(Approved for Issue by the Exchange Fund Advisory Committee on 27 March 2001)
Currency Board Operations for the Period 1 February - 21 February 2001
1. The Sub-Committee noted that this had been a stable period. The Base Rate had been adjusted downwards to 7.00% (150 basis points above the US Fed Funds Target Rate) following the 50 basis points cut in the US Fed Funds Target rate on 31 January. The Convertibility Undertaking had been triggered once, on 9 February, but the impact of this on the Aggregate Balance had been quickly offset by the sale of Hong Kong dollars in response to bank offers on the same day. The Sub-Committee also noted that, following the Chinese New Year holiday, there had been a reduction in the outstanding amount of Certificates of Indebtedness, and a consequent decrease in the monetary base from HK$227.10 bn to HK$216.36 bn. Having examined the trends in previous years, Members observed that the increase and decrease in Certificates of Indebtedness before and after the Chinese New Year holiday in 2001 followed very much the traditional pattern.
2. The Sub-Committee noted that on 20 February, towards the end of the reporting period, the backing ratio had reached 112.53%, passing the trigger of 112.5%. On the following day, in accordance with the policy approved in January 2000, assets had been transferred from the backing portfolio to the investment portfolio to reduce the backing ratio to around 110%.
3. Noting developments that had taken place after the reporting period, Members remarked that Hong Kong's markets had remained stable throughout the recent Turkish crisis.
4. The report on Currency Board operations for the period under review is at Annex A.
Monitoring of Risks and Vulnerabilities
5. The Sub-Committee noted the regular information paper on external and internal risks facing Hong Kong. Externally, the Sub-Committee noted that, barring a hard landing, the economic slowdown in the US was unlikely to arrest recovery in the Asian region as a whole, although the region would not escape some impact, and certain sectors (for example electronics) and economies might be affected more than others. Members also noted that the Turkish crisis, while it might have had some mild contagion effect on certain emerging markets, had so far had no great effect on Asia and none at all on Hong Kong.
6. Domestically, the Sub-Committee noted the moderation in economic growth, and the complex relationships between property prices and economic activity.
Corporate Restructuring in Hong Kong
7. The Sub-Committee noted an information paper on corporate restructuring in Hong Kong in the aftermath of the Asian Financial Crisis. The paper examined how economic adjustment had taken place under Hong Kong's linked exchange rate system (in contrast to the adjustment through currency depreciation in many of the other crisis-hit economies), taking into account the general principle that, under a fixed exchange rate system, competitiveness is restored through productivity increases or through internal price restructuring. Members noted a sharper slowdown in nominal wage increases in Hong Kong compared with other Asian economies, but greater resilience in wages in Hong Kong if measured in US dollar terms. Members observed that there had been reductions in rent of between 20% and 33%, although they noted that these reductions had been smaller than in other Asian economies when currency movements were taken into account. Members also noted significant and successful financial restructuring by companies in Hong Kong, and a gain of 6.5% in labour productivity during the post-crisis period, compared with a range of 2% to 6.9% for the region as a whole.
Interest Rate Spreads
8. The Sub-Committee noted an information paper analysing the various risk components in the yield spreads of Exchange Fund paper over US Treasuries. The Sub-Committee remarked that the study, which covered the recent Asian Financial crisis and the recovery following it, dealt with an extremely volatile period, during part of which the currency had been the main focus of concern. Such spreads had widened to over 500 basis points during the Asian Financial crisis but had come down considerably over the past two years. They remarked that, while it was extremely difficult to decompose the yield spread and attribute its components quantitatively to various risk factors, it appeared that long-term currency risk had been the main concern for investors over the crisis period, although, in retrospect, the risk seemed to have taken the form of confounded expectations.
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