Keynote address by the
Mr. Yam gives a keynote address on the Hong Kong dollar link
Chief Executive of the Hong Kong Monetary Authority, Mr. Joseph Yam, at the Hong Kong Trade
Development Council, Financial Roadshow in Tokyo on 3/3/98.
Introduction
1. I am honoured to be delivering the keynote address of this Financial Roadshow of Hong
Kong. I shall, as you are aware, be talking about the Hong Kong dollar link. The Hong Kong dollar has been
linked to the US dollar at a fixed exchange rate since October 1983. Notwithstanding what must be the worst
financial turmoil in the history of Asia in recent months, and an abundance of events which might have
undermined confidence on the Hong Kong dollar in the past fourteen and a half years of the existence of the
fixed link, the exchange rate has remained very stable. Indeed, the Hong Kong dollar is one of the two major
currencies in the Asian region that have not been affected by the recent tidal wave of devaluations, the other
being the renminbi (RMB) of the Mainland of China. Furthermore, it is the only freely convertible currency in
the region that has survived the turmoil unscathed.
2. There has been much scepticism expressed on the Hong Kong dollar's link with the US
dollar over the years and in particular in the past few months when one after another the Asian currencies
tumbled. Indeed, to some, the Hong Kong dollar increasingly sticks out like a sore thumb, but to others it is
being seen increasingly as a pillar of stability in financial markets in the Asian region and an example of
financial prudence. I hope you belong to the latter group of people rather than the former, but I fear that I may
be expecting too much, for indeed it is quite natural when you do not have the chance to examine in detail an
apparently controversial matter to be sceptical about it rather than to hang your faith in it. But my task today
is, so to speak, to try and win you over.
Exchange Rate Policy
3. Let me start with Hong Kong's exchange rate policy. Here one is often attracted by the
simplistic argument that Hong Kong, which prides itself as the freest economy in the world, should best
operate with a freely floating exchange rate. I obviously do not subscribe to that view. Hong Kong, as you all
know, is a highly externally oriented economy. Almost all our daily needs are imported, including for
example the water from our tap at home and sand for construction. And almost all our manufactured products
are exported. Furthermore, we are very much an entrepot, handling a large volume of re-exports1, supported
by the largest container port in the world. And our service industries are also very externally oriented,
providing financial and other services for the region, in particular for the Mainland of China. The total value
of our external trade in goods and services in a year is equivalent to well over 250% of our gross domestic
product (GDP).
4. Businessmen engaged in these externally oriented economic activities would I am sure be
acutely conscious of the currency risk arising from the many international transactions that they enter into.
They would obviously prefer clarity and predictability in the exchange rates of the domestic currency against
those currencies to which their business is exposed. They would, I am sure, prefer fixed exchange rates over
floating exchange rates, unless they are in the foreign exchange business in which case it is understandable
that they would prefer the greater volatility that comes with floating exchange rates. It is of course an uneasy
feeling that profits might be eroded, or for that matter enhanced, by volatile exchange rates. One simply
cannot plan one's business ahead properly with such volatility. Under the circumstances, prudent
businessmen have no alternative but to hedge their currency exposures at considerable costs. It would clearly
be beneficial for those conducting externally oriented business if currency risks could be eliminated by a
fixed exchange rate system that has credibility. I believe this is why Europe has largely been operating with
fixed exchange rates, the benefits of which are so clear that we shall soon see the unification of European
currencies as the Euro comes into being. And I would be surprised if some of the Asian economies which
floated their currencies recently are not regretting it. Indeed, there have been serious discussions to try and
reestablish exchange rate stability by again fixing their exchange rates, possibly through the adoption of the
currency board regime.
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Economic Fundamentals
5. But obviously it takes a lot to establish credibility in a fixed exchange rate, or indeed any
fixed exchange rate system. However, I believe that we have a highly credible fixed exchange rate system in
Hong Kong. Our track record of exchange rate stability is an impressive one. This is against the background
of sharp gyrations in the exchange rates of major currencies. The dollar/yen rate, for example, increased
sharply in the mid-eighties to 263 in February 1985 before falling equally sharply over a short period to
around 120 by the end of 1987, meanwhile triggering the worldwide stock market crash in that year. The
sharp gyrations continued in more recent times, with the dollar/yen rate again falling to around 80 in April
1995 before increasing to 134 in January 1998. There was also the ERM crisis of 1992, which at the time
brought sharp focus to the viability of fixed exchange rates; and there was the financial crisis in Mexico,
which affected many emerging markets at the beginning of 1995. Then there is currently the worst financial
turmoil in the history of Asia. On other fronts, there was also an abundance of events which could have
affected confidence in the currency over the sensitive period of political transition leading to the resumption
in the exercise of sovereignty over Hong Kong by China on 1 July 1997. But the Hong Kong dollar's link
with the US dollar has remained rock solid, with the exchange rate staying very close to the fixed level of
HK$7.80 to US$1.
