ENG-2000 — Page 129

FINANCIAL AND MONETARY AFFAIRS

applicable to the issuance and redemption of Certificates of Indebtedness at HK$7.80 on August 12, 2000. Since then, the convertibility rate has remained at HK$7.80.

By assuming responsibility for the interbank clearing system, the HKMA also became responsible for the provision of lending to any banks experiencing day-to-day shortages of liquidity. A Liquidity Adjustment Facility (LAF) was set up in 1992 for this purpose. This was replaced in September 1998 by the Discount Window arrangement under which banks have unrestricted access to day-end liquidity through repurchase agreements using Exchange Fund Bills and Notes as collateral. A two-tier structure of Discount Rates has been adopted to ensure that interest rates are adequately responsive to capital flows, while avoiding excessive interest rate volatility if liquidity shortages are only modest. Banks are charged the Base Rate with respect to the first 50 per cent of their holding of Exchange Fund Bills and Notes. For the next 50 per cent, the charge is the Base Rate plus 5 per cent, or the overnight Hong Kong Interbank Offer Rate (HIBOR) of the day, whichever is higher. The Base Rate is set at the higher of the simple average of the five-day moving averages of overnight and one-month HIBORS, and the US Federal Funds Target Rate plus an adjustment factor, currently set at 150 basis points.

Under the currency board system, Hong Kong dollar exchange rate stability is maintained through an interest rate adjustment mechanism. The monetary base increases when the foreign currency (in Hong Kong's case, US dollars) to which the domestic currency is linked is sold to the currency board for the domestic currency (inflow into the Hong Kong dollar). It contracts when the foreign currency is bought from the currency board (outflow from the Hong Kong dollar). The expansion or contraction in the monetary base leads interest rates for the domestic currency to fall or rise respectively, creating the monetary conditions that automatically counteract the original capital movement, ensuring stability of the exchange rate.

To strengthen the institutional framework for the operation of the currency board system in Hong Kong, a Subcommittee on Currency Board Operations was established under the Exchange Fund Advisory Committee (EFAC) in August 1998. The subcommittee has been entrusted with the responsibility of overseeing the operation of the currency board system in Hong Kong and may, where appropriate, recommend measures to the Financial Secretary through the EFAC to enhance the robustness and effectiveness of Hong Kong's currency board arrangements.

The HKMA pursues a policy of transparency to ensure that the financial industry and the wider public are fully informed of the currency board operations. The Aggregate Balance has been disclosed on a virtually real time basis since December 1996, when the RTGS system was launched. Forecast changes to the Aggregate Balance attributable to the currency board's foreign exchange transactions have also been published daily since June 1998. Since November 1998, the size of the monetary base and its components have been published daily. The records of the meetings of the Subcommittee on Currency Board Operations have been published within six weeks of each meeting. The Currency Board Account has also been published monthly since March 1999.

The Government is fully committed to the maintenance of the linked exchange rate system, which is a cornerstone of Hong Kong's monetary and financial stability, and to the strict discipline of the currency board arrangement under that system.

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