(Approved for Issue by the Exchange Fund Advisory Committee on 14 July 2005)
Report on Currency Board Operations (1 June - 20 June 2005)
The Sub-Committee noted that the three refinements to the Linked Exchange Rate system introduced on 18 May, including the gradual shifting of the weak-side Convertibility Undertaking from 7.80 to 7.85, which had been completed on 20 June, had so far worked smoothly. Hong Kong dollar interest rates had tracked more closely their US dollar counterparts, despite some slight tightening of interbank rates associated mainly with a number of equity initial public offerings. The Aggregate Balance, having declined sharply after the introduction of the three refinements, had remained stable during the reporting period at around HK$1.3 billion. Members observed that the correlation between 12-month renminbi non-deliverable forward points and Hong Kong dollar forward points appeared to have weakened since the introduction of the three refinements.
- The Sub-Committee noted that, in accordance with Currency Board principles, changes in the Monetary Base had been fully matched by corresponding changes in foreign reserves during the reporting period.
- The report on Currency Board operations for the period under review is at Annex A.
Monitoring of Risks and Vulnerabilities
- Members noted the continuing decline of the euro against the US dollar, reflecting both continued economic weakness in the euro zone and the recent political uncertainty about the future direction of European integration. In the US, although the manufacturing sector had shown signs of weakness, indicators of consumer spending and investment remained firm. Members noted that growth in Hong Kong and in the region generally continued to be strong, with retail sales in Hong Kong increasing markedly and exports rebounding from their decline in the first quarter of the year.
- The Sub-Committee noted a special analysis in the report examining the potential impact on Hong Kong of the recent trade dispute over Mainland textile, clothing and footwear exports to the US and Europe. The analysis suggested that the currently imposed limits on the growth of such exports would have only a minor impact on Hong Kong GDP growth.
Operations within the Convertibility Zone
- The Sub-Committee considered a paper setting out the proposed broad guiding principles for market operations conducted by the HKMA within the Convertibility Zone, which had been introduced as one of the three refinements to the Linked Exchange Rate system in May. Members considered that, given complex and changing market conditions, it would be extremely difficult to lay down detailed and specific rules for operations within the Convertibility Zone. They therefore endorsed four broad principles that should govern these operations. The first principle was that all operations within the Convertibility Zone should be carried out in strict accordance with Currency Board rules: that is, both the stock and changes in the Monetary Base should be fully backed by foreign exchange. Secondly, the primary objective of any operations should be to preserve exchange rate stability implied by the Linked Exchange Rate system and to maintain confidence in the system. Thirdly, operations might be undertaken to support such interest rate adjustments as would maintain exchange rate stability under the Linked Exchange Rate system, and would avoid destabilising behaviour in interest rates. Fourthly, operations might also be undertaken in order to remove market anomalies. With regard to the fourth guiding principle, Members acknowledged that it was a matter of judgement what constituted a market anomaly, and that this judgement would need to be exercised case by case, taking account of market dynamics.
- The Sub-Committee also considered that, while these four principles should be generally applicable for the time being, they should be kept under review in the light of experience and changing conditions.
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Hong Kong Monetary Authority
15 July 2005