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THE ECONOMY
adjust automatically to balance of payments pressures, without government intervention being necessary. Interest rates have therefore assumed a more passive role than before, changing more frequently in response to the inflows and outflows of funds.
The Hong Kong Association of Banks, which sets the maximum rates of interest payable on deposits of original maturities up to 15 months (except those of $500,000 or above with a term to maturity of less than three months) with licensed banks, has a statutory obligation to consult the government on the determination of these interest rates. This procedure is designed to ensure that the association takes the wider public interest into account in making its decisions, including their effect on the exchange rate. Under the linked exchange rate system, the interest rates administered by the association tend to follow the market interest rates quite closely. It is, therefore, no longer necessary or desirable for the government to play an active role in this process.
Through its bankers, the Exchange Fund operates a scheme which enables it to draw short-term funds out of the local interbank market and to ensure that these funds are not recycled back into that market. This arrangement has the effect of tightening up the local money market and putting upward pressure on short-term market interest rates. Thus, despite the change in the monetary framework which took place in October 1983, arrangements whereby the government may influence interest rates through the Hong Kong Association of Banks or the local money market still remain in place.
The Exchange Fund
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The Hong Kong Government's Exchange Fund was established by the Currency Ordin- ance of 1935 (later renamed the Exchange Fund Ordinance). Since its inception, the Exchange Fund has held the backing to the note issue. In 1976, the role of the Exchange Fund was expanded, with the assets of the Coinage Security Fund (which held the backing for coins issued by the government) as well as the bulk of foreign currency assets held in the government's General Revenue Account transferred to the Fund. In both cases, the transfer was made against the issue by the Exchange Fund of interest-bearing debt certificates denominated in Hong Kong dollars. On December 31, 1978, the Coinage Security Fund was merged with the Exchange Fund and all the debt certificates held by the Coinage Security Fund were redeemed.
The Exchange Fund was further expanded in 1978 when the government began to transfer the Hong Kong dollar balances of its General Revenue Account (apart from the working balances) to the Exchange Fund against the issue of interest-bearing debt certificates. Thus the bulk of the government's financial assets are now held in the Exchange Fund, mainly in the form of bank deposits in certain foreign currencies and in Hong Kong dollars, and of interest-bearing instruments in foreign currencies.
The principal activity for the Exchange Fund is the day-to-day management of these assets. Its statutory role as defined in the Exchange Fund Ordinance is to influence the exchange value of the Hong Kong dollar. The Exchange Fund is managed by the Monetary Affairs Branch of the Government Secretariat under the direction of the Financial Secretary, who is advised by a committee comprising prominent members of the banking and financial community.
Another function related to the Exchange Fund is the supply of notes and coins to the banking system. Apart from a very small fiduciary issue, which is backed by securities issued or guaranteed by the British or Hong Kong government, currency notes in every- day circulation (currently of $10, $20, $50, $100, $500 and $1,000 denominations) may only be issued by the Hongkong and Shanghai Banking Corporation and the Standard