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FINANCIAL AND MONETARY AFFAIRS
Nations Sanctions) (Dependent Territories) Order 1992 came into force on June 5, 1992 imposing restrictions on a number of transactions with Serbia and Montenegro and persons connected with Serbia and Montenegro. Guidelines on the operation of the Order were also published on July 18, 1992.
Monetary Policy
A linked exchange-rate system was introduced on October 17, 1983 after a period of much instability in the exchange rate of the Hong Kong dollar. Under the system, certificates of indebtedness (CIs) issued by the Exchange Fund which the two note-issuing banks are required to hold as cover for the issue of Hong Kong dollar notes are issued and redeemed against payments in US dollars at a fixed exchange rate of HK$7.80 to US$1. In practice therefore any increase in note circulation is matched by a US dollar payment to the Exchange Fund, and any decrease in note circulation is matched by a US dollar payment from the Exchange Fund. The two note-issuing banks in turn extend this fixed exchange rate to their note transactions with all other banks in Hong Kong. In the foreign exchange market, the exchange rate of the Hong Kong dollar continues to be determined by forces of supply and demand. However, the interplay of arbitrage and competition between banks ensures that the market exchange rate stays close to the rate of HK$7.80 to US$1 fixed for the CIS.
- With the adoption of the linked rate system, the exchange rate is no longer a variable in the economy's adjustment process. Interest rates, the money supply and the level of economic activity over time adjust automatically to balance of payments pressures. If there is an outflow of money, caused for example by a tendency for the balance of payments to be in deficit, there will be a contraction in the money supply and higher interest rates. These will, on the one hand, induce an inflow of funds to offset the original outflow arising from the balance of payments deficit and, on the other hand, reduce domestic demand, restrain imports and enhance export competitiveness and thereby also contribute to restoring the external balance. Alternatively, if there is an inflow of money, caused for example by a tendency for the balance of payments to be in surplus, there will be an expansion in the money supply and lower interest rates. These will, on the one hand, induce outflow of funds and, on the other hand, increase domestic demand and imports and erode export competitiveness, again restoring the external imbalance.
When there is a tendency for the Hong Kong dollar to weaken relative to the US dollar, Hong Kong dollar interest rates will rise relative to US dollar interest rates. They may rise to a level where the interest rate gap between the Hong Kong dollar and the US dollar is large enough to stem or reverse the outflow from the Hong Kong dollar. Similarly, when there is a tendency for the Hong Kong dollar to strengthen relative to the US dollar, Hong Kong dollar interest rates will fall relative to US dollar interest rates. They may fall to a level where the interest rate gap between the Hong Kong dollar and the US dollar is large enough to stem or reverse the inflow into the Hong Kong dollar. From the monetary policy point of view, it is sometimes desirable to expedite this adjustment process in order that the economy is not unduly disrupted by speculative flows of funds aimed at manipulating the value of the Hong Kong dollar. So that the interest rate gap could be large enough to produce the corrective inflows or outflows, there therefore should ideally be no limit on how low or high interest rates can move.
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