TNAG-1347-FCO40-1777-Financial-policy-in-Hong-Kong-1984 — Page 48

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RECEIVED A REGISTRY

10 JUL 1904

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FM HONG KONG 091035Z JUL 84

TO IMMEDIATE F C O

TELEGRAM NUMBER 1872 OF 9 JULY

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See 18

Seale

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FOLLOWING STRICTLY PERSONAL FOR CLIFT HONG KONG DEPARTMENT

FROM GOVERNOR.

YOUR TELNO 1250 HONG KONG DOLLAR.

1. WE HAVE ALWAYS KNOWN THAT THE SYSTEM INSTITUTED LAST OCTOBER

DEPENDS, INTER ALIA, UPON BANKS BEING PREPARED TO FORCE UP INTEREST

RATES AS A DEFENCE AGAINST CUSTOMERS SWITCHING INTO FOREIGN CURRECNTY OR WITHDRAWING DEPOSITS, AND UPON BANKS MAINTAINING FULL

CONVERTIBILITY OF CUSTOMER DEPOSITS INTO BANKNOTES. BEST LENDING

RATES WERE RAISED LAST FIRDAY BY THREE AND A QUARTER PER CENT.

CLEARLY, BANKS FACE A CONFLICT OF INTEREST WHEN CONSIDERING WHETHER

TO SANCTION HIGHER INTEREST RATES AND THEY MAY ULTIMATELY BE TEMPTED

BY THE ALTERNATIVE OF RESTRICTING THE CONVERTIBILITY OF DEPOSITS

INTO NOTES. THIS WOULD LEAD TO A TWO-TIER MARKET AND SPELL THE END

OF THE STABILITY WHICH THE MAIN FOREX MARKET HAS ENJOYED SINCE

OCTOBER. THIS WOULD CERTAINLY HAPPEN IF THE LEVEL OF INTEREST RATES

NECESSARY TO CHOKE OFF EXCESS DEMAND FOR FOREIGN CURRENCY WAS SO

HIGH, OR HAD TO BE SUSTAINED FOR SO LONG, AS TO TAKE BANKS WAY

OUTSIDE THEIR USUAL BUSINESS PARAMETERS.

2. THE HONGKONG BANK IS OF COURSE IN THE FOREFRONT AND IS THE

DETERMINED FORCE. THE BANK ARE ARGUING AND WE WOULD TO SOME EXTENT CONCUR, THAT THE SYSTEM HAS SUCCEEDED BY PSYCHOLOGY AS MUCH AS BY

SUBSTANCE. THEY GO ON TO ARGUE THAT TO RETAIN CONFIDENCE IN THE

SYSTEM IT IS THEREFORE ESSENTIAL TO HOLD THE RATE WITHIN QUITE

A NARROW BAND (E.G. 7.78 7.82) BY INTERVENTION, SINCE THE

SIGHT OF WEAKER LEVELS MIGHT SNAP PSYCHOLOGICAL SUPPORT AND THE

SUBSTANCE OF THE SYSTEM MIGHT THEN BE SEVERELY TESTED AND FOUND

WANTING. THIS, COMING FROM THE BANK, MUST BE INTERPRETED AS A

WARNING THAT THEY WOULD NOT HESITATE TO OPT FOR A TWO-TIER MARKET

IF LIFE BECAME TOO DIFFICULT FOR THEM. THEIR POSITION IS ENTIRELY

UNDERSTANDABLE. THEY HAVE BEEN COURAGE TOUS IN SUPPORTING THE SYSTEM

TO DATE.

3. IT IS AGAINST THIS BACKGROUND THAT WE HAVE HAD TO JOIN THE

HONG KONG BANK IN INTERVENTION. THERE ARE HOWEVER SUBSTANTIAL

QUESTIONS OF PRINCIPLE INVOLVED IN YOUR REQUEST FOR DETAILS, WHICH IS INPRECEDENTED. YOU DO NOT SAY WHICH MINISTERI HAVE ASKED FOR THE

INFORMATION. IN ANY CASE THE MANAGEMENT OF THE EXCHANGE FUND IS

BY ORDINANCE VERY MUCH THE PREROGATIVE OF THE FINANCIAL SECRETARY

WHO IS NOT SUBJECT TO EXTERNAL MONITORING ON THE FUND. INFORMATION

ON THE EXTENT OF INTERVENTION IS RESTRICTED IN HONG KONG TO A VERY

SMALL NUMBER OF OFFICIALS DIRECTLY INVOLVED IN THE MANAGEMENT OF

THE FUND, IT IS PRESUMABLY THE OVERALL PICTURE OF THE WORKING OF THE

SCHEME WITH WHICH MINISTERS ARE CONCERNED AND WE CAN SEND YOU OUR

COMMENTS ON THAT WITHOUT THE NEED TO GO INTO SUCH HIGHLY SENSITIVE

ISSUES IN TELEGRAMS OVER WHOSE DISTRIBUTION WE HAVE NO CONTROL.

I TRUST THEREFORE THAT YOUR REQUEST FOR DETAILS WILL NOT BE

PURSUED.

4. TODAY THE FOREX MARKET WAS RELATIVELY QUIET UNTIL LATE

AFTERNOON. THE RATE AGAINST THE U.S. DOLLAR OEPEND AT 7.8350/

78450 AND IMPROVED TO 7.8280/7.8350 BY LUNCHTIME. THE RATE CLOSED

AT 7.8530/7.8630 AND IN AFTER HOURS TRADING WEAKENED FURTHER ON

RUNOURS OF YET EVEN HIGHER U.S. DOLLAR INTEREST RATES AND

ALLEGED DISAGREEMENT BETWEEN CHINA AND BRITAIN ON THE SETTING UP

OF A JOINT COMMITTEE TO OVERLOOK HONG KONG'S ADMINISTRATION IN THE

NEXT 13 YEARS.

YOUDE

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