6. There are good reasons why our exchange rate has remained so stable against such
eventful background. Hong Kong's economic fundamentals are strong2. We pursue sound macroeconomic
policies. We have an impressive track record of fiscal discipline3. In the last 14 years of the fixed exchange
rate link, while most countries were grappling with fiscal deficits, Hong Kong has consistently run budget
surpluses averaging 2% of the GDP per year. Our fiscal surplus in the financial year 1997-98 was 5.8% of
GDP. As a result, we have over the years built up strong fiscal reserves. These are deposited with the
Exchange Fund which holds the foreign reserves of Hong Kong, including those backing the issue of our
currency. As at the end of 1997, Hong Kong's foreign reserves stood at US$92.8 billion, which was the third
largest in the world after Japan and the Mainland of China, providing not just 100% backing, but nearly 800%
backing for the currency4.
7. Moreover, the structure of Hong Kong's economy is flexible and efficient, encouraged by
a small government5 with a strong commitment of public policy towards free markets. This enhances Hong
Kong's resilience in absorbing external shocks and its ability to adjust quickly. The best example is the labour
market. Owing to massive relocation of manufacturing processes across the border to the southern part of the
Mainland of China, employment in the manufacturing sector had declined by nearly 65 percent from 870,000
in 1986 to 310,000 in September 1997. In most economies, one would have seen a jump in structural
unemployment and much politicized demands for government intervention. But not in Hong Kong. In fact,
the labour market is so flexible and efficient in relocating workers to the service industries6 that the
unemployment rate in Hong Kong has remained low throughout at between 2 and 3 percent.
2
During the past 14 years under the linked exchange rate system, the Hong Kong economy achieved an average annual
growth rate of 6.1% in real terms. Inflation rate, measured by Consumer Price Index (A), averaged 7.5% during this period. In
the tradable goods sector, inflation was more subdued, with the unit price of exports rising by around 2.2% per annum. The
unemployment rate stayed at a low level of 2 to 3% throughout the period.
3
This has further been enshrined in Article 107 of the Basic Law which specifies that "the Hong Kong Special
Administrative Region shall follow the principle of keeping expenditure within the limits of revenues in drawing up its
budget, and strive to achieve a fiscal balance, avoid deficits and keep the budget commensurate with the growth rate of its
gross domestic product."
4
The amount of foreign reserves as at end-1997 at US$92.8 billion was equivalent to 7.8 times the amount of currency notes
and coins in circulation, 7.1 times the monetary base, 3.8 times Hong Kong dollar M1, 54% of GDP or 15 months of retained
imports.
5
Public expenditure, which comprises total government expenditure and expenditure by public sector organizations, currently
accounts for only around 18% of GDP.
6
Employment in the services sector rose from 1.1 million workers in 1986 to almost 1.8 million in September 1997,
absorbing more workers than the job losses incurred by the contraction of the manufacturing sector during the period.
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8. Hong Kong's robust financial system has also provided an important foundation for
exchange rate stability. We have seen many examples in which the maintenance of a stable exchange rate has
been undermined by a fragile financial system. Examples include the Mexican peso crisis in 1994 and the
recent currency turmoil in Asia. In Hong Kong, however, we have a robust monetary management
mechanism, a modern system of prudential supervision and a sophisticated financial infrastructure. Our
banking system, for example, is strong, with the capital adequacy ratios of locally incorporated banks
averaging around 17% and problem debt ratios of less than 2%. Although the irrational exuberance that has
been a feature of asset markets in the Asian region was also present in Hong Kong, prudent risk management
practices have enabled our banks to absorb the inevitable asset price deflation that has occurred as the
contagion of financial turmoil spread in the Asian region7.
