ENG-2001 — Page 136

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FINANCIAL AND MONETARY AFFAIRS

The overall exchange value of the Hong Kong dollar, 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. Largely reflecting a strengthening of the US dollar against the Japanese Yen, the Euro as well as the British Pound, the EERI rose during the first seven months of 2001, from 136 at the end of 2000 to a high of 141 in mid-July 2001. Thereafter, the EERI decreased slightly, along with the weakening of the US dollar against the Japanese Yen and the Euro, amid concerns on a marked slowdown in US economic activity. Towards the end of the year, the US dollar strengthened again against the Yen in the face of a deepening recession in Japan, and the EERI rose again to close the year at 141.

Hong Kong dollar narrow money experienced negative year-on-year growth in the first quarter of 2001, along with a decline in demand deposits, which probably reflected lower transactions demand for money alongside corrections in the stock market. Thereafter, growth of narrow money accelerated to reach a year-on-year rate of 13 per cent in December 2001, substantially higher than growth in private consumption in nominal terms. This was in part associated with the lower opportunity cost of holding narrow money amid continued decreases in deposit rates. Growth of Hong Kong dollar broad money moderated to around 1 per cent in December 2001, from around 5 per cent in the first half.

Loans for use in Hong Kong contracted by 4.3 per cent during the year, along with a slowdown in economic activity. Credit expansion analysed by economic use was mixed in 2001. Residential mortgage loans grew modestly during the year, while loans for building, construction, property development and investment contracted moderately. Loans for financial concerns shrank notably. Credit card advances increased significantly during the year as a result of banks' promotion efforts on some personal segments. As growth of Hong Kong dollar deposits outpaced that of Hong Kong dollar loans, the Hong Kong dollar loan-to-deposit ratio declined slightly to 89 per cent at the end of 2001, from 89.4 per cent a year earlier.

Exchange Fund

The Exchange Fund was established by the Currency Ordinance of 1935 (later renamed the Exchange Fund Ordinance). Since its creation, the Fund has held the backing to the banknote issues of Hong Kong. In 1976, the Fund's role was expanded. The backing for coins issued and the bulk of the foreign currency assets. held in the Government's General Revenue Account, were also transferred to the Exchange Fund. Meanwhile, to centralise the investment management of its financial assets, the Government began to transfer the fiscal reserves of its General Revenue Account (apart from the working balances) to the fund. Therefore the bulk of the Government's financial assets are placed with the Fund. On December 31, 1978, the Coinage Security Fund was merged with the Exchange Fund.

Prior to April 1, 1998, fiscal reserves were placed with the Exchange Fund as deposits on which market interest rates were paid by the Fund to the General Revenue. As the official reserves had grown significantly over the years, it was decided that the fiscal reserves placed with the Exchange Fund should seek to achieve a higher long-term real rate of return. With effect from April 1, 1998, the return on the fiscal reserves placed with the Exchange Fund is linked to its overall return.

Upon the establishment of the Hong Kong Special Administrative Region on July 1, 1997, the assets of the Land Fund Trust were vested in the Hong Kong SAR