TNAG-1347-FCO40-1777-Financial-policy-in-Hong-Kong-1984 — Page 22

Federal Reserve Bank of Minneapolis. Quanery. Review Fall 1983

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supported by an analysis of who stood to gain and who stood to lose from such a depreciation.'

A Look at Hong Kong's Monetary System Monetary and fiscal affairs in Hong Kong are now managed by a single institution, known as the Exchange Fund. (Though originally just Hong Kong's monetary institution, it took on most of the Treasury's functions in 1977.)

The types of items on the Exchange Fund's balance sheet. divided into parts attributable to the monetary branch and the fiscal branch, are shown in Figure 1. The certificates of indebtedness are non-interest-bearing in- struments held by private banks as backing for currency. The debt certificates are an internal bookkeeping device between the monetary and fiscal branches of the Ex- change Fund, which completely net out in the consoli- dated balance sheet. They seem to be a device for crediting the revenues accumulated from currency issue (the seignorage) to the fiscal branch.

The Exchange Fund issues all of Hong Kong's coins. but two large private banks issue most of the paper currency, known as the Hong Kong dollar (HK$). These banks are the Hongkong and Shanghai Bank, which issues from 80 to 90 percent of the paper currency, and the Chartered Bank, which issues most of the rest.

These private banks issue the currency entirely at their own discretion, but they do not profit greatly from this privilege. Since the banks' names appear prominently on

Figure 1

The Exchange Fund's Balance Sheet

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Hong Kong bank deposits denominated in Hong Kong dollars

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Hong Kong Dank deposits denominated in Hong Kong dollars

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the notes, they get some prestige and free advertising from the privilege. However, as already noted. the govemment collects all of the seignorage It does this by requiring the banks to hold, behind all currency issues. 100 percent reserves of the non-interest-bearing certificates of in- debtedness mentioned above as liabilities of the Ex- change Fund. The banks must buy these certificates of indebtedness from the Exchange Fund, which holds as assets behind these certificates a portfolio of interest- bearing assets denominated in foreign currencies and interest-bearing deposits in accounts in Hong Kong banks. These assets can thus be thought of as ultimately backing the Hong Kong dollar. The regulation governing certificates of indebtedness states that they are redeem- able at the option of the Financial Secretary.

The asset effects of currency issues on the Exchange Fund and the banks are illustrated in Figure 2.

Although only two banks issue notes. there is relatively free entry into other aspects of banking in Hong Kong. Furthermore, there are no reserve requirements against deposits and no government-supplied deposit insurance. There is a cartel. the Hong Kong Association of Banks, which sets interest rates.

The Official Float Policy

The system just described contains vestiges of Hong Kong's pre-1972 system, which was a British Currency Board System. In that system. the Exchange Fund pegged the Hong Kong dollar to the British pound. Behind certificates of indebtedness the Exchange Fund held 100 percent reserves in interest-bearing British pound instru- ments. After 1972, for about two years, the Hong Kong dollar was pegged to the U.S. dollar. Thereafter (unti) October 1983) it was allowed to float. During the float period, the Exchange Fund held a portfolio of interest- bearing instruments denominated in a variety of foreign currencies and of interest-bearing deposits in Hong Kong banks. According to the official policy, the Exchange Fund passively supplied any amount of certificates of indebtedness that the private banks requested in ex- change for foreign currencies at market rates of exchange. In effect, then, the Exchange Fund was willing to buy and

¡Except for minor editorial changes, most of this paper was written during the summer of 1983 The tast sccuor an epilogue, was written afer October 15 1983, when the Hong Kong authorities announces and implementos a sniz to 2 dolicy of begging the value of the Hong Kong dollar i tha of inc US ana

The goverment compensates the banks To the cos: maintaining the stock or current.