ENG-1998 — Page 121

FINANCIAL AND MONETARY AFFAIRS

The total outstanding amount of Exchange Fund Bills and Notes was $97.5 billion at the end of December 1998, down from $102 billion at end-1997. The decrease was mainly due to the reduction of the size of the tap issue of the 28-day Exchange Fund Bill*. Demand for Exchange Fund paper remains strong. The average over- subscription rate for the Note issues was about 2.7 times in 1998. At end-1998, the yield of 10-year Exchange Fund Notes stood at 6.33 per cent, some 163 basis points (bps) above that on 10-year US Treasury Notes. The daily turnover of Exchange Fund paper during January to December 1998 averaged $8.9 billion.

Issuance activities of private sector debt paper remained active in the local debt market, contributed largely by supranational paper. A total of $95.7 billion Hong Kong dollar debt issues were launched in 1998. Of this, fixed-rate issues registered a record volume of $77 billion, over 2.8 times that of last year. Of this amount, 82 issues involving $41.8 billion were issued by supranational borrowers including the World Bank, the International Finance Corporation and the European Bank for Reconstruction and Development.

The growth of the domestic debt market can be attributed partly to a combination of government initiatives and continued improvement in supply and demand conditions. The launch of the Exchange Fund Bills and Notes Programme in 1990 marked an important milestone in the development of the Hong Kong debt market. Government debt paper provides a benchmark yield against which private debt issues can be priced. From a weekly issue of 91-day bills, the programme was gradually expanded to include 182-day and 364-day bills and two-, three-, five-, seven- and 10- year Exchange Fund Notes. As for the tap issues of 28-day Exchange Fund Bills, the size of each issue was cut from $5 billion to $2 billion during the year due to reduced demand as mentioned earlier.

As part of the measures to strengthen the currency board arrangements, the HKMA has tightened the provision of day-end liquidity through the Discount Window against debt securities not backed by foreign reserves with effect from September 7. No new issues of paper other than Exchange Fund paper will be eligible for discounting under the Discount Window. The existing eligible issues will continue to be accepted for Discount Window purposes until the paper matures. New Exchange Fund paper will be issued only when there is an inflow of funds enabling the additional paper to be fully backed by foreign reserves. Existing issues of Exchange Fund paper, which are already backed by foreign reserves, will be rolled over as and when they mature. This measure will, to some extent, have some adverse implications on private sector issues in the short run. In the long run, however, a stable dollar exchange rate will bring a more stable interest rate environment, which is conducive to the development of the local debt market.

To encourage the supply of high-quality debt issues in Hong Kong, profits tax exemption has been granted to the Hong Kong dollar debt securities issued by 10 multilateral financial organisations, such as the World Bank and the Asian Development Bank. To facilitate further the development of the local debt market, in May 1996 the government introduced a scheme under which the interest income and

* The 28-day Exchange Fund Bills were initially launched in the end of 1996 to facilitate the implementation of the Real Time Gross Settlement system. Demand for them decreased as banks have become more proficient in managing their intraday liquidity. The HKMA therefore cut the size of each tap issue of the 28- day Bills from $5 billion to $2 billion.

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