ENG-2003 — Page 138

FINANCIAL AND MONETARY AFFAIRS

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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

The Hong Kong dollar exchange rate stayed close to the linked rate of 7.80 during the first three quarters of 2003, but strengthened markedly to 7.70 in early October before easing to 7.7631 at the end of 2003. In response to banks' bids, the HKMA has sold a cumulative $31.9 billion of Hong Kong dollars since late September 2003. The notable strengthening of the Hong Kong dollar reflects improved prospects of the economy, the US dollar weakness, and the international pressure for the renminbi to appreciate.

Hong Kong dollar interest rates were on a downtrend during the year, with a brief increase in April-May on worries about the negative impact of the SARS outbreak. Domestic interest rates have dropped below the US dollar counterparts since August 2003. In terms of one-month money, Hong Kong dollar interbank interest rate (HIBOR) closed the year at 0.07 per cent, 99 basis points below the corresponding euro-dollar rate, owing in part to a larger Aggregate Balance. The best lending rate quoted by major banks in Hong Kong was unchanged at 5.0 per cent during the year, while the savings deposit rate quoted by major banks dropped marginally from 0.03 per cent to 0.01 per cent.

The yields on Exchange Fund paper largely followed those on US Treasuries, with 7-year and 10-year Notes closing the year at 3.73 and 4.37 per cent respectively. The yield curves of Exchange Fund papers steepened during the year, mainly reflecting decreases in short term interest rates. The yield differentials between the Exchange Fund Notes and US Treasuries decreased during the year, to -50 basis points and 12 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 weakening of the US dollar against other major international currencies, the EERI decreased from 102 at the end of 2002 to 99 at the end of 2003.

Growth of Hong Kong dollar narrow money (HK$M1) and broad money (HK$M3) accelerated notably from mid-2003. Narrow money (seasonally adjusted) increased by 35.8 per cent during the year, while broad money rose by 5.9 per cent. The brisk growth of narrow money was attributable in part to a low opportunity cost of holding non-interest bearing monetary assets as well as a significant rebound in stock market activity in the second half of 2003. The pick-up in growth of broad money reflected a revival in economic activity although it was still restrained by record-low deposit rates. For example, the estimated return on broad money, which is a weighted average of the yields of its components, was close to zero, and much lower than yields on longer-term US Treasuries.

Loans for use in Hong Kong shrank for the third consecutive year by 1.4 per cent in 2003, as credit demand continued to be affected by sluggish private investment, the weak property market and slack in the labour market. Analysed by economic use, residential mortgage loans, and loans for building, construction, property development and investment fell further in 2003. In other sectors, outstanding credit card advances continued to decrease in 2003, although the rate of decline moderated