(Approved for Issue by the Exchange Fund Advisory Committee on 29 May 2003)
Report on Currency Board Operations (27 March - 15 April 2003)
The Sub-Committee noted that this was a generally stable period. Nevertheless, concerns about the economic impact of the outbreak of atypical pneumonia had led to a firming of Hong Kong dollar interbank interest rates and a widening of spreads between Hong Kong dollar interest rates and their US counterparts. Members further noted that, slightly beyond the period covered by the report, the concerns about atypical pneumonia had contributed to a rise in Hong Kong dollar 12-month forward points, which, having peaked at around 370 in late April, had since eased to well below 300.
2. The Sub-Committee noted that, in accordance with Currency Board principles, changes in the Monetary Base during the reporting period had been fully matched by changes in the foreign reserves.
3. The report on Currency Board operations for the period under review is at Annex A.
Monitoring of Risks and Vulnerabilities
4. The Sub-Committee noted that the outlook of the global economy was clouded by the weaker-than-expected growth in the US in the first quarter and by continued weakness in Europe and Japan. In Asia, the near-term prospects had been further damaged by the outbreak of atypical pneumonia. Within Hong Kong, there were preliminary indications that the outbreak was having a significant impact on the economy, with sharp declines in tourist arrivals and resident departures, and the Purchasing Managers Index. Members noted that multinational institutions and private financial firms had downgraded their growth forecasts for the Asian economies: the downward revision for Hong Kong ranged from 0.5 to 3.0 percentage points.
5. Members observed that, for the time being, the outbreak of atypical pneumonia presented no immediate or direct concerns for currency stability. However, the profitability of the banking system could be affected, particularly if the outbreak persisted for a prolonged period.
The Macroeconomic Effects of Pressures on the Link: Some Estimates for 1990-2002
6. The Sub-Committee noted a report on research into the impact of speculative pressures (on the Link) on real economic activity and prices in Hong Kong using data for the 1990-2002 period. The higher interest rates caused by the speculative attacks had resulted in a gradual fall in real GDP, with the peak effect being felt after about four quarters (reaching a level of 1.6% below benchmark) and a decline in prices over time (reaching about 1.5% below benchmark after three years).
7. Members observed that the findings of the research showed clearly that the economy as a whole was sensitive to, and responded to, speculative attacks on the currency. Members also observed that the technical measures introduced to improve the Currency Board system in 1998 (including the introduction of the discount window and a substantial increase in the size of the Monetary Base) had, through reducing the sensitivity of interest rates to speculative attacks, probably reduced the amount by which GDP and prices would decline following a speculative attack. They noted, however, that there was, for the time being, insufficient empirical data for this to be clearly shown.
An Analysis of Balance of Payments Developments in 2002
8. The Sub-Committee noted a report analysing balance of payment developments from a macroeconomic perspective, particularly in the light of Hong Kong's very strong current account surplus in 2002. The analysis indicated some autonomous net outflow of capital, financed in part by the current account surplus. However, the outflow was in line with economic fundamentals and there was no significant evidence of capital flight triggered by reduced confidence. The strong current account surplus reflected both an improvement in competitiveness, resulting from the depreciation of the real effective exchange rate, and weak domestic demand.
9. Members observed that it was likely that the current account surplus would be affected in the second quarter of 2003 by the sharp decline in tourist arrivals.
The Yen Exchange Rate and Net Foreign Assets
10. The Sub-Committee noted an information paper reporting on research into the trend (equilibrium) value of the yen by considering fundamental factors, such as net foreign assets. The findings supported the view that investment income generated by these assets underpinned the strength of the exchange rate in the long run, which helped to offset the negative impact on the exchange rate arising from weaknesses in the Japanese economy.
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Hong Kong Monetary Authority
2 June 2003