(Approved for Issue by the Exchange Fund Advisory Committee on 25 February 1999)
Operations of the Currency Board Arrangements
The Sub-Committee noted that, during the period from 4 to 26 January 1999, changes in the size of the monetary base were fully matched by corresponding changes in the foreign reserves, in accordance with the Currency Board arrangements. It was also noted that the HKMA had sold US$10 mn for HK$77.5 mn under the Convertibility Undertaking on 25 January 1999, causing the forecast Aggregate Balance on 27 January 1999 to decline to HK$2.44 bn. The HK$ exchange rate had remained stable during the review period.
The Sub-Committee noted that the total asset value of the Backing Portfolio in the Exchange Fund was around 108% of the monetary base as at the end of December 1998. Although specific US$ Exchange Fund assets had been designated for the Backing Portfolio, all Exchange Fund assets were available to support the HK$ exchange rate.
The report on currency board operations for the period under review is at Annex A.
Investment Strategy for the Backing Portfolio
The Sub-Committee noted that the Backing Portfolio was established in October 1998 by designating certain asset and liability items in the Exchange Fund balance sheet as those specifically related to currency board operations. It was also noted that the overall investment strategy for the Backing Portfolio was to match as closely as possible the duration of the asset and liability sides. The majority of the assets in the portfolio are invested in interest-bearing securities with high liquidity and credit quality, such as US Treasuries.
The Sub-Committee agreed that the ratio of assets to liabilities in the Backing Portfolio would fluctuate in the short run but would tend to rise in the long run as interest earned on the asset side out-paced interest paid on the liability side. The question of whether there should be any asset transfers into or out of the Backing Portfolio when the backing ratio reached certain pre-determined or formula-based benchmarks should be explored further. This will be the subject of a further submission to the Sub-Committee.
Currency Board Accounts
The Sub-Committee considered a proposal to prepare a statement of the Currency Board Accounts presented in the form of a management report, to be included as a supplement to the annual statutory accounts of the Exchange Fund as well as the abridged Exchange Fund Balance Sheet to be published each month. In preparing the Currency Board Accounts, all financial assets and liabilities would be marked to market. To ensure that the monetary base and the backing ratio would not be affected by the trade date accounting approach, amounts of accounts receivables and accounts payable arising from unsettled transactions would be shown in HK$ and US$ separately and on a net basis. Furthermore, the Sub-Committee noted that repos would be treated as collateralised lending, which was in line with the accounting policy adopted in preparing the Exchange Fund Balance Sheet. In other words, an increase in the Aggregate Balance due to repo transactions under the Discount Window would be matched, in accounting terms, by an increase in HK$ lending rather than a reduction in outstanding Exchange Fund paper. To avoid confusion that the monetary base had been expanded on the back of HK$ lending, such lending would be presented as a "HK$ accounts receivable" item on the liability side (i.e. the monetary base) of the Currency Board Accounts.
The Sub-Committee endorsed the proposed approach, but also suggested a number of improvements, such as providing month-to-month comparative figures. It was agreed that a revised format would be prepared for Members' consideration before the issue was finalised.
Hong Kong Monetary Authority
1 March 1999
