SECRET
(a) The banks' sterling has always been the most difficult part.
(b) This has also been the most difficult problem internally for the Hong Kong Government, especially since they themselves instituted the over-generous Hong Kong dollar guarantee. To let the commercial banks go their own way might even have the effect of reducing public interst in the whole subject of foreign exchange reserves.
(c) We would be able to open up our points about the need for banking reform in Hong Kong without the
suspicision that our actions were tied to short-term sterling agreement considerations.
13. If we were to let the commercial banks sterling go, this would still not solve the problem. Hong Kong would still be looking for a reduction in their official sterling to about 50% of their total external assets. If we take those assets as being about £400 million, this would mean a diversification of about £150 million. A judgement would have to be made, in the context of the general picture, about how far such a diversification might be tolerable and over what
period.
14.
But, if the problem of the commercial banks had disappeared, then the gap between the present 89% and the demand for 50% looks bridgeable by negotiation.
15. To sum up, I suggest that, in the forthcoming meetings with the Hong Kong authorities, we should:-
a) Go as far as possible in indicating that we are prepared to consider a reduction in MSP.
(b) Ask for the actual figure of the sterling which the commercial banks have sold forward.