9. The prudent behaviour of our banks has also encouraged prudent business practices
generally. There is, in the non-bank sector of Hong Kong, much less of a maturity mismatch in borrowing
short-term money to make long-term investments and a currency mismatch in borrowing foreign currency
without foreign currency income. These are some of the tragic errors responsible for the dire state that some
of the Asian economies have now found themselves in. Furthermore, with the benefits of financial
liberalization creating an euphoria that regrettably encouraged neglect on the need to build a robust financial
system in order to cope with the associated volatility in financial flows, it seems inevitable, at least with the
benefit of hindsight, that there could be tremendous pressures on their currencies. Not so for Hong Kong,
already with a long history of liberalized markets and the absence of any forms of exchange control. We have
learnt our lessons in the early eighties and have been meticulous in building ourselves a robust financial
infrastructure and continuously upgrading it. We even managed to do so, in certain issues, ahead of time
rather than catching up in a crisis induced situation. Yes, there were still business failures - indeed this is an
inevitable feature of free markets - but there is little moral hazard for the public sector. Yes, there were still
cracks showing up in unregulated areas that require mending, for example recently in equity margin
financing, but nothing of a systemic nature or of any threat to the stability of our currency.
10. These strong economic fundamentals of Hong Kong also do not require Hong Kong to
get involved in the process of competitive devaluation of currencies recently seen in the Asian region. In the
second half of 1997, the Thai baht depreciated by 49%, the Indonesian rupiah by 56%, the Korean won by
48%, the Malaysian ringgit and the Philippine peso both by 35%. Even the relatively strong economies of
Taiwan and Singapore had allowed their currencies both to depreciate by 15%. Notwithstanding this, the
Hong Kong economy is still expected to grow in 1998 by 3.5% in real terms. Although this is somewhat
below the growth rate of 5.2% recorded in 1997, it is a highly respectable growth rate in the light of the
circumstances that we face in the Asian region and is higher than most of the economies in the region that
have devalued their currencies. Most developed economies would be delighted to achieve such a growth rate
in 1998. The slowdown is also considered healthy, given a degree of irrational exuberance seen in asset
markets in the past couple of years. Indeed, inflation this year will slow down further to 5% from 5.8% in
1997, with the unemployment rate staying low and the current account remaining broadly in balance. Thus
the Hong Kong economy will not be too much affected by the devaluation of the exchange rates of our
competitors. This is understandable for a highly service-oriented economy which Hong Kong now is8.
One Country, Two Currencies
11. Perhaps I should digress a little here and address a related issue which has been the
subject of some attention, with considerable apprehension amongst observers. This concerns whether the
currency of the Mainland of China, the RMB, would be forced into devaluation by the Asian financial turmoil
and if so what would be the implications for the Hong Kong dollar's link to the US dollar. The Chinese
7
As an illustration, residential mortgage loans, which account for roughly 25% of total domestic loans extended by the
banking sector, have been of very high quality, helped by the prudent lending policy of the banks, including for example a
maximum loan to valuation ratio of 70%. As at the end of September 1997, the actual average of this ratio was only 52%. The
delinquency ratio, measured by loans overdue for more than 90 days as a percentage of total outstanding loans, stood at only
0.1% as at end-September 1997. Even during the property downturn in the second half of 1994 and 1995, the delinquency
ratio remained low, at around 0.2%.
88 The contribution of the services sector to GDP is now about 85%.
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leaders have clearly and repeatedly said that the RMB will not be devalued9. The cynics would of course
immediately remind us that in the monetary history of the world, devaluations of currencies were frequently
preceded by strong denials and that these matters are determined by market forces and not the words of
government officials. But I hope the cynics would also spend a little time to look at the facts.
12. First, there are still capital controls in the Mainland of China. That makes the control of
the exchange rate much easier. Indeed, the foreign exchange market in the Mainland of China is dominated
by one large player sitting on about US$140 billion of foreign reserves and that is the State Administration of
Foreign Exchange (SAFE) of the People's Bank of China (PBoC). One simply cannot take a short position
against the RMB and so technically the RMB is not exposed to speculative attacks.
13. Second, there are political and policy considerations for the Mainland of China to refrain
from involving itself in competitive devaluation. A devaluation of the RMB would risk creating trade friction,
particularly with the United States given that the trade surplus of the Mainland of China with the United
States has risen to almost US$50 billion in 1997, very close to Japan's trade surplus with the United States at
US$55.7 billion. On the multilateral front, a devaluation may also undermine China's re-entry to the World
Trade Organization because it could be seen as a move to gain undue competitive advantage and increase its
trade share. It would also be highly destabilizing for the currencies and financial markets of the Asian region,
including those of Hong Kong which the Mainland is very keen to avoid. It could even be destabilizing for
financial markets beyond the region, and all this would inevitably in the end impact on the Mainland of China
itself. A devaluation would also adversely affect the flow of foreign direct investments into the Mainland and
renew inflationary pressures, which would be a pity after winning the tough battle against inflation in the past
three years10.
