The Money Supply and the Ratio of Advances and Loans to Deposits
42. The rate of growth of the money supply has been significantly affected at various times by the extent to which deposits have been generated as a result of increases made by the banks in the ratio of their advances and loans to deposits. If the ratio had not increased appreciably in 1969, as shown in Table 14, the rate of growth of the money supply would have been rather closer to the rate of growth of the gross domestic product than was in fact the case. There was a rapid increase in the ratio of bank advances and loans to deposits in 1973, but, in that year, the money supply was in- creasing less rapidly than the gross domes- tic product. In 1971, by contrast, when the money supply was growing at a significantly faster rate than the gross domestic product, the ratio of advances and loans to deposits declined slightly. Furthermore, whilst the increase in the ratio of advances and loans to deposits in 1972 goes some way towards accounting for the fact that the money supply grew more rapidly than the gross domestic product in that year, it by no means provides a total explanation.
Ratio of Banks' Advances and Loans to Deposits, 1968-1973
Table 14
As at end of month:
Dec 1968
Dec 1969
Dec 1970
Dec 1971
Jun 1972
Dec 1972
Jun 1973
Dec 1973
%
58.2
64.1
64.7
63.0
62.0
72.0
85.4
88.8
The Money Supply and Net Flows of Funds through the Foreign Exchange Market
43. On the assumption that there are no changes in the ratio of advances and loans to deposits, the money supply will largely be influenced by net flows of Hong Kong dollars through the foreign exchange market, since money can only be transferred to or from Hong Kong through accounts with the licensed banks. An inflow of funds resulting in the creation of Hong Kong dollars involves, by definition, an increase in the money supply whilst the money supply will decline if Hong Kong dollars are used to purchase foreign currencies.
14
44. The net flow of funds to or from Hong Kong through the foreign exchange market tends, therefore, to reflect, when allowance is made for time factors, Hong Kong's balance of visible and invisible trade with the rest of the world. This relationship can, however, be disturbed by, for example, significant changes in the extent to which export earnings are repatriated and by capital movements which may be quite unrelated to Hong Kong's current account trading performance.
45. The net flow of funds is considerably more volatile than the balance of merchandise trade. In 1971, the merchandise trade deficit was far larger than in any other recent year; yet, as has already been mentioned, the money supply increased much more rapidly in that year than the gross domestic product. This was because there was a much larger net move- ment of funds into Hong Kong in that year, and this continued into 1972. These funds came partly from overseas institutional sources for investment on the Hong Kong stock market. In the latter months of 1972 and the early months of 1973 this movement was reversed.
The Money Supply and the Stock Market
46. Despite the net outflow of funds through the foreign exchange market beginning in the latter months of 1972, bank deposits increased by HK$2,863 million in the second half of 1972, compared with HK$2,965 million in the first half of the year. This increase stemmed from the fact that bank advances and loans increased by HK$4,249 million in the second half of 1972, compared with HK$1,641 million in the first half of the year and HK$3,952 million in 1970 and 1971 taken together. The fact that the rate of growth of the money supply in 1972 was very much in excess of that for the gross domestic product is, therefore, explained by the rapid increase in advances and loans in the second half of the year together with the apparent substantial net inflow of funds in the first half of the year.
47. Just as the large net inflows of funds in 1971 and the first half of 1972 partly reflected significant investment by overseas institutions on the stock market, so a proportion of the subsequent net outflow of funds was due to profit-taking by these institutions. The Hang Seng Index of Share Prices, shown in Diagram 1 for 1972 to 1973, stood at only 450 at the end of August 1972, but, as a result of renewed buying pressure from overseas institutions coupled with a very widespread demand for shares from the Hong Kong public, it in- creased to 843 by the end of the year. This was made possible by the rapid increase in
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