FINANCIAL AND MONETARY AFFAIRS
The foreign exchange and local money markets remained stable in the second quarter, with active two-way fund flows. The convertibility rate for the Aggregate Balance began to move by 1 pip per calendar day from 7.75 with effect from April 1. There was some selling of Hong Kong dollars ahead of the Easter holidays, reflecting market expectations of a slight weakening of the convertibility rate. As a result, some US dollars were sold under the Convertibility Undertaking during March 31 to April 5 and the Aggregate Balance fell to $2.5 billion on April 8. During the period, overnight interest rates firmed up slightly to 5.6-5.9 per cent. The flow of funds quickly reversed as many US and European equity fund managers began to replenish their heavily under-weighted Asian equity portfolios. The HKMA passively bought some US dollars in response to bank offers in late April, and overnight interbank interest rates eased to below 5 per cent on the back of improved liquidity.
There were some outflows from the Hong Kong dollar during late May to the end of August, amid rumours of the abolition of Argentina's currency board system in late May, escalating tension across Taiwan Strait and renewed rumours of RMB devaluation in July and August. The Convertibility Undertaking was triggered on several occasions. The decline in interbank liquidity was buffered in part by Discount Window activities and a moderate rise in interbank interest rates. Overnight interest rates edged up from around 5 per cent in late May to peak at 6.75 per cent in mid- August, before easing back to around 5-6 per cent thereafter. These moderate increases in interest rates were sufficient to induce capital inflows that offset the original outflows.
Market sentiment improved in September amid the announcement of a stable RMB policy by senior Chinese officials and the release of benign US economic indicators, which alleviated concerns over an imminent US interest rate hike. In addition, the announcement of special money market arrangements to prepare for possible market tightening around the turn of the year in early September helped relieve market anxiety. As a result of these developments, interbank interest rates moved on a downtrend, to around 4.5 per cent at end-September.
There was some outflow from the Hong Kong dollar in October amid the local stock market correction. The exchange rate weakened to touch the convertibility rate during October 13-15, triggering the Convertibility Undertaking. Thereafter, alongside a shrinkage of interbank liquidity, interest rates edged up moderately and the flows of funds reversed. Interbank liquidity increased notably in November in the face of increasing demand of Hong Kong dollar assets, driven by the favourable reception of the sale of the Tracker Fund of Hong Kong and the conclusion of the Sino-US agreement on the terms of the Mainland's entry into the World Trade Organisation.
Demand for Hong Kong dollar assets further increased in December on the back of positive economic news and market perceptions of Hong Kong as a Year 2000 safe haven. The Aggregate Balance increased substantially from HK$3.28 billion at end- November to HK$6.26 billion on December 2 and remained at HK$6-8 billion until the end of the year. The high liquidity alleviated market concerns over possible tightness arising from the Year 2000 problems and market conditions remained calm in the run up to the end-year period. The enlarged Discount Window and the term repo facility offered by the HKMA during the Year 2000 critical periods were not invoked. The Hong Kong dollar exchange rate strengthened to close at 7.7734 on 30 December, 40 pips stronger than the convertibility rate.
95