Financial and Monetary Affairs 97
After staying close to the strong side of the Convertibility Zone in 2006, the Hong Kong dollar market exchange rate depreciated in the first seven months of 2007, reaching a peak of 7.8295 on August 2 and 3. This partly reflected interest rate arbitrage activities taking advantage of the lower domestic interest rates relative to those of the US and the conversion of proceeds from IPOs into US dollars by Mainland companies newly listed in Hong Kong. From August to October, the Hong Kong dollar exchange rate quickly strengthened towards the strong-side CU of 7.75. This was caused by several factors: the US sub-prime mortgage problems and the resultant increase in global risk aversion induced the unwinding of Hong Kong dollar- funded carry trade positions; equity-related demand for Hong Kong dollars increased substantially under the influence of a series of highly-subscribed IPOs between September and November; and a buoyant stock market, which helped sustain large equity-related demand for Hong Kong dollars. In the last two months of 2007, the Hong Kong dollar exchange rate depreciated towards the centre of the Convertibility Zone due to carry trades amid a low interbank interest rate environment.
Movements in the Hong Kong dollar interbank interest rates largely tracked the US dollar interest rates in 2007, with occasional deviations due to sharp rises in funding demand arising from heavily-subscribed IPOs. They generally increased between January and mid-September, first as a result of interest rate arbitrage activities, and then increased liquidity demand arising from concerns about the contagion effect of the US sub-prime mortgage problem. Interest rates began to ease in mid-October, gaining momentum when supply of liquid funds in the interbank market increased because of the expansion in the Aggregate Balance after the triggering of the strong-side CU.
Monetary conditions eased in 2007, with monetary aggregates and domestic loans growing at a brisk pace. For the year as a whole, broad money and domestic credit picked up by 18.1 per cent and 15.7 per cent respectively. The loan-to-deposit ratio, on the other hand, fell to a record low towards the end of the year, suggesting a prudent approach to credit quality by individual banks and the relatively abundant liquidity in the banking system.
Exchange Fund
The Exchange Fund was established by the Currency Ordinance of 1935 (later renamed the Exchange Fund Ordinance). Since its establishment, the fund has been responsible for backing Hong Kong dollar note issues. The role of the fund was expanded in 1976 to include the backing for coins issues. The Coinage Security Fund was merged with the Exchange Fund on December 31, 1978.
The Government transferred the fiscal reserves of its General Revenue Account (apart from the working balances) to the fund to centralise the investment management of its financial assets. Through this transfer, the bulk of the Government's financial assets were placed with the fund.
When the Hong Kong Special Administrative Region (HKSAR) was established on July 1, 1997, the Chief Executive appointed the Financial Secretary as the public officer to receive, hold and manage the Land Fund, as part of the HKSAR