14. Third, there are other less risky and more effective means of maintaining
competitiveness. Continuing reform of the state-owned sector, confirmed by the decision of the Party
Congress in September 1997, unleashing the powerful forces of the market, will achieve more efficient
allocation of resources and enhance productivity of the economy. There is also continued trade reform11,
liberalizing import barriers and cutting import tariff rates on more than 4,800 product categories by over 26%
effective from 1 October 1997. The reform of export tax rebates will also benefit exporters. Continuing
efforts to strengthen financial markets and the financial infrastructure12 will enable more effective financial
intermediation and promote economic growth and development.
15. Fourth, in any case, the competitiveness of the Mainland of China is based on broader
structural factors including underlying factor costs, market leadership and the trade policies of major
importers. Even after the marked depreciation of Asian currencies, labour costs in the Mainland of China is
still lower than most of Asian economies, perhaps with the exception of Indonesia13. And there is in China a
continued access to a huge labour pool made up of redundant state sector workers and surplus labour in rural
areas. The effect of devaluation on the manufacturing costs in the Asian economies, on the other hand, are
9
Chinese Vice-Premier Mr Zhu Rongji said on 14 January 1998 that 'the renminbi will be maintained at a stable rate.... it
will not be devalued'. Governor of the People's Bank of China, Mr Dai Xianglong, reiterated this on 16 February 1998.
10
Based on the Mainland's consumer price index, inflation declined from 24.1% in 1994 to 2.8% in 1997 and, based on the
retail price index, from 21.7% to 0.8%.
11
According to European Union (EU) Trade Commissioner Sir Leon Brittan who led an EU team to visit Beijing in February
1998, China had promised to submit to the WTO in March 1998 detailed tariff cuts as part of its bid to re-join the trade body.
12
The General Bank Clearance Centre was established by the PBoC in December 1997 to help prevent financial risks and
maintain a stable payment order. The PBoC has also abolished credit quotas for working capital loans for all state-owned
commercial banks since January 1998. Besides, in a banking conference held at that time, PBoC Governor Dai Xianglong
highlighted four major banking reform directions, namely reorganizing the PBoC's branch network, streamlining commercial
bank operations, converting co-op banks into commercial banks and cleaning up non-performing loans.
13
Based on Goldman Sachs and World Bank's studies, the estimated total worker compensation (i.e. wages plus social
security benefits) per week in the manufacturing sector in 1998 is US$30 for China, US$21 for Indonesia, US$71 for
Malaysia, US$47 for the Philippines, US$56 for Thailand, US$244 for Korea and US$329 for Taiwan.
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likely to be offset by higher inflation, higher costs of imports and higher interest rates. China has also
established market leadership in a variety of products in world markets. It is difficult to see this dominant
position being significantly eroded, particularly with the existence of international trade barriers which limit
the extent of the possible shift of export orders from China to other Asian economies.
16. Fifth, the economic fundamentals of the Mainland of China are strong. Economic growth
in 1998, forecasted to be 8% in real terms, is only a shade below the growth rate of 8.8% achieved in 1997.
Furthermore, inflation is expected to be below 3%. Last year, the Mainland of China ran a trade surplus of
US$40 billion, equivalent to 4.5% of GDP. Foreign direct investment amounted to US$45 billion. Its foreign
reserves are the second highest in the world. Its foreign debt amounted to only about 14% of GDP and
consisting of mostly long-term loans from official sources such as the World Bank and the Asian
Development Bank, and the debt service ratio at well below 10% of exports. The fiscal deficit in 1997 was
small at below 1% of GDP and the monetization of such deficits is now prohibited. My contacts in Beijing
have told me that even on the basis of very extreme assumptions with the amount of foreign direct
investments and the growth rate of exports being halved in 1998, there will still be a balance of payments
surplus. In the circumstances there really is no pressure to devalue the RMB.
17. The stability or otherwise of the RMB, understandably, would appear to some observers
to have implications for the Hong Kong dollar's link with the US dollar, particularly given the economic
closeness between Hong Kong and the Mainland of China. But this does not necessarily mean that the Hong
Kong dollar will need to move in sync with the RMB, in the highly unlikely event that the RMB is devalued.
