36
FINANCIAL STRUCTURE
a member of the sterling area, was required in practice to keep its official reserves, and the greater part of the reserves of the banking system, in the form of sterling.
Thus, when sterling was devalued by 14.3 per cent in November 1967, Hong Kong suffered a substantial loss estimated at £50 million. After an immediate devalua- tion of the same proportion, the Hong Kong dollar was revalued by 10 per cent four days after the British move, making a final devaluation of 5.7 per cent. This did not reduce in any way the loss to the community; rather it determined where the loss would fall. The cost to Hong Kong's public funds amounted to $450 million, including compensation paid from the Exchange Fund to commercial banks against their consequential losses.
These events finally made it clear that the old relationship with the pound was no longer appropriate to Hong Kong's economic situation. On the other hand, it was not possible for Britain to allow any significant diversification of Hong Kong's sterling assets (amounting then to £350 million) into other currencies, in view of her own depleted reserves; while at that stage she was not prepared to offer guarantees of the international value of sterling reserves.
Following negotiations in London, however, a novel arrangement was introduced in June 1968, whereby Hong Kong was allowed to use its sterling assets to purchase British Government bonds, of seven years maturity, denominated in Hong Kong dollars. These bonds were purchasable to a value of £100 million or 50 per cent of official reserves, whichever was greater, up to an absolute maximum of £150 million. The arrangement, for which a charge was made, gave limited protection against loss from a further revaluation of the Hong Kong dollar in terms of sterling, but was soon superseded by a wider arrangement.
Under the new deal, which was made possible by the backing of the so-called Basle arrangement, Britain offered all members of the sterling area, including Hong Kong, a free guarantee in terms of US dollar value of all officially held sterling in excess of 10 per cent of each country's total official external reserves. This was in return for their undertaking to maintain a minimum proportion of their reserves in sterling. The guarantee is for five years from September 25, 1968. Hong Kong accepted this new scheme, undertaking to maintain in her reserves a minimum sterling pro- portion of 99 per cent. This proportion was reduced to 89.1 per cent (or by 10 per cent) in September 1971, when the British Government agreed to a general reduction of the minimum sterling proportions which sterling area countries had undertaken to maintain in their reserves.
Because there is no central bank, a substantial part of Hong Kong's exchange reserves are held by commercial banks. While the sterling assets held by these banks are not in themselves covered by the British guarantee, the UK/HK guarantee arrange- ment has a unique feature which was carried on from the earlier Hong Kong Dollar Bond Scheme-a provision whereby official sterling deposits with commercial banks in Hong Kong rank as official reserves for the purposes of the guarantee. This enabled arrangements to be made in February 1969, through the mechanism of the Exchange Fund, to bring a substantial part of commercial banks' sterling within the scope of the guarantee.