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Hong Kong Monetary Authority

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Record of Discussion of the Meeting of
the Exchange Fund Advisory Committee
Sub-Committee on Currency Board Operations held on 3 September 1999

(Approved for Issue by the
Exchange Fund Advisory Committee on 23 September 1999)

Currency Board Operations for the Period 2 - 20 August 1999

The Sub-Committee noted that during the period under review the market exchange rate for the Hong Kong dollar had eased from 7.7620 to 7.7641, which broadly matched the movement of the convertibility rate in respect of the Aggregate Balance. Escalating tensions across the Taiwan Straits coupled with renewed rumours of an RMB devaluation in August had contributed to a weakening of the exchange rate and a triggering of the Convertibility Undertaking in the first and third weeks of August. This had sent the Aggregate Balance briefly to negative levels. Members noted that, influenced by expectations of a rise in US rates, interbank interest rates had shown a general increase, but interest rate volatility had slightly decreased. The Sub-Committee observed that the operations of the Currency Board system during the period under review had demonstrated that the system was working well. The Sub-Committee further noted that changes in the Monetary Base throughout the period had been fully matched by corresponding changes in foreign reserves, in accordance with the rules of the Currency Board system. The report on Currency Board operations for the period under review is at Annex A.

Liquidity Arrangements for the Money Market in the Year 2000 Context

The Sub-Committee considered proposals to increase the supply of liquidity to the money market to relieve possible market tightness arising out of Year 2000 positioning. These proposals provided an elaboration on the general strategy discussed by the Sub-Committee at its meeting in July. The proposals included a term repo facility to licensed banks and an enlarged discount window. The Sub-Committee gave its support to these proposals. It also considered that the exceptions to the Currency Board rules were acceptable in the special circumstances of the Year 2000 problem. The Sub-Committee advised that banks should be encouraged first to resort to their own liquidity arrangements as far as possible. The Sub-Committee further advised that, following the Year 2000 event, the unwinding of any special liquidity arrangements under the proposed measures should be clearly reflected in the reports on Currency Board operations early in 2000.

Report on Selected Millennium Indicators

The Sub-Committee noted an information paper on selected market indicators reflecting the Year 2000 positioning of market participants. It was noted that the indicators would be updated regularly for the information of the Sub-Committee.

Recent Developments in the Argentinian Currency Board System

The Sub-Committee was briefed by Mr John Greenwood on recent developments in the Argentinian Currency Board system.

Annex A

Report on Currency Board Operations
( 2 - 20 August 1999 )

During the reporting period, the market exchange rate for the HK dollar eased from 7.7620 to 7.7641, in parallel to the movement of the convertibility rate in respect of the Aggregate Balance. Some outflows of funds were seen in the first and third weeks of August, as a result of which the Aggregate Balance was reduced to relatively low levels, and interbank interest rates firmed up. The monetary base decreased marginally from HK$196.54 bn to HK$194.77 bn, mainly due to the redemption of Certificates of Indebtedness and a fall in the Aggregate Balance. Changes in the monetary base were fully matched by corresponding changes in foreign reserves in accordance with the Currency Board arrangements.

Hong Kong Dollar Exchange Rate

1 The HK dollar exchange rate eased slightly from 7.7620 to 7.7641 during the reporting period, broadly matching the movement of the convertibility rate in respect of the Aggregate Balance. Amid the escalating tension across the Taiwan Straits and renewed rumours of RMB devaluation in early August, the exchange rate weakened towards the convertibility rate (at 7.7628) on 6 August, triggering the Convertibility Undertaking. Following a tightening of interbank liquidity, the exchange rate rebounded marginally to 7.7625 on 11 August. In the third week of August, the HK dollar exchange rate touched the convertibility rate again as some outflows of funds resurfaced. Under the Convertibility Undertaking, the HKMA bought HK dollars, tightening interbank liquidity. The HK dollar exchange rate closed at 7.7641 at the end of the reporting period, 1 pip stronger than the convertibility rate of 7.7642 (Chart 1 and Chart 2).

Interest Rates

2 Interbank interest rates moved on a general uptrend in the reporting period. Amid expectations of another US interest rate hike at the August FOMC meeting and a minor outflow of funds in early August, 1-month HIBOR edged up to a peak of 6.50% on 11 August. When the Aggregate Balance subsequently increased (to HK$0.82 bn) on 12 August alongside a reversal of fund outflows, 1-month HIBOR eased to 6.06% on 16 August before firming again to close at 6.38% on 20 August. 12-month HIBOR increased, albeit at a less rapid pace, during the period under review, from 7.38% on 2 August to a peak of 7.75% on 5 August, before easing to 7.50% at the end of the period (Chart 3).

