ENG-2006 — Page 126

98 | Financial and Monetary Affairs

Convertibility Undertaking by the HKMA to buy US dollars from licensed banks at $7.75; (b) the shifting of the existing weak-side Convertibility Undertaking by the HKMA to sell US dollars to licensed banks from $7.80 to $7.85; and (c) within the zone defined by the levels of the Convertibility Undertakings, the HKMA may choose to conduct market operations consistent with currency board principles.

To strengthen the institutional framework for the operation of the currency board system in Hong Kong, the Subcommittee on Currency Board Operations was established under 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 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

The Hong Kong dollar spot exchange rate moved between the central parity rate of 7.8 and the strong-side Convertibility Undertaking of 7.75 during the year, partly reflecting increased equity-related demand for Hong Kong dollar associated with the buoyant stock market. Within this range, the Hong Kong dollar traded around 7.75- 7.76 in the first four months of the year. From May to early October, it weakened gradually to 7.7946, owing to interest rate arbitrage activities taking advantage of the widening negative gaps between Hong Kong dollar interest rates and their US dollar counterparts.

Thereafter, the exchange rate strengthened towards the end of the year to close at 7.7763 on December 29, attributable to equity-related inflows. Despite the appreciating renminbi spot exchange rate, the Hong Kong dollar spot exchange rate seemed to have decoupled with the renminbi. The Hong Kong dollar foreign exchange market remained calm when the renminbi spot rate appreciated beyond 7.85 (the weak-side Convertibility Undertaking of the Hong Kong dollar). Overall, Hong Kong's foreign exchange market remained stable in 2006.

The overall exchange value of the Hong Kong dollar, measured by the trade- weighted effective exchange rate index, was mostly influenced by the exchange rate of the US dollar against other major currencies. Reflecting the weakening trend of