FINANCIAL AND MONETARY AFFAIRS
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Under these arrangements, the HSBC maintains a Hong Kong dollar account with the Exchange Fund. The HKMA uses the account at its discretion to effect settlement of its Hong Kong dollar transactions with the HSBC or with other banks. The HSBC is required to ensure that the net clearing balance (NCB) of the rest of the banking system does not exceed its balance in the account and that the NCB is not in debit; otherwise, it will have to pay interest to the HKMA for the account of the Exchange Fund.
Consequently, the HKMA, through the use of the Exchange Fund, has effectively become the ultimate provider of liquidity in the interbank market, a role which was previously performed by the HSBC. Through the borrowing of Hong Kong dollars in the interbank market, or selling foreign currencies for Hong Kong dollars in the foreign exchange market, the HKMA is able to reduce the supply of Hong Kong dollars and so raise interest rates in the interbank market, in this way offsetting a weakening of the exchange rate of the Hong Kong dollar against the US dollar. Similarly, it may increase interbank liquidity and lower interest rates by taking action in the opposite direction, offsetting a strengthening of the exchange rate.
Under the accounting arrangements, the HKMA can also influence monetary conditions in the interbank market through its buying or selling of Hong Kong dollar financial assets of acceptable quality. For this purpose, the HKMA has developed a programme for the issue of short-term and longer-term paper for the account of the Exchange Fund (the Exchange Fund Bills and Notes). The Exchange Fund paper is designed to complement the accounting arrangements by providing the HKMA with an additional instrument for conducting money market operations.
In June 1992, the Liquidity Adjustment Facility (LAF) was introduced to help banks make late adjustments to their liquidity positions. The bid rate (for taking overnight deposits from banks) and offer rate (for lending overnight money to banks) are set having regard to the level of interest rate appropriate for maintaining exchange rate stability. These rates provide an additional tool for the HKMA to influence the movements of the interbank interest rates.
Monetary Situation
After the Mexican currency crisis in January, the Hong Kong dollar and several other Asian currencies came under speculative attack, notwithstanding the sound economic fundamentals of these economies. Selling interest in the Hong Kong dollar intensified in the second week of January, pushing the exchange rate from 7.7375 at the beginning of 1995 to 7.7725 on January 12. The HKMA responded promptly by engineering a liquidity squeeze in the interbank market, thereby pushing up the interbank interest rate to increase the cost of speculation. The overnight interbank offered rate rose from 6 per cent to 12 per cent on January 13. The following week, the HK dollar exchange rate quickly rebounded to the prevailing level before the speculative attack.
The HKMA's prompt and decisive actions successfully fended off the speculators and reinforced confidence in the link. Despite occasional rumours about the health of Chinese leaders during the year, the exchange rate of the Hong Kong dollar remained very stable. For most of the year, the exchange rate moved within a narrow range of $7.730-$7.745 to US$1.
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