The Hong Kong dollar is linked to the US dollar and not to the RMB. The economic relationship has always
been very close between Hong Kong and the Mainland of China. There has always been separate currencies
for Hong Kong and the Mainland, and "one country, two currencies" is further enshrined in the Basic Law
governing Hong Kong for 50 years after the resumption of sovereignty14. The many differences between
Hong Kong and the Mainland of China argue for monetary segregation and not monetary union. In 1994
when measures were taken in the Mainland to unify the official and market exchange rates for the RMB,
involving a de facto devaluation of the RMB of 33% on an unweighted basis and 7% on a weighted basis.15
But this did not affect the Hong Kong dollar at all. So why should a devaluation in the exchange rate of the
RMB, which in any case has been ruled out by the Chinese leaders, affect the stability of the Hong Kong
dollar's link to the US dollar now or in the foreseeable future?
The Currency Board System
18. Technically, the Hong Kong dollar's link to the US dollar is a very strong form of fixed
exchange rate system which is called, in academic terms, a currency board system. It is quite different from
the pegged exchange rate system that is more widely known and which requires active intervention in the
foreign exchange market by the central bank to keep the exchange rate within pre-determined levels. By
contrast, a currency board system does not require this type of foreign exchange market intervention. Instead,
it requires the monetary base, defined in the case of Hong Kong as the amount of Hong Kong dollar bank
notes issued and the Hong Kong dollar clearing balance of the banking system held with the Hong Kong
Monetary Authority (HKMA), to be fully backed by US dollars at a fixed exchange rate16. In other words,
14
Article 111 of the Basic Law provides, among other things, that "the Hong Kong dollar, as the legal tender in the Hong
Kong Special Administrative Region, shall continue to circulate".
15
As a matter of fact, in the fourteen and a half years since the Hong Kong dollar's link was established in October 1983, the
RMB has depreciated by a total 76% against the US dollar.
1616 Insofar as the banknotes are concerned, since the inception of the linked exchange rate system in October 1983, the issue
and redemption of bank notes, through the note issuing banks, are required to be made against US dollars at the fixed
exchange rate of HK$7.80 to US$1. However, at the time when the linked exchange rate system was introduced, there was no
institutional arrangement whereby banks in Hong Kong maintained clearing accounts with the currency board. This situation
was rectified in 1988 through the so-called Accounting Arrangements which required the Hongkong and Shanghai Banking
Corporation Limited, as the Management Bank of the Clearing House of Hong Kong Association of Banks, to maintain a
clearing account with the then Monetary Affairs Branch of Government for the account of the Exchange Fund. Thus the
monetary base was only clearly defined then. The Accounting Arrangements were subsequently replaced by another
arrangement, on the occasion of the introduction of Real Time Gross Settlement for interbank transactions in Hong Kong
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any change in the monetary base has to be matched by a corresponding change in the amount of US dollar
reserves held by the HKMA, and the change brought about by the HKMA rather passively converting Hong
Kong dollars in the monetary base into US dollar reserves and vice versa at much the initiative of the banks.
19. The advantage of such a requirement is that whenever there is capital outflow, which
would take the form of the sale by the banks of Hong Kong dollars to the HKMA for US dollars at the fixed
exchange rate, there will, on settlement of the deals, be a shrinkage of the clearing balance of the banking
system. This will lead to Hong Kong dollar interest rates in the interbank market increasing. The greater the
outflow, the larger will be the fall in the clearing balance of the banking system and the higher will be the
interest rates in the interbank market. And this process is very much an automatic one which does not require
the exercise of discretion on the part of the HKMA. There is no active foreign exchange market intervention
as such, and certainly no money market operations for recycling Hong Kong dollars sold to the HKMA when
there is capital outflow; or sterilization of Hong Kong dollars passively provided to the market by the HKMA
when there is capital inflow. Even until now, after we have been operating such a system successfully for
over fourteen years, this technical strength of our exchange rate system and the important technical
distinction from other fixed exchange rate systems are still not very widely appreciated. But I cannot really
blame the uninformed. Perhaps we have not done enough to keep them informed on these admittedly rather
esoteric monetary issues.
