FINANCIAL AND MONETARY AFFAIRS
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to the US Federal Reserve continuing with the present practice of making timely announcement of changes in the Fed Funds Target Rate.
The overnight interbank interest rate remained stable and moved within the corridor set by the LAF bid and offer rates. Towards the end of June, share subscriptions and mid-year settlements by some banks and companies led to a sudden increase in the demand for liquidity. Overnight HIBOR briefly firmed to 6.625 per cent, exceeding the then LAF offer rate, at 6 per cent. Upon the injection of $420 million by the HKMA, tightness in the interbank market eased.
Moving in line with the three-month Euro dollar deposit rate, the three-month HIBOR fell from 5.75 per cent at the beginning of the year to around 5.30 per cent in early February. Following the cut in the US Discount Rate and the Fed Funds Target Rate, the three-month HIBOR edged up slightly, reflecting the market expectation of a possible upward adjustment in the US interest rate later in the year. In mid-March, following the release of strong US economic indicators, the three-month HIBOR rose further from 5.375 per cent in early April to 5.688 per cent in mid-July. For the year as a whole, the three-month HIBOR fell by 37.5bps to 5.5 per cent at end-December. The interest rate spread between the three-month HIBOR and Euro dollar interest rate remained narrow. The average differential in 1996 stood at only 9.7bps. Longer term interest rates were more affected by the market expectation of a US interest rate hike and the Hong Kong dollar yield curve steepened from February. By end-1996, the yields of the five-year and seven-year Exchange Fund Notes stood at 6.7 per cent and 7.01 per cent, respectively, 46bps and 43bps above the yields at the beginning of 1996.
Reflecting an increase in transaction demand for money, contributed in part by a recovery of retail sales, Hong Kong dollar M1 rose by 15.8 per cent (to November), significantly higher than the growth rate of 2.2 per cent recorded in 1995. Hong Kong dollar M3, the broad money supply, rose by 19 per cent, consistent with the growth rate of nominal GDP and broadly in line with the growth of total HK dollar loans of 16.9 per cent in the same period.
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 fund has held the backing to the note issue. In 1976, its role was expanded. 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, were transferred to the fund. On December 31, 1978, the Coinage Security Fund was merged with the Exchange Fund.
In 1976, the government began to transfer the fiscal reserves of its General Revenue Account (apart from the working balances) to the fund. This arrangement was introduced to avoid fiscal reserves having to bear exchange risks arising from investments in foreign currency assets and to centralise the management of the government's financial assets. The fiscal reserves are not permanently appropriated for the use of the Exchange Fund, but are repaid to the General Revenue Account when they are required to meet the obligations of the general revenue. Through this transfer of the fiscal reserves, the bulk of the government's financial assets are, therefore, with the fund.