CONFIDENTIAL
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STERLING BALANCES
25.
"Either as a form of retaliation, or to replace loss of foreign exchange
earnings from exports, Hong Kong might consider reducing her sterling balances.
Under the Sterling Agreement, which was signed with Hong Kong in September 1968,
the United Kingdom provides a US dollar value guarantee of the bulk of Hong
Kong's sterling balances in return for an undertaking by Hong Kong to maintain
a minimum proportion of her reserves in sterling throughout the life of the
Agreement. The proportion, which was established in bilateral negotiation with
Hong Kong, is high and obliges Hong Kong to keep almost all of her total
external reserves (about £400 million at end-May 1970) in sterling. The Agree-
ment with Hong Kong lasts for 5 years until September 1973. In common with
the agreements with other Sterling Area countries, most of which are of only
3 years' duration, it is due for review between March and September 1971.
26. Hong Kong could use the occasion of this review to press for a lower
minimum sterling proportion if she felt that United Kingdom entry into the EEC
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would reduce her trade with the United Kingdom, on the grounds that in these
circumstances she would need larger dollar balances. It is quite possible that
she will press for some reduction even apart from the EEC point. In 1968 the
Colony felt that the minimum sterling proportion proposed by the United Kingdom
was too high, but she accepted it. Since 1968 Hong Kong's reserves have more
than doubled, and almost all that increase has been held in sterling, because
of the operation of the agreement. The United Kingdom's attitude to a request
of this sort would depend upon its timing, upon what was being done vis-a-vis
other OSA countries, and on the precise proportion to which Hong Kong sought
to drop. We should probably accept that a major change in trading patterns
was reasonable grounds for a reduction in the minimum sterling proportion, but
in 1971 the precise nature of such changes in respect of Hong Kong would not in
be clear and we should be unlikely to want to make such a concession then.
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The Colony's reaction to such a refusal might be lively. However, with
a 5 year Agreement Hong Kong could not make a lower sterling proportion a
condition of continuing the Agreement and is thus prevented from using the size
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CONFIDENTIAL
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