ENG-1971 — Page 88

50

FINANCIAL STRUCTURE

allow any significant diversification of Hong Kong's sterling assets (amounting then to £350 million) into other currencies, in view of her own depleted reserves; while at this stage she was not prepared to offer guarantees of the international value of sterling reserves.

Following negotiations in London, however, a novel arrangement was introduced in June 1968, whereby Hong Kong was allowed to use its sterling assets to purchase British Government bonds, of seven years maturity, denominated in Hong Kong dollars. These bonds were purchasable to a value of £100 million or 50 per cent of official reserves, whichever was greater, up to an absolute maximum of £150 million. The arrangement, for which a charge was made, gave limited protection against loss from a further revaluation of the Hong Kong dollar in terms of sterling, but was soon superseded by a wider and greatly improved arrangement.

Under the new deal, which was made possible by the backing of the so-called Basle arrangement, Britain offered all members of the sterling area, including Hong Kong, a free guarantee in terms of US dollar value of all officially held sterling in excess of 10 per cent of each country's total official external reserves. This was in return for their undertaking to maintain a minimum proportion of their reserves in sterling. The guarantee is for five years from September 25, 1968. Hong Kong accepted this new scheme, under- taking to maintain in her reserves a minimum sterling proportion of 99 per cent. This proportion was reduced to 89.1 per cent (or by 10 per cent) in September 1971, when the British Government agreed to a general reduction of the minimum sterling proportions which sterling area countries had undertaken to maintain in their

reserves.

Because there is no central bank, a substantial part of the Colony's exchange reserves are held by commercial banks. While the sterling assets held by these banks are not in themselves covered by the British guarantee, the UK/HK guarantee arrangement has a unique feature which was carried on from the earlier Hong Kong Dollar Bond Scheme-a provision whereby official sterling deposits with commercial banks in Hong Kong rank as official reserves for the purposes of the guarantee. This enabled arrangements to be made. in February 1969, through the mechanism of the Exchange Fund, to bring a substantial part of commercial banks' sterling within the scope of the guarantee.

While the guarantee remains in force, the Hong Kong dollar is automatically protected from the effects of any lowering in the sterling exchange rate vis-à-vis the US dollar so far as its capital