CUNFIDENTIAL
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9.
Under the linked exchange rate system, the overall
exchange value of the Hong Kong dollar, as measured by the effective
exchange rate index, is basically influenced by the movement of the
US dollar against other major currencies. While the US dollar was
relatively soft in early 1991, from mid-February it strengthened
markedly following victory in the Gulf War. However, sentiment
turned bearish against the dollar during the third and fourth
quarters in the face of poor economic performance and the low
interest rate policy in the US. Reflecting these developments, the
effective exchange rate index fell from 109.3 at end-1990 to 107.7
on 7 February, but then rebounded to reach a peak of 115.0 on 19
June before easing in the second half of 1991 to close the year at
109.2. Another factor which influenced the movement of the index
was the devaluation of the Renminbi. During April to October, it
was devalued 5 times (in total by 3.5% against the Hong Kong dollar
and other major currencies). This contributed to an increase of
about 0.9 of a point in the effective exchange rate index.
10.
Generally speaking, local interest rates moved in line with corresponding US rates during the year. Consequently, the 3-month Hong Kong dollar interbank rate softened from 7 15/16% at
end 1990 to 6 3/16% on 6 February 1991. Amidst rising public
concern over inflation and to complement other
complement other anti-inflationary measures, the Hong Kong Association of Banks (HKAB) deposit rates
were raised by one percentage point in the last week of May. The
three-month Hong Kong dollar interbank rate rose to around 8 3/8%,
widening the interest rate gap to about 2 3/8% percentage points in favor of the Hong Kong dollar. In response, the Hong Kong dollar exchange rate strengthened to a high of 7.714 against the US dollar
on 22 June. With the reversal of the interest rate hike in early
July, the Hong Kong dollar exchange rate returned to a level closer
to 7.80. Meanwhile, the gap between the 3-month Hong Kong interbank
rate and the Euro-dollar rate narrowed and was completely closed in
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