ENG-2013 — Page 116

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Financial and Monetary Affairs

exchange market against the USD, at around $7.80 to US$1. This objective is achieved through the linked exchange rate system introduced in 1983.

The linked exchange rate system consists of currency board arrangements requiring the HKD monetary base to be at least 100 per cent backed by and changes in it to be 100 per cent matched by - corresponding changes in USD reserves held in the Exchange Fund at the fixed exchange rate of $7.80 to US$1. In Hong Kong, the monetary base includes the amount of currency notes and coins issued, the Aggregate Balance13, and the outstanding amount of EFBNs. Banks have unrestricted access to a Discount Window for overnight liquidity through repurchase agreements using EFBNs as collateral. Under the currency board system, HKD exchange rate stability is maintained through an interest rate adjustment mechanism. The expansion or contraction in the monetary base leads interest rates for the domestic currency to fall or rise, respectively, creating the monetary conditions that automatically counteract the original capital movements, ensuring stability of the exchange rate.

A Currency Board Sub-Committee under the Exchange Fund Advisory Committee (EFAC) oversees the operation of the currency board system in Hong Kong and recommends to the Financial Secretary through EFAC measures to enhance the robustness and effectiveness of Hong Kong's currency board arrangements.

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 arrangements under that system.

Monetary Situation

The HKD exchange rate traded within a tight range of 7.751 to 7.765 in 2013. The strong-side Convertibility Undertaking was not triggered during the year. A total of $92 billion worth of additional Exchange Fund Bills were issued from January to June 2013 to meet increased demand for such bills following the expansion of the Aggregate Balance in the last quarter of 2012 due to net inflows. As a result, the Aggregate Balance fell in the first half of 2013 to $163.9 billion at the end of June and stayed at this level until the end of 2013.

Interbank liquidity remained abundant during the year. The one-month HKD interbank offered rate eased slightly from 0.12 per cent at the beginning of 2013 to 0.09 per cent in mid-June, mainly reflecting a decline in the USD interbank interest rates. It then edged back up to 0.13 per cent by the end of 2013, partly due to active equity fund-raising activities during the year. Overall, the HKD money market and foreign exchange market continued to operate in an orderly and smooth manner in 2013.

Exchange Fund

The Exchange Fund's primary statutory role under the Exchange Fund Ordinance is to affect the exchange value of the HKD. It can also be used to maintain the stability and integrity of the

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Aggregate Balance is the sum of the clearing balances of banks held with the HKMA for the purpose of effecting the clearing and settlement of transactions between banks themselves and also between the HKMA and banks.

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