ENG-1999 — Page 127

FINANCIAL AND MONETARY AFFAIRS

The overall exchange value of the Hong Kong, as measured by the trade-weighted Effective Exchange Rate Index (EERI), was predominantly affected by the exchange rate of the US dollar vis-à-vis other major currencies. The EERI increased notably in the first quarter to a high of 135 in early March amid a strengthening of the US dollar against the Japanese Yen and the Euro and it then remained stable at around that level during mid-March and mid-July. Alongside the weakening of the US dollar since mid-July, the EERI decreased to around 131.5 at end-December.

Narrow money (HK$M1) accelerated significantly from a year-on-year decline of around 17 per cent in mid-1998 to a positive growth of around 11 per cent in September, before easing to 5.4 per cent in November. The rise reflected partly an increase in transactions demand for money as economic activity recovered and stock market turnover increased. Reflecting an increase in cash withdrawals around the turn of the millennium due to seasonal demand and the Year 2000 factor, HK$M1 rose notably by 8.8 per cent during the month of December, implying a year-on-year growth of 15.2 per cent. Of the total, currency held by the non-bank public increased substantially by 13.8 per cent on a month-on-month basis and 22.6 per cent on a year-on-year basis in December. Broad money (HK$M3) rose significantly in the first half of 1999 on a year-on-year basis but the growth slowed in the second half of the year, probably due to the effect of high base comparison, as a notable amount in offshore deposits was repatriated to Hong Kong in the second half of 1998, following the introduction of the exemption of interest income derived from deposits placed in Hong Kong from profit tax in June 1998. Adjusted for the repatriation of deposits, the growth of HK$M3 was rather moderate, at 4.5 per cent year-on-year in December. Hong Kong dollar deposits rose by around 10 per cent year-on-year in June and the growth slowed gradually to 4.5 per cent in December. Adjusted for the effect of deposit repatriation, the growth of Hong Kong dollar deposits was more moderate, 3.6 per cent year-on-year in December.

Loans for use in Hong Kong shrank on a year-on-year basis by 8.2 per cent in 1999, but the monthly decline has slowed down to around 0.4 per cent in the second half, compared with a monthly average decline of 1.1 per cent during the first half. The contraction in loans was mainly driven by banks' concerns over credit risk and subdued loan demand rather than by liquidity concerns. As Hong Kong dollar deposits rose while loans declined, the Hong Kong dollar loan-to-deposit ratio fell from 100.6 per cent at end-1998 to 91.3 per cent at end-1999.

Exchange Fund

The Exchange Fund was established by the Currency Ordinance of 1935 (later renamed the Exchange Fund Ordinance). Since its inception, the fund has held the backing to the note issue. In 1976, the fund's role was expanded. The assets of the Coinage Security Fund (which held the backing for coins issued by the Government), as well as the bulk of foreign currency assets held in the Government's General Revenue Account, were transferred to the fund. On December 31, 1978, the Coinage Security Fund was merged with the Exchange Fund.

In 1976, the Government began to transfer the fiscal reserves of its General Revenue Account (apart from the working balances) to the fund. This arrangement was introduced to avoid fiscal reserves having to bear exchange risks arising from investments in foreign currency assets and to centralise the management of the Government's financial assets. The fiscal reserves are not permanently appropriated

97