CONFIDENTIAL
2.
Exchange rate discussions: what takes the strain?
Under present arrangements, attempts on the part of business and individuals to shift funds out of Hong Kong dollars (and decisions not to repatriate earnings into HK$) result in downward pressure on the exchange rate. As the events of 23/24 September demonstrated, if the flight from the HK$ reaches panic proportions, the exchange rate can spiral downwards at a horrific pace, with scant sign of any equilibrating forces to restore stability.
Under the proposed scheme, which would fix the price for issuing and redeeming certificates of indebtness in terms of foreign currency, the pressure of a flight from the currency falls in the. first instance on the banks. Faced with a mechanism which effectively fixes the exchange rate within a narrow range, banks have to supply foreign currency to their customers or else seek to defend their position by raising HK$ interest rates, thereby discouraging depositors from switching out of HK$ and encouraging borrowers to reduce their HK$ borrowing, either absolutely or in favour of foreign currency borrowing.
3.
In essence, therefore, the scheme requires the banks to respond to the pressure of potential capital outflows by providing foreign currency out of their own positions (which already show sizeable net foreign currency assets for the system as a whole), or raising interest rates so as to staunch the flight.
4.
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While the burden of depreciation falls largely upon consumers and those with HK$ savings, HK$ pension rights, etc, the burden of higher interest rates would fall on borrowers, particularly certain distressed property companies and home buyers, with possible repercussions on some banks and DTCs.
5.
It is just as impossible to predict how high interest rates might go, and for how long (and therefore what damage they might do), as it is to predict how far the exchange rate might fall if no measures were taken. If people were confident that the fixed exchange rate for CIs would be maintained, come what may, then the rush to convert HK$ would subside, since people would know that they would be able to convert at any time ahead. However, it is difficult to envisage the scheme instilling such a degree of conviction. Nevertheless, there are grounds for hoping that any excessive levels of interest rates might last for only a short time days or weeks rather than months.
Monetary Affairs Branch
5 October 1983
HKK
10017
20 OCT 983
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CONFIDENTIAL
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