ENG-2002 — Page 133

FINANCIAL AND MONETARY AFFAIRS

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 to the Financial Secretary through the EFAC measures 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. To this end, the Aggregate Balance and forecast changes to the Aggregate Balance attributable to the currency board's foreign exchange transactions are disclosed on a real-time basis. In addition, the size of the monetary base and its components are published on a daily basis, while the Currency Board Account is published on a monthly basis. The records of the meetings of the Subcommittee on Currency Board Operations are also published within six weeks of each meeting.

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.

Monetary Situation

Monetary conditions were stable in 2002. The Hong Kong dollar exchange rate stayed close to the linked rate of 7.8, trading within a range of 7.7980 and 7.8000. Hong Kong dollar interest rates remained in the vicinity of their US dollar counterparts.

The exchange and money markets reacted calmly towards uncertainties in the external and internal environment, including the abolition of the currency board system in Argentina, the weakening of the Japanese Yen in the latter part of the year, speculation about a change in the Link and concerns about the budget deficit. The resilience of these markets reflected confidence in the linked exchange rate system, which has been reinforced by the technical reforms introduced in September 1998. During the year, the convertibility undertaking was triggered once. The HKMA purchased US dollars for Hong Kong dollars twice.

Hong Kong dollar interest rates were on a moderate downtrend during the year, along with the reduction in US dollar interest rates. Nevertheless, reflecting renewed concerns of an increasing budget deficit, short-term interest rates generally maintained a small positive differential against their US dollar counterparts (except for the third quarter when interbank liquidity was relatively abundant). In terms of one-month money, Hong Kong dollar interbank interest rate (HIBOR) closed the year at 1.4 per cent, six basis points above the corresponding Euro-dollar rate. The best lending rate quoted by major banks in Hong Kong was lowered by a total of 13 basis points during the year. It stood at 5.0 per cent at year-end. The savings deposit rate quoted by major banks followed a similar downtrend, declining from 0.15 per cent to around 0.03 per cent.

The yields on long-term Exchange Fund Notes largely followed those on US Treasuries, with 7-year and 10-year Notes closing the year at 3.8 and 4.4 per cent respectively. The yield curves flattened during the year, mainly reflecting subsided concerns over the inflation outlook in the US. The yield differentials between the Exchange Fund Notes and US Treasuries narrowed during the year, to 33 basis points and 44 basis points respectively for 7-year and 10-year paper.

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

97