ENG-1988 — Page 89

THE ECONOMY

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except where social considerations are regarded as over-riding, the allocation of resources in the economy will normally be achieved in the most efficient way if market forces are relied on and if government intervention in the private sector is kept to a minimum.

This basically free-enterprise, market-disciplined system has contributed to Hong Kong's economic success. The narrowly-based tax structure with relatively low tax rates provides incentives for workers to work and for entrepreneurs to invest. Both workers and en- trepreneurs are highly motivated, given that all individuals have equal opportunity to pursue the goals of individual betterment and accumulation of wealth. The primary role of the government is seen as the provision of the necessary infrastructure and a stable legal and administrative framework conducive to economic growth and prosperity.

Monetary Policy

The government has consistently worked towards providing a favourable environment in the financial sector, with sufficient regulation to ensure, as far as possible, sound business standards and confidence in the institutional framework, but without unnecessary impedi- ments of a bureaucratic or fiscal nature.

Unlike most major economies, Hong Kong has no central bank. Most of the functions which might normally be performed by one such as prudential supervision of financial institutions, managing official foreign exchange reserves, undertaking certain types of market operations, issuing banknotes, and providing banking services to the government -- are carried out by different government offices under the Monetary Affairs Branch of the Government Secretariat or by selected commercial banks.

On October 17, 1983, after a period of much instability in the exchange rate of the Hong Kong dollar, a revised exchange rate system was introduced. Under the new arrangement, certificates of indebtedness (CIs) issued by the Exchange Fund, which the two note-issuing banks are required to hold as cover for the issue of Hong Kong dollar banknotes, are issued and redeemed against payments in US dollars at a fixed exchange rate of HK$7.80=US$1. In practice, therefore, any increase in note circulation is matched by a US dollar payment to the Exchange Fund, and any decrease 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. In the foreign exchange market, the exchange rate of the Hong Kong dollar continues to be determined by forces of supply and demand. However, the inter-play of arbitrage and competition between banks ensures that the market exchange rate stays close to the rate of HK$7.80 to US$1 fixed for the CIs.

With the adoption of the linked rate system, the exchange rate is no longer a variable in the economy's adjustment process. Under this system, interest rates, the money supply and the level of economic activity adjust automatically to balance of payments pressures.

The Hong Kong Association of Banks, which sets the maximum rates of interest payable on deposits of original maturities up to 15 months (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 the wider public interest into account in making its decisions, including their effect on the exchange rate.

To deter the persistent speculation on a revaluation of the Hong Kong dollar which emerged in late 1987 and continued in early 1988, the Hong Kong Association of Banks, after consultation with the Financial Secretary, introduced new Interest Rates Rules whereby banks may impose deposit charges ('negative interest rates') on large Hong Kong