CONFIDENTIAL
72/E
HONG KONG: THE POSSIBILITY OF A "SPECIAL ARRANGEMENT"
The present Sterling Agreements expire on 24 September.
If nothing is put in their place, Hong Kong will face diffi-
culties not shared by other signatories. We therefore have
to decide whether there is a case for giving her spcial
treatment, perhaps in the form of a bilateral arrangement.
At the same time Hong Kong is also experiencing problems as
system a result of the structure of her banking/and also with regard
to exchange rate policy; but although there are links between
these problems, it is important to keep their analysis separate
as far as possible. What follows is an initial attempt to
examine the first two problems in the hope that it will encourage
people to focus on the issues involved.
Since
The immediate problem is the Hong Kong commercial banks
sterling and this does represent a genuine difficulty.
there are no local assets available, the banks have to hold
substantial proportions of their assets in foreign exchange,
principally sterling. They therefore have Hong Kong dollar
liabilities and sterling assets which present them with exchange
risks not normally encountered by commercial banks. To alleviate
this, the banks' sterling was brought into official reserves
under the Sterling Agreement through the Hong Kong Government
signing a separate Agreement with them: the Exchange Fund
Guarantee Scheme. If the Sterling Agreement expires the Hong Kong
authorities have already made plain that they would consider it
"politically impossible for the Exchange Fund to assume the
exchange risk in respect of the banks' sterling assets as well
as its own" and would therefore "advise the banks that they
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