FINANCIAL AND MONETARY AFFAIRS
accounts with the currency board. Thus that part of the monetary base represented by the clearing balance of the banking system was initially not subject to the discipline imposed by a currency board system. Action was taken to correct this in 1988 through arrangements which required the Management Bank of the Clearing House of the Hong Kong Association of Banks to maintain a clearing account with the government's then Monetary Affairs Branch for the account of the Exchange Fund. This was replaced by another arrangement, when the RTGS system was introduced for interbank transactions in Hong Kong towards the end of 1996. These reform measures subjected the whole of the monetary base to the discipline of the currency board arrangement and strengthened the linked exchange rate system of Hong Kong in ensuring exchange rate stability.
By assuming responsibility over the clearing system for money, the HKMA also became responsible for the provision of last-resort lending for banks with day-to-day shortage of liquidity. A mechanism to facilitate the performance of this important role was instituted through the Exchange Fund Bills and Notes Programme, which started in 1990, and the introduction of LAF in 1992. The former served, among other things, to provide a money market instrument which banks could use to obtain liquidity by selling them in an active secondary market or pledge them for liquidity from the HKMA at the end of the day through the latter.
The HKMA maintains the strict discipline of the currency board system when engaging in any activity that has the effect of altering that part of the monetary base represented by the clearing balance of the banking system, and when issuing and redeeming Certificates of Indebtedness that give authority to the note-issuing banks to issue currency notes.
Monetary Situation
Monetary conditions were generally stable in the first half of 1997. The foreign exchange market reacted calmly to the death of Mr Deng Xiaoping on February 20. The exchange rate stayed around the $7.740 level in the latter part of February before easing to $7.750 in late March along with the correction in the stock market. The Hong Kong dollar strengthened to $7.736 in mid-May, in part reflecting an inflow of funds into the local stock market.
Money market conditions were also steady in the first half of the year, except on a few occasions when share subscription activities and month-end settlement caused a temporary tightening in the market. For most of the time, Hong Kong dollar interest rates followed closely those of the US dollar. On March 25, the Fed Funds Target Rate was raised by 25 basis points (bps, or one-hundredths of one per cent). In line with the move, the LAF bid and offer rates were adjusted upwards by the same magnitude, to 4.25 per cent and 6.25 per cent respectively. The savings deposit rate and the Best Lending Rate of major banks were also raised by 25 bps. During most of the first half of 1997, the overnight Hong Kong Interbank Offered Rate (HIBOR) remained steady and largely moved within the corridor set by the LAF bid and offer rates. Likewise, the three-month HIBOR moved closely in line with the three-month Euro dollar deposit rate. The average differential between the two rates was only 23 bps. As regards longer term interest rates, yields of the seven-year and 10-year Exchange Fund Notes tracked closely the corresponding US Treasuries. The average spreads above the US Treasuries were 39 bps and 63 bps respectively.
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