ENG-1986 — Page 79

THE ECONOMY

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in US dollars at the fixed exchange rate of US$1=HK$7.80. In practice, therefore, any increase in note circulation is matched by a US dollar payment to the Exchange Fund, and

any

fall in note circulation is matched by a US dollar payment from the Exchange Fund. The two note-issuing banks in turn extend this fixed exchange rate to their note transactions with all other banks in Hong Kong. The forces of competition and arbitrage have worked to keep the market exchange rate of the Hong Kong dollar against the US dollar stable and close to the fixed rate since October 1983.

This important aspect of Hong Kong's monetary framework means that the exchange rate is no longer a variable in the economy's adjustment process. Under the linked exchange rate system, the interest rates, the money supply and the level of economic activity tend to adjust automatically to balance of payments pressures, without government intervention being necessary. Interest rates have therefore assumed a more passive role than before, changing more frequently in response to the inflows and outflows of funds.

The Hong Kong Association of Banks, which sets the maximum rates of interest payable on deposits (except those of $500,000 or above with a term to maturity of less than three months) with licensed banks, has a statutory obligation to consult the government on the determination of these interest rates. This procedure is designed to ensure that the association takes into account the wider public interest in its decisions, including their effect on the exchange rate. Under the linked exchange rate system, it is neither so necessary nor so desirable as in the past for the government to play an active role in this process.

Through its bankers, the Exchange Fund operates a scheme which enables it to draw short-term funds out of the local interbank market and to ensure that these funds are not recycled back into that market. This arrangement has the effect of tightening up the local money market and putting upward pressure on short-term market interest rates. Thus, despite the change in the monetary framework which took place in October 1983, arrangements whereby the government may influence interest rates through the Hong Kong Association of Banks or the local money market still remain in place.

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In response to the rapid development of Hong Kong's financial markets and the in- creasing interaction between them, policy responsibilities within the government were reorganised in 1986 so that the Monetary Affairs Branch of the Government Secretariat is now responsible for the securities, commodities and futures markets and for the insurance industry in addition to its portfolio of banking and monetary policy issues. Vesting policy responsibility for all aspects of the financial sector in a single branch enables the government to keep abreast of changes in the financial markets and facilitates the proper co-ordination of policies towards these markets.

Public Sector and Public Finances

For expenditure analysis purposes, the public sector is conventionally taken to include the government itself, together with the Housing Authority and the Urban Council and Regional Council. Expenditure by institutions in the private or quasi-private sector is in- cluded to the extent that it is met by government subventions, but expenditure by organ- isations in which the government has only an equity position, such as the Mass Transit Railway Corporation and the Kowloon-Canton Railway Corporation, is not included.

The government controls its finances through a series of fund accounts. General Revenue is the main account for day-to-day departmental expenditure and revenue collection. Six other funds have been established mainly to finance capital expenditure and to make loans. They are the Capital Works Reserve Fund, the Development Loan Fund, the Home Ownership Fund, the Lotteries Fund, the Mass Transit Fund and the Student Loan Fund.