TNAG-1270-FCO40-1620-Financial-policy-in-Hong-Kong-1983 — Page 208

Better Methods of Control

SECRET

12.

The Government could in principle limit the growth in the

circulation of HK notes by restricting the issue of HKGEF

Certificates of Indebtedness. There would be difficulties associated

with the sharp seasonal fluctuations. There would also be a major presentational difficulty in ensuring that the consequent inability of any bank with a Chinese depositor base to supply its customers with notes was accepted by those depositors as an act of government policy, rather a demonstration of the inability of the bank to meet its obligations. For political reasons the Government would be bound to be very cautious about running this risk. In any case the most that would be achieved, presumably, would be to induce depositors

to make more use of bank current accounts and cheques, or of foreign

currency notes.

13. The change now apparently envisaged, to make Certificates of Indebtedness denominated in dollars in future (rather on pre-1971 lines, when they were effectively denominated in sterling) would not seem, necessarily, in itself to provide improved control over the size of the note issue. But it would presumably improve its backing. And it could at the same time provide a way of boosting

Hong Kong's official exchange reserves provided the note issuing banks did not acquire the dollars to deposit by selling HK Øs in

the market.

14. Control of banks' clearing accounts, or wider measures of

money, is made difficult by the absence of any Government debt. Since the banking system holds no Government debt, the Government

has no leverage. Numberous attempts have been made to devise some

other way of influencing the different elements of banks' balance

sheets, including the size and composition of their un-lent assets, but all attempts so far have

foundered on the twin factors of an absence of Government debt, and a totally open economy (no exchange control, over 70 overseas banks in Hong Kong and an internationally-oriented industrial/trade sector).

15. The interest rate mechanism, which is the only one available, has proved an unsatisfactory second best, even when supplemented by the reverse open-market operations introduced in 1981.