Record of Discussion of the Meeting of
the Exchange Fund Advisory Committee
Sub-Committee on Currency Board Operations held on 8 October 1999

(Approved for Issue by the
Exchange Fund Advisory Committee on 28 October 1999)

Currency Board Operations for the Period 23 August - 29 September 1999

The Sub-Committee noted that during the period under review the market exchange rate for the Hong Kong dollar had eased from 7.7642 to 7.7678, largely in parallel with the movement of the convertibility rate for the Aggregate Balance. Following the 25 bp rise in the US Fed Funds Target Rate on 24 August, the Base Rate in Hong Kong was adjusted upwards on 25 August by 25 bp to 6.75% (150 bp above the US Fed Funds Target Rate). Subsequently, the Hong Kong Association of Banks raised the savings rate under the Interest Rate Rules by 25 bp, to 3.75%, effective 30 August.

The Sub-Committee noted that the differential between Hong Kong dollar and US dollar interest rates had narrowed substantially during most of September before levelling off towards the end of the month. This narrowing of spreads was attributable partly to the market response to the HKMA's announcement on 6 September on Year 2000 liquidity arrangements, and partly to an improved economic environment in Hong Kong and on the Mainland.

The Sub-Committee noted that changes in the monetary base throughout the period under review 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.

Report on Selected Millennium Indicators for the period 23 August - 29 September 1999

The Sub-Committee noted an information paper on selected market indicators reflecting the Year 2000 positioning of market participants. The Sub-Committee noted that, while indicators continued to be generally stable during the period under review, the implied interest rate over the turn of the year displayed a modest premium. However, this was consistent with analogous indicators in other major currency markets, and did not appear to represent any Year-2000-related risk premium specific to the Hong Kong dollar.

Two-way Convertibility Undertaking

The Sub-Committee considered a paper exploring the advantages and disadvantages of providing a two-way Convertibility Undertaking in respect of the Aggregate Balance. Members examined the possible theoretical advantages of a two-way Convertibility Undertaking and noted that a number of other Currency Board systems had such an undertaking in place. The possible advantages included a more transparent exchange rate anchor and the forestalling of speculative pressure for revaluation. Members also noted potential practical disadvantages and risks involved in a two-way undertaking: among these were the greater opportunities that might be provided for speculative attacks on the currency and the possibility that too narrow a bid-offer spread might displace a substantial part of foreign exchange business involving the Hong Kong dollar.

The Sub-Committee concluded that there was at present no urgency for deciding whether a two-way Convertibility Undertaking should be introduced, particularly in light of the fact that the movement of the convertibility rate in respect of the Aggregate Balance was still in progress. The Sub-Committee advised that, in managing its foreign exchange operations on the bid side, the HKMA should continue to respond to offers from banks according to prevailing market conditions.

The Mandatory Provident Fund and its Implications for Hong Kong's Financial Markets

The Sub-Committee noted an information paper on the implications of the Mandatory Provident Fund for Hong Kong's financial markets.