CONFIDENTIAL
them forward as much and to buy sterling forward as little as possible. In these circumstances the banks would find themselves pressed to hold forward purchases of sterling unmatched by forward sales, and thus to carry the exchange risk themselves. This position was exacerbated in Hong Kong by the fact that the bunks themselves chose to operate their forward market, which was not very large, at fixed tariffs; this meant that the rates for forward deals did not reflect the demand to sell sterling forward, and accordingly the banks would be asked to take on more such forward purchases than might otherwise have been the case. In these circumstances, it is understandable that the Hong Kong banks have decided to suspend such forward deals.
In announcing their suspension of further forward purchases, the Exchange Banks' Association implied that one reason why they had reached this decision was that it had not been possible to bring forward transactions within the scope of the sterling guarantees. Of course, if their forward purchases of sterling were guaranteed in terms of the liong Kong dollar, the banks would have no exchange risk. There has been some talk in Hong Kong of guaranteeing such forward positions. However, as the llong Kong authorities clearly appreciate, no such guarantee can be arranged as part of the U.K.'s guarantee of Hong Kong's official sterling reserves under the sterling agreement concluded last summer, because it is a feature of all our sterling agreements that they exclude forward positions.
The situation in Hong Kong has not been precipitated by an outflow of money from the J.K. to Hong Kong. Such transactions, and we have no evidence that they are taking place on a significant scale at the moment, would produce a sale of spot sterling in Hong Kong which would be effected without any difficulty. The suspension adopted by the Exchange Banks' Association applies only to forward purchases.
Our view is that there is nothing that we could properly or usefully do to influence the decision of the banks in
Hong Kong. It is, however, a warning of the effect of sterling's current weakness on its trading use, a factor of which we are already uware.
I am sending a copy of this letter to Barrington (Foreign and Commonwealth Office).
(C. D. Butler)
CONFIDENTIAL
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