of the seven technical measures, the Liquidity Adjustment Facility was replaced by the Discount Window. We stated our intention to be as transparent as possible in the setting of the Base Rate under the Discount Window and eventually adopt a methodology that involves as little discretion on the part of the HKMA as possible. Feedback from the consultation exercise suggests that there is broad agreement on the need for the HKMA to reserve the rights to impose penal rates on banks which are found to be facilitating market manipulation and to review the chosen methodology from time to time.
The EFAC Sub-committee on Currency Board Operations was set up in late August to oversee the operations of the Currency Board arrangements in Hong Kong and to recommend measures to enhance the robustness and effectiveness of the Currency Board arrangements. The membership of the Sub-committee has been recently expanded with the appointment of two new members who are very familiar with Currency Board systems : Mr John Greenwood of Invesco Asia Ltd. and Prof. Tsang Shu-ki of the Baptist University. The three measures above have been thoroughly considered by Sub-committee, which subsequently put up the recommendations to the EFAC for endorsement.
Hong Kong Monetary Authority
26 November 1998
(Annex A)
A Record of Discussion of
the Exchange Fund Advisory Committee
Sub-Committee on Currency Board Operations on 13 November 1998
(Approved for Issue by the Exchange Fund Advisory Committee on 26 November 1998)
Operations of the Currency Board Arrangements
The Sub-committee noted the movements in the various components of the Monetary Base, including the Certificates of Indebtedness, coins in circulation, the Aggregate Balance of the banking system and the Exchange Fund Bills and Notes, since the last Sub-committee meeting held on 26 September. The Sub-committee was satisfied that the changes in the various components were matched by corresponding changes in the Foreign Reserves in accordance with the Monetary Rule of the Currency Board system.
Exchange Rate under the Convertibility Undertaking
2. The Sub-committee discussed the proposal to move the exchange rate under the Convertibility Undertaking for the Aggregate Balance from the current level of 7.75 to 7.80 by 1 pip per calendar day from 1 April 1999 (i.e. upon the expiry of the six-month no change period). It noted that the proposal had widespread support from the relevant industry associations and the academics as it enabled convergence with the Convertibility Undertaking for Certificates of Indebtedness backing the note issue, at 7.80, to be achieved with minimal disruptions to the foreign exchange and money markets. The Sub-committee agreed to recommend the proposed scheme to the Exchange Fund Advisory Committee (EFAC) for approval.
3. The Sub-committee also discussed the alternative of moving the exchange rate under the Convertibility Undertaking for the Certificates of Indebtedness from 7.80 to 7.75, but considered that this was a less desirable option.
Methodology for Setting the Base Rate
4. The Sub-committee considered the various proposals put forward by the Hong Kong Association of Banks and academics on the methodology to determine the Base Rate under the Discount Window. Taking into consideration the views obtained from the consultation exercise, the Sub-committee agreed to recommend the following methodology to the EFAC for approval:
- floor - the floor to the Base Rate would be set by reference to the US Fed Funds Target Rate, adjusted by a factor which is to be a premium of 150 basis points. The Sub-committee would review the adjustment factor from time to time, and where appropriate, recommend any change to the EFAC for approval;
- reference rate - subject to the floor stipulated in (a), the Base Rate would be derived by taking the simple average of the 5-day moving averages of overnight and 1-month Hong Kong Interbank Interest Rates (HIBORs);
- exceptions - the HKMA would reserve the right, in exceptional cases, to apply a different Base Rate to individual banks, for example, banks believed to be facilitating market manipulation. The HKMA would report exceptions to the Sub-committee and the EFAC; and
- review - this methodology for determining the Base Rate would be reviewed by the Sub-committee from time to time or as and when circumstances dictate.
Disclosure of Minutes
5. With a view to further enhancing the transparency of the operations of Currency Board arrangements in Hong Kong, the Sub-committee agreed to recommend to the EFAC that forthwith the minutes of its meetings be published within six weeks after each meeting. The draft minutes would be put to the EFAC for approval before publication.
