ENG-2017 — Page 124

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Financial and Monetary Affairs

Monetary Situation

The HKD monetary situation was stable in 2017. The forex market operated in a smooth and orderly way. During the year, the HKD exchange rate eased and traded between HK$7.7542 and HK$7.8265 to US$1. The easing was driven by interest arbitrage activities amid widening negative gaps between HKD and USD interest rates as US monetary policy continued to normalise. This reflects the normal functioning of the Linked Exchange Rate System. The HKD exchange rate closed the year at HK$7.8137 to US$1. The Convertibility Undertaking was not triggered during the year.

The HKD money market also operated in a smooth and orderly manner in 2017. Average daily turnover of HKD interbank transactions was around $337.2 billion. Interbank liquidity remained ample, with short-dated interbank interest rates staying low, except for intermittent tightness due to several well-received IPOS in the second half of 2017. Longer-dated rates moved higher, largely following, but remaining below, their USD counterparts. Separately, the HKMA issued an additional $80 billion of Exchange Fund Bills to meet banks' strong demand. The additional issuances were well received and had little impact on local money market conditions. The issuances were made in strict accordance with currency board principles. During the year, there was little change of the monetary base, which stood at about $1.7 trillion at year end. The aggregate balance declined to about $180 billion and the outstanding amount of EFBNs in market value increased to $1,047 billion. Looking ahead, HKD interest rates are expected to rise gradually as US monetary conditions continue to normalise.

Exchange Fund

The 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 monetary and financial systems, with a view to maintaining Hong Kong as an international financial centre.

The HKMA is responsible to the Financial Secretary for the use and investment management of the Exchange Fund. The fund is managed as distinct portfolios to meet the objectives of preserving capital, fully backing the entire monetary base, providing liquidity to maintain financial and monetary stability and preserving the fund's long-term purchasing power. The Backing Portfolio holds highly liquid USD-denominated assets to fully back the monetary base. The Investment Portfolio aims to preserve the fund's long-term purchasing power.

The fund's asset allocation strategy is guided by an investment benchmark determined by the Financial Secretary in consultation with the EFAC. A Strategic Portfolio holds all HKEX shares acquired for strategic purposes by the Financial Secretary using the fund. To better manage risks and enhance returns in the medium and long term, the HKMA has been diversifying part of the fund's investment in a prudent and incremental manner into a wider variety of asset classes, including private equity and real estate investments.

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