FINANCIAL AND MONETARY AFFAIRS
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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.
To deter persistent speculation on a revaluation of the Hong Kong dollar which emerged late in 1987 and continued in early 1988, the Hong Kong Association of Banks, after consultation with the Financial Secretary, introduced revised Interest Rates Rules whereby banks may impose deposit charges ('negative interest rates') on large Hong Kong 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 speculation.
To enable the government, through the use of the Exchange Fund, to exercise more effective influence over liquidity and interest rates in the interbank market and thus to assist it better to maintain exchange rate stability within the framework of the linked exchange rate system, new accounting arrangements were entered into in mid-July 1988 between the Exchange Fund and The Hongkong and Shanghai Banking Corporation Limited (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 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 interest to the Exchange Fund. The fund uses the account, at its discretion, to effect settlement of its Hong Kong dollar transactions with HSBC or with other banks.
Consequent upon these accounting arrangements, the Exchange Fund effectively became 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 fund is now able to reduce the supply of Hong Kong dollars and hence raise interest rates in the interbank market, thereby offsetting a weakening of the exchange rate of the Hong Kong dollar against the US dollar. Similarly, it may also increase interbank liquidity and lower interest rates by taking such actions in the opposite direction, thereby offsetting a strengthening of the exchange rate.
As well as these accounting arrangements between the fund and HSBC, the Treasury maintains a Hong Kong dollar account with the 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 debt certificates, the Exchange Fund has an additional tool to affect interbank liquidity.
Under the new accounting arrangements, the government could also influence monetary conditions in the interbank market through its buying or selling of Hong Kong dollar financial assets of acceptable quality. Although in other financial centres these are usually in the form of debt instruments issued by the government, there is no such instrument available in Hong Kong. In the latter part of 1988, the Monetary Affairs Branch initiated a study which concluded that a programme of issue of short-term government bills should be developed in Hong Kong, both for monetary policy reasons and for further development of the local capital market. This was announced by the Financial Secretary in his Budget Speech in March 1989. In consultation with the Hong Kong Capital Markets Association and other interested parties, a detailed examination was subsequently made of the technical and system requirements for the issue of such short-term government paper (to be called