3 Notwithstanding these movements, interest rate volatility, measured in terms of the standard deviation of 1-month HIBOR (Chart 4), decreased slightly from 0.20 percentage points in July to 0.18 percentage points in August (up to 20 August).

4 The differential between HK dollar and US dollar interest rates widened in the reporting period. The spread in terms of the one-month rate rose from 70 bp on 2 August to a peak of 121 bp on 11 August before narrowing to 75 bp on 16 August. The spread then widened again to 108 bp on 20 August alongside a tightening of interbank liquidity in the third week of August (Chart 5).

5 Yields on shorter-term Exchange Fund bills increased, while yields on longer-term Exchange Fund paper eased slightly during the period under review. The yields on 10-year Exchange Fund notes fell marginally from 7.50% on 2 August to 7.41% on 20 August, while yields on 5-year paper remained unchanged at 6.91% during the reporting period (Chart 6). Yield spreads between 5-year Exchange Fund paper and its US counterpart increased slightly from 101 bp to 104 bp, while that of 10-year Exchange Fund paper narrowed by 7 bp to 143 bp (Table 1).

6 The savings rate under HKAB's Interest Rate Rules and the best lending rate offered by major banks remained unchanged at 3.5% and 8.25% respectively during the period. The weighted average deposit rate offered by 44 major authorised institutions for 1-month time deposits (which are outside the Interest Rate Rules) rose marginally from 6.02% on 30 July to 6.09% on 13 August. Meanwhile, the effective deposit rate (taking into account the maturity of deposits) increased slightly from 4.30% in June to 4.33% in July (Chart 7).

Base Rate

7 The Base Rate remained unchanged at 6.50% (150 basis points above the US Fed Funds Target Rate) throughout the reporting period (Chart 8). [Following the 25 bp rise in the US Fed Funds Target Rate on 24 August, the Base Rate was adjusted upwards on 25 August by 25 bp to 6.75%.]

Monetary Base

8 The monetary base, which comprises the outstanding amount of Certificates of Indebtedness, coins in circulation, the Aggregate Balance and the outstanding amount of Exchange Fund Bills and Notes, decreased slightly from HK$196.54 bn on 2 August to HK$194.77 bn on 20 August (Table 2). Movements of individual components are discussed below.

Certificates of Indebtedness

9 The outstanding amount of Certificates of Indebtedness decreased from HK$90.25 bn on 2 August to HK$88.70 bn on 20 August. During the period, the three note-issuing banks returned to the Exchange Fund a total of HK$1.55 bn worth of Certificates of Indebtedness (CIs) in exchange for US$0.20 bn (Chart 9).

Coins

10 The total amount of coins in circulation increased marginally from HK$5.91 bn on 2 August to HK$5.94 bn on 20 August (Chart 10).

Aggregate Balance

11 Mainly reflecting a net outflow of funds, the Aggregate Balance (before Discount Window activities) decreased from HK$0.43 bn on 2 August to a negative level of HK$0.12 bn on 20 August (Chart 11).

12 Amid renewed rumours of RMB devaluation as well as escalating cross-straits tension, the HK dollar exchange rate weakened. The HKMA bought HK$427 mn under the Convertibility Undertaking on 6 August, sending the Aggregate Balance to a negative level of HK$0.03 bn on 10 August. Consequently, interbank interest rates firmed up and the outflows of funds reversed. The HKMA sold HK$776 mn on 12 August in response to bank offers and the Aggregate Balance rebounded to HK$0.82 bn. As some outflows of funds re-appeared in the third week of August, the HKMA bought HK$233 mn and HK$598 mn under the Convertibility Undertaking on 16 and 17 August respectively. As a result, the Aggregate Balance fell to a negative level of HK$0.14 bn on 19 August. The Convertibility Undertaking was again triggered on 19 and 20 August with a total of HK$931 mn bought by the HKMA (Table 3). [As interbank liquidity tightened and interest rates firmed up, the Aggregate Balance was restored to HK$1.67 bn on 23 August upon a reversal of fund outflows.]

13 During the reporting period, a total of HK$0.32 bn interest payments on Exchange Fund Paper were made, while an additional HK$0.39 bn (market value) of Exchange Fund paper was issued to absorb the interest payments.

Outstanding Exchange Fund Bills and Notes

14 During the reporting period, the market value of outstanding Exchange Fund paper increased marginally from HK$99.95 bn to HK$100.25 bn. The increase was mainly a result of the additional net issue (referred to in paragraph 13 above). All issues of Exchange Fund Bills and Notes were well received by the market (Table 4). Holdings of Exchange Fund paper by licensed banks before Discount Window activities (in terms of market value) decreased slightly from HK$81.58 bn (or 81.61% of total) on 2 August to HK$80.96 bn (or 80.76% of total) on 20 August (Chart 12).

