8.13
8.14
converted into US dollars. In the event that the Hong Kong dollar interest rate on the borrowings exceeded the US dollar yield on the investments by more than an agreed margin, the Hong Kong Government could guarantee to absorb the excess cost of the borrowing. It might be possible to hedge the risk involved in the currency or interest rate markets. MAB commented on an earlier draft of this report that they did not support this idea on the grounds that it amounted to a subsidy. As I have made clear, my starting point was that the scheme should involve no funding, direct or indirect, by the Government. But as is also clear from the preceding paragraphs, the current state of the markets makes it unlikely that a workable scheme could be devised without some support from the Government. I imagine that a decision on whether such support could be consented to in principle would be one for the Governor in Council, advised by Finance Branch.
This raises the question of whether such a guarantee should be subscribed no matter how large the gap, or whether the guarantee should be capped. A cap would make the scheme less effective in convincing officers that their entitlements were protected. The most appropriate compromise, which would avoid exposing anyone to unlimited liability, would be for a trigger point to be established (the point at which HK$ interest rates on the borrowings equalled the assumed or guaranteed rate of interest on the investments): when that trigger point was reached, all further borrowings under the scheme would be suspended (ie no-one would be allowed either to join the scheme for the first time and existing members would not be able to increase their borrowings); and the Government would absorb the additional interest rate costs. A second trigger point would also be established: if the interest rate on the HK$ borrowings exceeded the investment rate by more than (say) 3 percentage points for more than (say) three months, the scheme would be liquidated. Historically, abnormally high (or abnormally low) interest rates only last for short periods, The investment funds would be used to repay the loans/redeem the bonds, and any surplus re-invested, and paid to participating officers as a supplement to their entitlements on retirement. (Given the risks that participating officers are accepting - see section 2.5 above - it would be unfair for them to be denied the benefit of any surplus which might have accumulated) MAB have commented on an earlier draft of this report that the operation of such a scheme would exacerbate any crisis by causing officers to rush to join it at such times, thus increasing the pressure on the exchange rate. The above paragraph has been redrafted to make it clear that this would be impossible.
As the debt market matured, and there appeared to be sufficient potential liquidity in the market for longer term instruments, the maturities of the securities issued could gradually be extended, thereby reducing progressively the demand for the interest rate guarantee.
8.15 However, if the Government is willing to take the decision in principle to commit some funds to help officers hedge their long term exposure, there are simpler ways of deploying those funds than through this rather complex interest rate cap.
8.16