During a month of considerable volatility on the stock market Hong Kong's currency market has been operating smoothly.
In comparison with the intense volatility seen in the stock market over the past few weeks, the calm in the currency market has been a pleasant contrast indeed. The exchange rate has stayed close to that for the Convertibility Undertaking. Interest rates, other than those for very short-term interbank money, have remained stable. The Convertibility Undertaking was, nevertheless, triggered on the evening of Friday 14 April, interestingly just ahead of the large downward adjustment in the US stock market on that day. But thankfully this did not produce any unusual reaction in the money market at all. The Aggregate Balance did fall and short-term interest rates did rise. But if the experience in the functioning of the reformed currency board system since September 1998 is anything to go by, this should be quite a temporary phenomenon.
Readers will have noticed the occasional outflow, particularly in the past few months, similarly triggering the Convertibility Undertaking and leading to a fall in the Aggregate Balance of the banking system, or a shortage of interbank liquidity. In a few instances, the amounts involved were big relative to the Aggregate Balance, enough to push it into negative territory. In all such instances, interbank interest rates at the short end, in particular the overnight rate, firmed to near the level of the Base Rate at which licensed banks with Exchange Fund paper can access the Discount Window for liquidity assistance. Meanwhile, with short-term interest rates for the Hong Kong dollar at a slight premium over those for the US dollar, compensating inflows soon emerged. US dollars were invariably put to us, for the Currency Board account; and the Aggregate Balance consequently moved back into positive territory and short-term interest rates eased back to near the corresponding levels for the US dollar. Depending on the circumstances, this cycle of outflow, fall in Aggregate Balance, higher short-term interest rates, compensating inflow, rise in Aggregate Balance and lower short-term interest rates took on average about a week or two to complete. And the cycle often manifested itself also in a reverse sequence, when the inflows of funds were substantial enough to require absorption of foreign reserves into the Currency Board account and subsequent money market adjustments.
In whichever sequence, the cycle of events in the foreign exchange and money markets, when it involves the buying and selling of US dollars against the Aggregate Balance through the Currency Board mechanism, has now become very well understood by market participants. In view of the automatic and transparent nature of the process, there is a high degree of predictability and confidence in it. And there has, therefore, been no panic reaction in the markets to the occasional inflows and outflows of funds, although these have still created headlines in the local papers.
While our currency system has been working well, even under stressful conditions in the stock market, there is no room for complacency. We must realise that, with the economic fundamentals now clearly strong, as the economy continues in its robust recovery, the climate is not conducive to speculative activities against our currency. But beyond the domestic economy there are factors that may weigh heavily on us, affecting market sentiment and possibly general confidence. For example, a few weeks ago there was a technical glitch in the reporting of the market exchange rate of the renminbi, showing a movement of less than 0.05%. This, admittedly, is large, relative to recent movements in the renminbi exchange rate; and so it generated some press interest, to the extent that a front page headline story appeared the next day in a leading global financial newspaper, which also predicted difficulties for the Hong Kong dollar. We must, therefore, be on the alert in the management of our currency system. On the one hand, our Currency Board Committee will continue, as it has since its establishment, to examine, and, if thought fit, to introduce ways to strengthen our Currency Board arrangements. On the other hand, we shall continue to operate the system transparently and consistently, in accordance with the rule-based arrangements, to enhance credibility in the system and confidence in the currency. And we shall continue to publicise the fact that we are religiously doing so, even at the risk of seeming tediously long-winded and repetitive to those who are familiar with the system.
Joseph Yam
27 April 2000
More information on the Currency Board System can be found here.
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