Discount Window Activities

15 The Discount Window provides banks access to overnight liquidity to facilitate their cash flow management, and hence helps to ensure the smooth functioning of the interbank payment system. Bank's access is unrestricted in respect of borrowings collateralised against Exchange Fund paper. During the period under review, banks borrowed a total of HK$4.52 bn from the HKMA through the Discount Window. Of the total, an amount of HK$1.69 bn was borrowed by banks during 19-20 August, when the Aggregate Balance fell into negative territory for two consecutive days. Other than this period, the daily amount of Discount Window borrowing was generally less than HK$500 mn (Chart 13).

16 A total of 21 banks borrowed overnight liquidity through the Discount Window (Table 5). Most banks used the Discount Window facility only infrequently and only one of them borrowed more than 4 times.

17 All the borrowings made during the period were collateralised against Exchange Fund Bills and Notes. There was only one occasion on which a bank borrowed an amount exceeding 50% of its holdings of Exchange Fund paper.

Backing Portfolio

18 As the decrease in the value of backing assets associated with the decline in the monetary base was partly offset by the investment earnings during the reporting period, the backing ratio increased marginally from 110.38% on 2 August to 110.55% on 20 August. Under the linked exchange rate system, although specific Exchange Fund assets have been designated for the Backing Portfolio, all Exchange Fund assets are available to support the HK dollar exchange rate.

Hong Kong Monetary Authority
27 September 1999

Source: Hong Kong Monetary Authority

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Hong Kong Dollar Exchange Rate

1 The HK dollar exchange rate eased slightly from 7.7620 to 7.7641 during the reporting period, broadly matching the movement of the convertibility rate in respect of the Aggregate Balance. Amid the escalating tension across the Taiwan Straits and renewed rumours of RMB devaluation in early August, the exchange rate weakened towards the convertibility rate (at 7.7628) on 6 August, triggering the Convertibility Undertaking. Following a tightening of interbank liquidity, the exchange rate rebounded marginally to 7.7625 on 11 August. In the third week of August, the HK dollar exchange rate touched the convertibility rate again as some outflows of funds resurfaced. Under the Convertibility Undertaking, the HKMA bought HK dollars, tightening interbank liquidity. The HK dollar exchange rate closed at 7.7641 at the end of the reporting period, 1 pip stronger than the convertibility rate of 7.7642 (Chart 1 and Chart 2).

Interest Rates

2 Interbank interest rates moved on a general uptrend in the reporting period. Amid expectations of another US interest rate hike at the August FOMC meeting and a minor outflow of funds in early August, 1-month HIBOR edged up to a peak of 6.50% on 11 August. When the Aggregate Balance subsequently increased (to HK$0.82 bn) on 12 August alongside a reversal of fund outflows, 1-month HIBOR eased to 6.06% on 16 August before firming again to close at 6.38% on 20 August. 12-month HIBOR increased, albeit at a less rapid pace, during the period under review, from 7.38% on 2 August to a peak of 7.75% on 5 August, before easing to 7.50% at the end of the period (Chart 3).

3 Notwithstanding these movements, interest rate volatility, measured in terms of the standard deviation of 1-month HIBOR (Chart 4), decreased slightly from 0.20 percentage points in July to 0.18 percentage points in August (up to 20 August).

4 The differential between HK dollar and US dollar interest rates widened in the reporting period. The spread in terms of the one-month rate rose from 70 bp on 2 August to a peak of 121 bp on 11 August before narrowing to 75 bp on 16 August. The spread then widened again to 108 bp on 20 August alongside a tightening of interbank liquidity in the third week of August (Chart 5).

5 Yields on shorter-term Exchange Fund bills increased, while yields on longer-term Exchange Fund paper eased slightly during the period under review. The yields on 10-year Exchange Fund notes fell marginally from 7.50% on 2 August to 7.41% on 20 August, while yields on 5-year paper remained unchanged at 6.91% during the reporting period (Chart 6). Yield spreads between 5-year Exchange Fund paper and its US counterpart increased slightly from 101 bp to 104 bp, while that of 10-year Exchange Fund paper narrowed by 7 bp to 143 bp (Table 1).

6 The savings rate under HKAB's Interest Rate Rules and the best lending rate offered by major banks remained unchanged at 3.5% and 8.25% respectively during the period. The weighted average deposit rate offered by 44 major authorised institutions for 1-month time deposits (which are outside the Interest Rate Rules) rose marginally from 6.02% on 30 July to 6.09% on 13 August. Meanwhile, the effective deposit rate (taking into account the maturity of deposits) increased slightly from 4.30% in June to 4.33% in July (Chart 7).

