TNAG-2466-FCO40-3590-Economic-situation-in-Hong-Kong-1992 — Page 26

BACKGROUND

NOTE ON LINKED EXCHANGE RATE SYSTEM

1.

The primary monetary policy objective under the linked exchange rate system is to maintain a stable exchange rate between the Hong Kong dollar and the US dollar around the linked rate of 7.80. Pursuit of other monetary policy objectives, such as curbing inflation, is possible only within the confines of this overriding goal.

2.

The linked exchange rate system was introduced on 17 Oct 1983, after a period of rapid depreciation of the exchange rate of the Hong Kong dollar as a result of unease over the direction of the talks

with China on Hong Kong's future. The most important features of the

system are as follows:

(a) Two note issuing banks, Hong Kong and Shanghai Banking Corporation and Standard Chartered, receive a certificate of indebtedness (CI) for each US dollar they have deposited with the Exchange Fund. The CI authorises the issue of 7.8 Hong Kong dollars by the note issuing banks. The US dollars held by the Exchange Fund constitute a part of Hong Kong's foreign exchange reserves. The Exchange Fund does not pay interest on them: they are thus a source, through interest received, of a steady income stream.

(b) Hong Kong has two interrelated foreign exchange markets: one between the Exchange Fund and commercial banks featuring the fixed rate of HK$7.80 per US dollar, and the other between commercial banks and the public featuring free market rates.