TNAG-1270-FCO40-1620-Financial-policy-in-Hong-Kong-1983 — Page 233

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acquire local currency either as notes (from the note-issuing banks) or as deposits in the foreign exchange market. The market value of·

the HK$ was effectively under-pinned by this mechanism,

The system could not however so easily protect the value of the currency in the face of heavy capital flows, particularly after the abolition of exchange control had reduced the share of the balance of

payments earnings which was held by the large banks, and had made the

local foreign exchange market better developed, and able to absorb

larger transactions.

In June 1972, in a period of heavy capital

inflows, the HK$ was linked to the US$ instead of to £, and Certificates of Indebtedness were henceforth issued against payment in Hong Kong in HK$. (From November 1974 the HK$ has floated freely.) Since that

time the volume of capital flows, in and out, has increased very

substantially, as has the number of financial institutions and the

depth of the local foreign exchange market.

The issue of bank-notes is now entirely demand-led: there is no brake

on it other than the need for the note-issuing banks to pay to the EF a market rate of interest on the HK$ counterpart of CIs issued by the EF. Those banks therefore merely respond passively to changes in the public's demand for notes*.

Equally the role of the EF is entirely passive: CIs are issued or

cancelled in response to the requests of the note-issuing banks. While the Exchange Fund Ordinance would permit the Government to refuse to issue a CI on request, that power has never been exercised.

*There is a very strong seasonal pattern in the note circulation, with the peak demand in the week before Chinese New Year running at up to

3087 above the low point of the previous 12 months.

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