TNAG-1270-FCO40-1620-Financial-policy-in-Hong-Kong-1983 — Page 71

SECRET

SECRET

DESKEY 11083OZ

FM HONG KONG 1104002 OCT 83

TO IMMEDIATE FCO

C

TELEGRAM NUMBER 1501 OF 11 OCTOBER

TOP COPY

FOR CLIFT (HONG KONG DEPARTMENT) FROM BREMRIDGE.

MIPT: PROPOSED FINANCIAL MEASURES.

MEMORANDUM FOR EXECUTIVE COUNCIL STABILISATION OF THE EXCHANGE RATE

INTRODUCTION

HKCK 100/7

RECEN VER

THIS MEMORANDUM DESCRIBES A SCHEME TO STABILISE THE EXCHANGE RATE OF THE HONG KONG DOLLAR, AND SEEKS MEMBERS' ADVICE AS TO WHETHER IT SHOULD BE IMPLEMENTED IMMEDIATELY.

BACKGROUND

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PA

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2. SINCE 1974 THE HONG KONG DOLLAR HAS BEEN A FREELY FLOATING CURRENCY. ALTHOUGH THE EXCHANGE FUND HAS ALWAYS POSSESSED THE CAPABILITY OF INTERVENTION IN THE FOREIGN EXCHANGE MARKET, SUCH INTERVENTION HAS GENERALLY BEEN LIMITED TO SEEKING TO SMOOTH OUT SHORT-TERM FLUCTUATIONS, ACKNOWLEDGING THE EXPERIENCE OF GOVERNMENTS AND CENTRAL BANKS ACROSS THE FREE WORLD THAT HINTERVENTION CANNOT RESIST MORE FUNDAMENTAL PRESSURES. IN BRIEF MASSIVE EXPENDITURE OF FOREIGN CURRENCY RESERVES IS FUTILE. A PARTICULAR DIFFICULTY AN HONG KONG HAS BEEN THE LIMITED EFFECT- *VENESS OF OTHER POLICY INSTRUMENTS AVAILABLE TO INFLUENCE THE

DOMESTIC MONEY SUPPLY N SUPPORT OF ANY INTERVENTION IN THE

FOREIGN EXCHANGE MARKET.

3. OVER THE LAST NINE YEARS THE FLOATING EXCHANGE RATE REGIME

HAS SERVED HONG KONG WELL. ITS MERHT HAS BEEN IN ASSISTING THE

FULL EMPLOYMENT AND OUTSTANDING ECONOMIC GROWTH, BUT IT HAS

BEEN ACCOMPANIED BY HIGH RATES OF INFLATION AT TIMES - PARTICULARLY

RECENTLY AND BY UNCONTROLLED GROWTH OF THE MONEY SUPPLY.

4. DURING THE PAST 12 MONTHS THE EXCHANGE RATE HAS BECOME

INCREASINGLY AFFECTED BY POLITICAL UNCERTAINTIES AND LOSS OF

CONFIDENCE AS OPPOSED TO CURRENT ECONOMIC FACTORS. THE LATTER

ARE EXCELLENT. CURRENCY DEPRECIATION HAS NEVERTHELESS SHOWN

SIGNS RECENTLY OF FEEDING ON ITSELF, WHICH HAS LED TO CONSTERNATION AND INDEED A DEGREE OF PANIC AMONGST THE PUBLIC.

THE GOVERNMENT HAS BEEN UNABLE TO CONTROL THE SLUDE, DESPITE BOTH SUBSTANTIAL INTERVENTION BY THE EXCHANGE FUND IN THE

FOREIGN EXCHANGE MARKET AND UPWARD PRESSURE ON INTEREST RATES.

THE ADMINISTRATION HAS CONSEQUENTLY EXPLORED THE POSSIBILITY OF

INTRODUCING FUNDAMENTAL STRUCTURAL CHANGES TO THE EXCHANGE RATE

SYSTEM, GIVEN THAT THE FREE FLOAT, HOWEVER SUCCESSFUL IN THE PAST, MAY NO LONGER BE APPROPRIATE TO HONG KONG'S UNIQUE PRESENT

CIRCUMSTANCES. GREAT CAUTION IS CLEARLY ESSENTIAL. WE DO NOT

WITH TO LEAP FROM THE FRYING PAN INTO THE FIRE.

SECRET

/PROPOSAL

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