(Approved for Issue by the Exchange Fund Advisory Committee on
24 January 2002)
Currency Board Operations for the Period 29
November - 19 December 2001
The Sub-Committee noted that the Hong Kong dollar had been
generally stable during the period under review. Amid tightening
interbank liquidity, the HKMA had, in response to banks' offers,
sold a total of HK$0.23 bn, resulting in an expansion of the
Aggregate Balance and a consequent softening of interbank interest
rates. Interbank interest rates had further eased in the second
week of December, following the 25 bps cut in the US Fed Funds
Target Rate. Towards the end of the period, there had, as usual,
been an increased demand for the Hong Kong dollar, partly
reflecting market anticipation of higher local interest rates
during the year-end period: the exchange rate had, as a result,
strengthened. The Sub-Committee observed that, largely as a result
of net interest income on backing assets and an increase in the
outstanding amount of Certificates of Indebtedness, the backing
ratio had increased during the period, although, at 111.60% at the
end of the period, it was still some distance away from the trigger
point of 112.5%, at which assets would be transferred from the
Backing Portfolio to the Investment portfolio sufficient to reduce
the backing ratio to 110%.
2. Members noted that neither the crisis in Argentina nor
concerns about the depreciation of the yen had had much impact on
the Hong Kong dollar exchange and money markets. With reference in
particular to the Argentinian situation, it appeared that the
markets were clearly differentiating between Hong Kong's currency
board system and that in Argentina.
3. The Sub-Committee noted that, in accordance with Currency
Board principles, changes in the monetary base continued to be
fully matched by changes in foreign reserves.
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 on external
and internal risks facing Hong Kong. Members observed that,
externally, the situation in the major economies was continuing to
evolve very slowly. There had been little hard evidence of any
improvement in the indicators for the fourth quarter of 2001. More
recently, however, some indicators suggested the beginnings of an
upturn in the US economy, though it was too early to say whether
these would be sustained. A particular concern was the
deterioration in the labour markets of both the US and Japan, which
could have a negative impact on consumer confidence and spending.
Members noted the depreciation of the yen during the period under
review. This was, in a sense, a two-edged sword: it raised concerns
about pressures on other currencies in the region; yet if it helped
stimulate Japanese economic growth this would generally be of
benefit to the region. Members also noted that, so far, there had
been little contagion from the Argentinian crisis into other
markets. If, however, the peso devalued, the risk of contagion
could increase.
6. The Sub-Committee noted that, for Hong Kong, the indicators
continued to point to a slowdown in economic activity, despite an
increase in the transaction volume of residential properties in
November. The slowdown was expected to continue well into 2002,
although there continued to be uncertainty about the prospects for
growth for the year as a whole. Members noted that a particular
concern was the continuing difficult fiscal situation.
Estimating Hong Kong's Output Gap and its
Impact on Inflation
7. The Sub-Committee noted an information paper on Hong Kong's
output gap and its relationship with inflation, with particular
reference to the deceleration in Hong Kong's growth from an annual
average of 7% in the period 1977-1994 to 3.5% in 1995-2000. The
analysis in the paper suggested that, although Hong Kong's
potential growth had moderated since the Asian financial crisis, it
was still above the average of the G-7 countries. The negative
output gap, which had emerged in 1998-9, had virtually vanished
following the strong recovery in 2000, although a negative output
gap was likely to re-emerge in 2001. The analysis suggested that
the output gap had a significant impact on inflation both in the
short run and the long run. A change in the import price had a
significant contemporaneous effect on inflation, and was fully
passed through to the domestic price over the long run. According
to the research, the current deflation process was more a cyclical
than a structural phenomenon, and was likely to continue in the
immediate future as a result of the possible re-emergence of a
negative output gap in 2001 and the long-run effect of the negative
gaps of 1998-2000.
For further enquiries, please contact:
Jasmin Fung, Manager (Press), at 2878 8246 or
Sylvia Yip, Manager (Press), at 2878 1687
Hong Kong Monetary Authority
28 January 2002