Base Rate

7 The Base Rate remained unchanged at 6.50% (150 basis points above the US Fed Funds Target Rate) throughout the reporting period (Chart 8). [Following the 25 bp rise in the US Fed Funds Target Rate on 24 August, the Base Rate was adjusted upwards on 25 August by 25 bp to 6.75%.]

Monetary Base

8 The monetary base, which comprises the outstanding amount of Certificates of Indebtedness, coins in circulation, the Aggregate Balance and the outstanding amount of Exchange Fund Bills and Notes, decreased slightly from HK$196.54 bn on 2 August to HK$194.77 bn on 20 August (Table 2). Movements of individual components are discussed below.

Certificates of Indebtedness

9 The outstanding amount of Certificates of Indebtedness decreased from HK$90.25 bn on 2 August to HK$88.70 bn on 20 August. During the period, the three note-issuing banks returned to the Exchange Fund a total of HK$1.55 bn worth of Certificates of Indebtedness (CIs) in exchange for US$0.20 bn (Chart 9).

Coins
10 The total amount of coins in circulation increased marginally from HK$5.91 bn on 2 August to HK$5.94 bn on 20 August (Chart 10).
Aggregate Balance
11 Mainly reflecting a net outflow of funds, the Aggregate Balance (before Discount Window activities) decreased from HK$0.43 bn on 2 August to a negative level of HK$0.12 bn on 20 August (Chart 11).

12 Amid renewed rumours of RMB devaluation as well as escalating cross-straits tension, the HK dollar exchange rate weakened. The HKMA bought HK$427 mn under the Convertibility Undertaking on 6 August, sending the Aggregate Balance to a negative level of HK$0.03 bn on 10 August. Consequently, interbank interest rates firmed up and the outflows of funds reversed. The HKMA sold HK$776 mn on 12 August in response to bank offers and the Aggregate Balance rebounded to HK$0.82 bn. As some outflows of funds re-appeared in the third week of August, the HKMA bought HK$233 mn and HK$598 mn under the Convertibility Undertaking on 16 and 17 August respectively. As a result, the Aggregate Balance fell to a negative level of HK$0.14 bn on 19 August. The Convertibility Undertaking was again triggered on 19 and 20 August with a total of HK$931 mn bought by the HKMA (Table 3). [As interbank liquidity tightened and interest rates firmed up, the Aggregate Balance was restored to HK$1.67 bn on 23 August upon a reversal of fund outflows.]

13 During the reporting period, a total of HK$0.32 bn interest payments on Exchange Fund Paper were made, while an additional HK$0.39 bn (market value) of Exchange Fund paper was issued to absorb the interest payments.

Outstanding Exchange Fund Bills and Notes

14 During the reporting period, the market value of outstanding Exchange Fund paper increased marginally from HK$99.95 bn to HK$100.25 bn. The increase was mainly a result of the additional net issue (referred to in paragraph 13 above). All issues of Exchange Fund Bills and Notes were well received by the market (Table 4). Holdings of Exchange Fund paper by licensed banks before Discount Window activities (in terms of market value) decreased slightly from HK$81.58 bn (or 81.61% of total) on 2 August to HK$80.96 bn (or 80.76% of total) on 20 August (Chart 12).

Discount Window Activities

15 The Discount Window provides banks access to overnight liquidity to facilitate their cash flow management, and hence helps to ensure the smooth functioning of the interbank payment system. Bank's access is unrestricted in respect of borrowings collateralised against Exchange Fund paper. During the period under review, banks borrowed a total of HK$4.52 bn from the HKMA through the Discount Window. Of the total, an amount of HK$1.69 bn was borrowed by banks during 19-20 August, when the Aggregate Balance fell into negative territory for two consecutive days. Other than this period, the daily amount of Discount Window borrowing was generally less than HK$500 mn (Chart 13).

16 A total of 21 banks borrowed overnight liquidity through the Discount Window (Table 5). Most banks used the Discount Window facility only infrequently and only one of them borrowed more than 4 times.

17 All the borrowings made during the period were collateralised against Exchange Fund Bills and Notes. There was only one occasion on which a bank borrowed an amount exceeding 50% of its holdings of Exchange Fund paper.

Backing Portfolio

18 As the decrease in the value of backing assets associated with the decline in the monetary base was partly offset by the investment earnings during the reporting period, the backing ratio increased marginally from 110.38% on 2 August to 110.55% on 20 August. Under the linked exchange rate system, although specific Exchange Fund assets have been designated for the Backing Portfolio, all Exchange Fund assets are available to support the HK dollar exchange rate.