TNAG-1270-FCO40-1620-Financial-policy-in-Hong-Kong-1983 — Page 190

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We conclude, therefore, that the problem is essentially a political one. Although the Hong Kong Government's measures have had some immediate beneficial effect, it must remain doubtful whether the exchange rate has turned round to any lasting effect. Talks with the Chinese are due to resume on 20 October and unless public confidence in the prospects for an acceptable political solution can be restored the financial outlook will continue to be very worrying and financial measures alone may only have limited and temporary effects. The following paragraphs, however, discuss some of the financial measures that could possibly be taken either by the Hong Kong authorities alone, or with UK backing, to support the Hong Kong currency.

6.

The main possible responses to the immediate situation would seem to be:

(i) Mechanisms designed to peg the exchange rate for the HK against

the US or sterling: These are discussed in detail in Annex 2. The main

difficulties are that Hong Kong's own foreign currency reserves are small (probably around $6 billion) in relation to the kind of market pressures

that could all too easily arise and her borrowing capacity is probably limited (at least without an explicit HMG guarantee). The Hong Kong authorities may nevertheless feel it worth taking the risk (they have been

intervening "on a substantial scale" during the past few days), in order

to see whether they can use their reserves to better effect than hitherto

to support their currency, recognising that they may not succeed. To do

this s on their own account is however a very different matter than to do so

with explicit or even implied UK backing. In that case we could all

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too easily be drawn quickly into either committing our own - fairly limited

dollar reserves to support the HK $, or allowing sterling itself to take

the strain. Where, as at present, the difficulty is essentially one of

confidence a commitment to support the rate, particularly one backed with

HMG's resources, could all too easily increase pressures rather than reduce

them, encouraging large holders of HK $s to get out while the going was

good. So the cost to RMG could be very substantial; and, if we allowed

sterling to take some of the strain, the exercise could lead to fairly

sharp downward pressure on our own currency, although it is impossible to

attach any figures to this.

(ii)

Exchange controls: Reimposition of exchange controls could accompany a mechanism as at (i) above. But, as explained in Annex 3, we do not think

that these are likely to be effective for a sophisticated financial centre like Hong Kong. Anything less than fairly comprehensive controls (even assuming the Hong Kong authorities could put them quickly into place) would

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