FINANCIAL AND MONETARY AFFAIRS
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a higher long-term real rate of return. With effect from April 1, 1998, the return on the fiscal reserves placed with the Exchange Fund is linked to its overall return.
The Exchange Fund's statutory role, as defined in the Exchange Fund Ordinance, is primarily to affect the exchange value of the currency of Hong Kong. Its functions were extended on the enactment of the Exchange Fund (Amendment) Ordinance 1992 by introducing a secondary role of maintaining the stability and integrity of the monetary and financial systems, with a view to maintaining Hong Kong as an international financial centre.
The HKMA manages the Exchange Fund. Apart from ensuring that the fund meets its statutory roles, the HKMA's principal activity on a day-to-day basis is the active management of the fund's assets. These are held mainly in the form of high quality bonds and equities. To meet the government's operational needs, part of the Exchange Fund is also held in Hong Kong dollar denominated securities.
The HKMA regularly reviews its investment strategy and operations. In line with the statutory purposes of the Exchange Fund, the investment strategy in place is quite similar to those of other central banks and monetary authorities overseas. An investment strategy appropriate for a long-term fund such as a benchmark approach and a greater use of the long-term capital markets - has been adopted, and the range of currencies and instruments used has also been increased.
To meet the objectives of preserving capital, providing liquidity to maintain financial and currency stability and generating an adequate long-term return, the Exchange Fund is managed as two distinct portfolios. The first is a Backing Portfolio to ensure that the monetary base related to the currency board operations is fully backed by highly liquid, short-term US dollar denominated interest-bearing securities. The second is an Investment Portfolio to preserve the fund's value for future generations in Hong Kong. The management of the fund and the investment style adopted are set out and explained in the HKMA's annual report each year.
On June 30, 1998, the Exchange Fund's total assets stood at $656.3 billion, of which foreign currency assets amounted to $608.9 billion (or US$78.6 billion). Accumulated surplus of the Exchange Fund amounted to $201.9 billion. The fund's financial position from 1994 to June 1998 inclusive, is shown at Appendix 19. With a view to showing the government's continued commitment to greater openness and transparency, foreign currency asset figures have been published on a monthly basis since January 1997.
Another function related to the Exchange Fund is currency notes and coins. issuance. Banknotes in denominations of $20, $50, $100, $500 and $1,000 are issued by the three note-issuing banks in Hong Kong: the Hongkong and Shanghai Banking Corporation Limited, the Standard Chartered Bank and the Bank of China. The note-issuing banks may issue currency notes only by surrendering non-interest- bearing US dollar backing at a fixed exchange rate of 7.80. Thus the fund enjoys the seigniorage of the currency notes.
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Through the HKMA, the government issues coins of $10, $5, $2, $1, 50 cents, cents and 10 cents denominations. The shortage of coins, precipitated by investor demand for Queen's Head coins in 1997, has now been resolved. A total of 1.3 billion pieces were put into circulation in 1998, which is 3.7 times the normal annual order volume. The total notes and coins in circulation at the end of 1998 was $92.5 billion.