20. And the situation is not helped by ourselves also armed with the usual central banking
armoury of being in a position to exercise discretion to influence monetary conditions in the interbank market
by virtue of the fact that we run the interbank clearing system and therefore also serve as the lender of last
resort in facilitating day to day interbank clearing. There has been some concern that the HKMA might then
be subject to political influence to exercise discretion and use the central banking armoury to create money in
order to relieve the interest rate pain and in the process undermine the credibility of the currency board
arrangement itself. Whilst this is a legitimate concern, given the experience in other monetary systems, the
situation in Hong Kong is actually quite different. For as long as the monetary policy objective is exchange
rate stability within the framework of a currency board system, the additional armoury available to the
HKMA, the authority of which was derived from the same legislative foundation for the currency board
system, cannot be used in a manner inconsistent with the objective of the currency board itself. In other
words, it is arguably ultra vires for the HKMA to conduct money market operations or other market activities
contrary to the objective of the maintenance of exchange rate stability. This is a legal nicety which is again
not well appreciated.
21. The events leading to the sharp interest rate increase seen on one day last October
illustrate quite clearly how our system works. There was substantial capital outflow earlier that week, caused
by people taking a short position in the Hong Kong dollar and sparked off by Taiwan allowing its currency to
depreciate in order to maintain its export competitiveness17. The outflow caused the clearing balance of the
banking system to shrink sharply, in accordance with the discipline of the currency board system, as the
banks sold Hong Kong dollars to the HKMA for US dollars. There was in fact not enough Hong Kong dollar
in the clearing accounts of the banks to effect settlement with the HKMA. So many banks were bidding for
money that, collectively speaking, did not exist in the interbank market. As a result, the interest rate for
overnight money shot up to almost 300%18. Contrary to press reports and comments from analysts, the high
interbank interest rates were the making of the banks themselves and not the result of the HKMA squeezing
towards the end of 1996, requiring all licensed banks to maintain a clearing account with the HKMA for the account of the
Exchange Fund. In operating the Accounting Arrangements (1988 - November 1996) and the settlement accounts (since
December 1996), the Monetary Affairs Branch and subsequently the HKMA have ensured that the whole of the monetary
base is subject to the discipline of the currency board arrangement.
17
On 17 October 1997, Taiwan's central bank vice governor Liang Cheng-chin said there was "no need for the central bank
to intervene" and it was "the right time" to let market forces determine the Taiwan dollar rate." As a result, the Taiwan dollar
closed 3.3% lower at T$29.5 per US dollar on that day.
18
This was only for about an hour on 23 October 1997. When speculative shorting of the Hong Kong dollar was quickly
reversed, the overnight interbank interest rate came down quickly and closed at 100%-150% on 23 October and further to 7%
on 24 October.
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the money market. We were just sitting there passively, on settlement day, waiting for the banks to give us the
Hong Kong dollars that they had sold to us - Hong Kong dollars that they did not have.
22. In the circumstances, the banks had only two alternatives. First is for them to borrow
Hong Kong dollars from the HKMA at the end of the settlement day, through the Liquidity Adjustment
Facility (LAF), Hong Kong's version of a discount window. This would obviously not be cheap, particularly
for repeated borrowers, as the HKMA is not in the business of providing cheap Hong Kong dollar funding to
those shorting the Hong Kong dollar. And this would only be for overnight money. Second is for the banks to
obtain Hong Kong dollars more permanently from the HKMA by selling US dollars back to the HKMA,
which the HKMA again takes passively in accordance with the discipline of the currency board system. This
is exactly what happened on 23 October 1997 and the speculative capital outflow then was as quickly
reversed as it had started, in a matter of only two days, with the system operating very much on auto-pilot.
Interest Rates
23. But it had taken a little time for interbank interest rates for term money to come back
down, notwithstanding the fact that the crucial part of the monetary base, as represented by the clearing
balance of the banking system, has in fact returned to a level which is a lot higher than before the speculative
attack and that the HKMA had been accumulating more foreign reserves in the process19. I would attribute
this to market sentiment being affected by the continuing financial turmoil in the region. There is now clearly
an Asian premium in the interest rates for Asian currencies and Hong Kong, notwithstanding our currency
having remained very stable throughout, is not immune. This Asian premium will remain, for as long as
financial turmoil in the region lingers on and with uncertainties in the financial system of Japan looming large
in the background.
24. The higher interbank interest rates for the Hong Kong dollar could also be attributed to a
realization on the part of the banks of the need to be a lot more careful in their funding strategies. On the one
hand, they might have mistakenly provided cheap funding to finance speculative shorting of the Hong Kong
dollar by their customers. In doing so they put themselves in a difficult position when the interbank market
tightened to beyond their expectations implicit in the pricing of their lending to the speculators. On the other
hand, the contagious nature of financial turmoil with globalized financial markets is such that the possibility
of further attacks on our currency, unsuccessful as they inevitably would turn out to be, could not be