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Following is a question by the Hon Sin Chung-kai and an oral reply by the Financial Secretary, Mr Henry Tang, in the Legislative Council today (November 22):
Question:
Since 1 April 1998, the Government has, in calculating the annual investment income payable by the Exchange Fund ("EF") to the Government in respect of the fiscal reserves placed with EF, adopted the same rate of return as that achieved by the entire EF. Therefore, the investment income for the Government fluctuates with the performance of EF. On 13 September this year, the Government advised that: if we use the accumulated surplus of EF lightly, the ability of EF to resist attacks on the exchange rate of the Hong Kong dollar may be undermined. On the other hand, the International Monetary Fund ("IMF") mission to Hong Kong maintained its support for the Administration's commitment to the Linked Exchange Rate System in its statement of conclusions published at the end of last month. The mission, however, also pointed out that the Government should explore ways to stabilize investment income through arrangements with EF. In this connection, will the Government inform this Council whether:
(a) it has assessed if altering the method for calculating the investment income from the fiscal reserves will affect the ability of EF to resist attacks on the exchange rate of the Hong Kong dollar; if the assessment result is in the affirmative, of the rationale for that;
(b) it knows IMF's reasons for making the said recommendation; and
(c) it will accept IMF's recommendation on stabilizing investment income, such as drawing a fixed amount of money each year from the overall investment income of EF as government revenue; if it will not, of the reasons for that?
Reply:
Madam President,
(a) Article 113 of the Basic Law stipulates that the Exchange Fund (EF) is primarily for regulating the exchange value of the Hong Kong dollar. The Exchange Fund Ordinance (EFO) (Cap. 66) provides that EF should be used primarily for affecting, either directly or indirectly, the exchange value of the Hong Kong dollar, and then for ensuring the stability and integrity of the monetary and financial systems of Hong Kong with a view to maintaining Hong Kong as an international financial centre.
The Government has since 1976 deposited its fiscal reserves with EF in order to boost the financial position of EF for regulating the exchange value of the Hong Kong dollar. During the financial turmoil in 1998, we made use of over HK$110 billion of our exchange reserves to suppress the double-play carried out by hedge funds in the stock and exchange markets and subsequently expanded the monetary base to include over $100 billion of exchange fund papers, so as to reduce the volatility of the interest rate market. History has proved that the backing of sufficient resources from EF has helped ensure the stability of the monetary and financial markets in Hong Kong.
Although the Hong Kong economy has recovered, the number and size of hedge funds have increased significantly. Coupled with the existence of derivatives and their leverage, we cannot afford to lower our guard against the risks of international financial environment. Besides, with the market expectation that Renminbi would appreciate and a lack of direction for the global economy, together with the rapid and huge flow of international capital in Asia, it is definitely necessary for Hong Kong, as a small and open financial regime, to be well-prepared to face any potential financial risk.
In 1998, we decided to link the return of the fiscal reserves placed with EF to that achieved by the entire EF. In the past eight years, although the investment returns of EF have fluctuated in line with market performance, it has achieved an average annual return of 6.6%. This overall return is considered reasonable.
In considering methods for calculating the investment income for the fiscal reserves, one important principle is to avoid using the accumulated surplus of EF lightly. Otherwise, the asset base available for EF to withstand external attacks will be undermined. This would affect our ability to maintain the monetary and financial stability of Hong Kong.
(b) Based on the conclusions in its report published on 24 October 2006 and our understanding, the IMF Mission is concerned about the volatility of our income and our heavy dependence on investment and land income. The Mission suggests that, under the current revenue structure, significant fiscal reserves, possibly even higher than those already held, may be necessary to provide a sufficient buffer against the type of economic shocks seen over the past decade. The Mission considers the Government should explore ways to stabilise income and improve its revenue structure. Stabilizing investment income through arrangements with EF was one of the suggestions.
(c) We consider it necessary for EF to have sufficient resources for stabilizing the exchange value of the Hong Kong dollar when necessary. In the past 30 years, this objective has not changed. With the globalization of the financial market and the greater volume and volatility of international capital flows nowadays, we can say that this objective has become more important.
The Government will keep the income sharing arrangement with Exchange Fund under review. We will preserve the ability of EF to maintain the stability of the Hong Kong dollar and the monetary and financial systems in Hong Kong, and ensure that the fiscal reserves will secure a steady and reasonable rate of return. We will make appropriate announcement and explain to the community if there are changes to the sharing arrangement.
Ends/Wednesday, November 22, 2006
Issued at HKT 15:11
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