ENG-2007 — Page 136

or rise, respectively, creating the monetary conditions that automatically counteract the original capital movements, ensuring stability of the exchange rate.

In May 2005, the HKMA introduced three refinements to the operation of the linked exchange rate system: (a) the introduction with immediate effect of a strong- side 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 the Exchange Fund Advisory Committee 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. 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. 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 regularly.

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 remained stable in 2007 despite domestic and external shocks, demonstrating the resilience of the Linked Exchange Rate system. Activities in Hong Kong's foreign exchange and money markets were generally orderly and smooth, although there were increased volatility in exchange rates and interest rates in the latter half of 2007. Under the present monetary arrangements, the Convertibility Undertakings effectively limited the fluctuations of the Hong Kong dollar exchange rate within a narrow band, while the Discount Window borrowing mechanism dampened volatility of domestic interest rates in the face of different shocks.

Following the strengthening of the Hong Kong dollar to near the strong-side Convertibility Undertaking (CU), the HKMA conducted a monetary operation within the Convertibility Zone on October 23. Thereafter, licensed banks triggered the strong-side CU of 7.75 once on October 26 and five times on October 31, prompting the HKMA to passively sell Hong Kong dollars against US dollars at HK$7.75 to US$1.