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SECRET
CHANCELLOR
THE EXCHEQUER
S
reimposition of exchange controls;
further action on interest rates (following the increase in prime rates to 16 per cent on 26 September);
removal of the 10 per cent withholding tax currently levied on interest paid on Hong Kong dollar deposits.
For background, short notes on these latter possibilities are attached at annexes 1 to 4. The Chancellor does not think that any of the last three, either alone or in combination, would be effective (and the Hong Kong government have also indicated that they do not regard exchange control or removing the withholding tax as feasible options). From the UK point of view the objections to the first, or any arrangement under which UK backing might be given to defence of the Hong Kong dollar are, at this stage, overwhelming. We could all too easily be drawn quickly into either committing our own
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limited dollar reserves to support the Hong Kong dollar, or allowing sterling itself to take the strain. The down- ward pressure on sterling could be substantial.
The proposal which the Hong Kong government have devised, and wish to implement, does not have this disadvantage. The scheme, set out in telegram No 1435 of 29 September attached at Annex 5, is a practical version of the most recent scheme proposed by Sir Alan Walters which was discussed in Washington. Indeed it has benefitted from discussion with Sir Alan's Hong Kong contacts. In brief, it entails setting the price of Certificates of Indebtedness (CIs) the backing for the Hong Kong currency in terms of US$ at a fixed rate. This could, with the co-operation of the note-issuing banks, be implemented very quickly. Although the maintenance of the scheme might involve higher interest rates, it should stabilise the open market exchange rate in line with the CI rate.
Although on the basis of the knowledge available to us here it is not possible to evaluate the scheme thoroughly, and there are a number of points which we wish to clear up, it seems well worth trying, and quickly. But, arguably, the sooner an announcement of it is made, the better.
The Hong Kong authorities have however asked for technical advice on the implementation of their scheme. David Peretz from the Treasury (the Assistant Secretary in charge of the Balance and Payments Division) and Charles Goodhart from the
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SECRET