TNAG-0448-FCO40-513-Sterling-assets-and-balance-of-payments-of-Hong-Kong-1974 — Page 96

SECRET

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XCS(74)1

Declaration. However, the effective depreciation was as much as 20% in January. The possibility of further weakness during the remainder of this year clearly cannot be excluded.

(c) Assessment

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The guarantee can be assessed, on purely financial con- siderations, in relation to three possible courses of action for Hong

Kong:

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(a)

(b)

(c)

if Hong Kong wishes, on general grounds of risk- spreading, to hold appreciably less sterling than 70% of total reserves, and either the possibility of sterling depreciation is seen as remote, or the possibility of partial compensation for any depreciation is not sufficiently attractive to outweigh this wish, then Hong Kong should not participate;

if the payment of compensation for any weakening of sterling would outweigh the benefit of being able to hold somewhat less than 70% of total reserves in sterling, then Hong Kong should participate;

similarly, if we did not wish to move below 70% before the end of the year, then we would have nothing to lose, financially, by participating.

As regards paragraph 10 (a) above, Hong Kong is no longer locked into gilt edged securities to an extent that would prevent sub- stantial further diversification. Even so, in our own interests, we would wish to avoid unsettling the market for sterling. It could not escape publicity that Hong Kong had decided not to participate in the guarantee and this, together with sales of upwards of, say, £50 million of sterling over a few months, could severely depress the pound's exchange rate. For this reason, and also because diversifi- cation would best be achieved by taking advantages of favourable market opportunities over a period, it is unlikely that we would wish to go substantially below the 70% MSP/MSH level so quickly.

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In practice, the decision need not be taken now. The guarantee will remain open for as long as we meet our obligations under it by submitting returns and retaining at least 70% of total official external reserves (or £270.3 million if this were lower) in sterling. Thus it is open to Hong Kong to take advantage of the opportunity to bring our sterling holdings down to this figure over a period, and to reassess the situation at that point and continuously thereafter.