ENG-2016 — Page 116

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Financial and Monetary Affairs

A Process Review Panel reviews the council's handling of cases to ensure its actions and decisions comply consistently with its internal guidelines and procedures.

Monetary Policy

The city's monetary policy objective is currency stability, defined as a stable external exchange value of the HKD, in terms of its exchange rate in the forex market against the USD, at around. HK$7.80 to US$1. This objective is achieved through the Linked Exchange Rate System introduced in 1983. The government is fully committed to maintaining this system, which is a cornerstone of Hong Kong's monetary and financial stability, and to the strict discipline of the system's currency board arrangements.

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The Linked Exchange Rate System is characterised by 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 the USD reserves held in the Exchange Fund at the fixed exchange rate of HK$7.80 to US$1. In Hong Kong, the monetary base includes the amount of currency notes and coins issued, the aggregate balance", 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 and the HKMA's commitment to honour the Convertibility Undertaking. In particular, the HKMA undertakes to buy USD from licensed banks at HK$7.75 to US$1 (strong-side Convertibility Undertaking) and sell USD at HK$7.85 to US$1 (weak-side Convertibility Undertaking). The expansion or contraction in the monetary base arising from these currency board operations leads interest rates for the domestic currency to fall or rise respectively, creating the monetary conditions that automatically counteract the original capital movements and ensuring exchange rate stability.

A Currency Board Sub-Committee under the Exchange Fund Advisory Committee (EFAC) oversees the Currency Board system and recommends to the Financial Secretary measures to enhance the robustness and effectiveness of the Currency Board arrangements.

Monetary Situation

In 2016, the HKD exchange rate remained largely stable although global financial market volatility increased against the backdrop of weaker global growth prospects, uncertainty over the pace of US interest rate normalisation and unexpected outcomes of major market events, such as the results of the Brexit referendum in Britain and the US presidential election. Following the US interest rate hike in December 2015, the widened interest rate spreads between the HKD and USD led to an easing in the HKD exchange rate in early 2016, which was later exacerbated by sell-offs in global stock markets amid investors' concerns about slowing growth on the Mainland as well as weakness in the RMB and other emerging market currencies. The HKD to USD exchange rate eased briefly to beyond 7.80 in late January. Thereafter, along with improvements in global risk sentiment, the HKD strengthened and stabilised at levels near 7.75,

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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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