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THE ECONOMY
dollar credit balances maintained by their customers, if the need arises. In practice, however, there has been no need to impose the deposit charges, as the mere threat of their imposition has been effective in deterring the speculation.
To enable the government, through the use of the Exchange Fund, to exercise more effective influence over the availability and price of money in the interbank market and thus to assist it better to maintain exchange rate stability within the framework of the linked- rate system, new accounting arrangements were entered into in mid-July 1988 between the Exchange Fund and the Hongkong and Shanghai Banking Corporation (HSBC) as the Management Bank of the Clearing House of the Hong Kong Association of Banks. Under these arrangements, HSBC is required to maintain, in an account newly-created with the Exchange Fund, a Hong Kong dollar balance which is no less than the net clearing balance (NCB) of the rest of the banking system. HSBC has to ensure that either its own balance in the account does not fall short of the NCB, or the NCB is not in debit. Otherwise it will have to pay an interest to the Exchange Fund. The Exchange Fund will use the account,
at its discretion, to effect settlement of its Hong Kong dollar transactions with HSBC or with other banks.
Consequent upon these new accounting arrangements, the Exchange Fund effectively becomes the ultimate provider of liquidity in the interbank market, a role which until mid-July 1988 was performed by the HSBC. Through its borrowing Hong Kong dollars in the interbank market, or selling foreign currencies for Hong Kong dollars in the foreign exchange market, the Exchange Fund is now able to reduce the supply of liquidity and hence raise interest rates in the interbank market, and thus offset a weakening of the exchange rate of the Hong Kong dollar against the US dollar. Similarly, it may also increase the interbank liquidity and lower interest rates by taking such actions in the opposite direction, thereby offsetting a strengthening of the exchange rate.
Along with these new accounting arrangements between the Exchange Fund and HSBC, the Treasury also maintains a Hong Kong dollar account with the Exchange Fund where money transferred from the General Revenue to the Fund in return for interest bearing debt certificates is accounted for. Through the issuance and redemption of the debt certificates under the new arrangements, the Exchange Fund has an additional tool to affect interbank liquidity.
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 provides a further mechanism for the Exchange Fund to tighten up liquidity in the local money market, and thereby putting upward pressure on short-term market interest rates.
The Exchange Fund
The Hong Kong government's Exchange Fund was established by the Currency Ordinance 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.
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