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Following is a question by the Hon James Tien and a written reply by the Financial Secretary, Mr John C Tsang, in the Legislative Council today (December 5):
Question:
According to the statistics published by the Hong Kong Monetary Authority in November this year, the total assets of the Exchange Fund (EF) increased from about HK$570 billion in 1997 when the Hong Kong Special Administrative Region was established to about HK$2,650 billion at the end of September 2012. In this connection, will the Government inform this Council:
(a) of the total assets, investment return and rate of return, the amount apportioned to the Government, placements by fiscal reserves as well as accumulated surplus of EF each year since 1997 (listed in table form); the sharing arrangements between the fiscal reserves and EF for investment returns since 1997, as well as the details of the changes in such arrangements;
(b) as the statutory objective of EF is to maintain the stability and integrity of Hong Kong's monetary and financial systems, whether the authorities have assessed if the existing level of the total assets of EF is sufficient for fulfilling such statutory objective; if the assessment result is in the affirmative, of the details; if the assessment result is in the negative, the reasons for that;
(c) whether it knows if overseas governments or international financial institutions have set benchmarks for the appropriate levels of foreign exchange assets; if they have, of such benchmarks and how these benchmarks compare with those of Hong Kong; if it does not know, whether it will conduct such a study;
(d) whether it has assessed if it is feasible to maintain the total assets of EF at the current level and transfer all the investment returns earned each year to the Treasury for the purposes of improving people's livelihood and development; if the assessment result is in the affirmative, how the authorities will implement this measure; if the assessment result is in the negative, of the reasons for that;
(e) whether it knows how the investment performance of EF compares with those of similar funds managed by overseas governmental institutions; whether the authorities will make reference to the models adopted by overseas sovereign wealth funds in managing their reserve assets, so as to secure higher investment income on the premise of ensuring adequate liquidity for maintaining monetary and financial stability; and
(f) given that there are comments that the prices of the United States (US) Treasuries will drop once the US interest rates increase, and EF's assets may thus suffer investment losses, how the authorities tackle such risks?
Reply:
President,
My reply is as follows:
(a) The Government began to transfer its fiscal reserves to the Exchange Fund (EF) in 1976. Prior to April 1, 1998, the fiscal reserves were placed as deposits with the EF and received interest according to market rates. During the period from April 1, 1998 to March 31, 2007, the fiscal reserves were paid an annual return as achieved by the entire EF in the year concerned.
In order to stablise the investment return for the Government, starting from April 1, 2007, return of the fiscal reserves placed with the EF is calculated based on the average annual rate of return of the EF's Investment Portfolio for the past six years, or the average annual yield of three-year Exchange Fund Notes for the previous year subject to a minimum of 0%, whichever is higher.
The financial data of the EF is set out at Annex.
(b) The total assets of the EF stood at HK$2,612.3 billion at the end of October 2012. In October 2012, Hong Kong's Monetary Base amounted to HK$1,113.0 billion, which is part of the EF's liabilities.
The size of the Monetary Base is directly affected by the flow of funds into and out of the Hong Kong dollar. Since the outbreak of the global financial crisis in 2008, inflow of funds into the Hong Kong dollar during Q4 2008 and 2009 amounted to over HK$640 billion, resulting in a significant increase in the Monetary Base. However, should the current environment of abundant liquidity and exceptionally low interest rate begin to reverse, these funds might leave the Hong Kong market within a very short period of time, leading to a contraction in the Monetary Base and a reduction in the total assets of the EF.
The fiscal reserves of the HKSAR Government (approximately HK$635 billion) and placements by other government funds and statutory bodies (approximately HK$150 billion) make up another major portion of the EF's liabilities. These funds are only placements with the EF and the total assets of the EF will decrease alongside drawdowns by the Government and the relevant statutory bodies. The Accumulated Surplus, which is the EF's investment income accumulated over the years, is the only item that is not affected by changes in the components of EF's liabilities.
Although the EF assets have recorded significant increases in the past ten years or so, we should note that the size of Hong Kong's banking system as well as the financial markets have also experienced rapid growth during the same period. For instance, the total assets of the banking system have doubled from HK$6.7 trillion in 2000 to HK$14.2 trillion while the capitalisation of the stock market has also grown by several times from HK$4.9 trillion to the current HK$20.4 trillion. The larger the financial system is, the more sizable EF would be required to support government measures to maintain stability of the banking and financial systems of Hong Kong in the event of a global financial crisis.
The EF must hold sufficient liquid foreign currency assets predominantly denominated in the US dollar that can be readily available and deployed when necessary. As a small and open economy, Hong Kong will not be immune to shocks in the global financial markets even though we have a robust financial system. Amid the current highly uncertain global macro financial and economic environment, it is difficult to predict whether or not and, if so, when the next global financial crisis will occur, and the amount of liquidity we will need when that happens. Therefore, the confidence of financial market participants, including the rating agencies, in the resilience of Hong Kong's financial system will be very much dependent on the EF.
(c) Some international organisations have conducted researches on the appropriate level of official foreign exchange reserves and put forward some reference indicators, such as short-term debt, gross domestic products, imports and money supply. However, these researches mainly targeted the developing and low-income countries and aimed at advising these countries to avoid imbalances in their international balance of payments. Therefore, the research outcomes may not be applicable to open economies.
In reality, the appropriate level of foreign currency reserves for an economy depends on various factors, including the objective as well as the costs and benefits of holding foreign currency reserves. There is no single benchmark or criterion to assess whether the foreign currency reserves of different economies are adequate or not. For small and open economies such as Hong Kong and Singapore, they are vulnerable to the large and rapid flows of international capital into and out of their economies. As a result, such economies will have to maintain a high level of foreign currency reserves so as to deal with unpredictable financial crisis and maintain market confidence.
(d) The statutory objective of the EF is to maintain stability in the exchange value of the Hong Kong dollar as well as the stability of Hong Kong's financial system. Any proposal to reduce the total assets of the EF might send a wrong signal to the market. While Hong Kong has a robust financial system, its size is growing rapidly. Also considering the very volatile international financial markets and the highly uncertain global economic outlook, it is of utmost importance to maintain the size and robustness of the EF in order to ensure monetary and financial stability in the event of external shocks.
The Government's fiscal reserves are placed with the EF and the investment return on fiscal reserves is part of Government revenue and used for meeting the expenditure of various public services.
(e) The main objective of the EF is to affect the exchange value of the Hong Kong dollar directly or indirectly. Reserve assets managed by the EF must be readily available to the monetary authority for maintaining monetary and financial stability. Therefore, the main investment objective of the EF is to maintain high liquidity and preserve capital. On the contrary, overseas funds managed by government institutions, in particular sovereign wealth funds, are not required to meet short-term liquidity needs. Their investment objective is to maximise return over a relatively longer time horizon. Since the investment objectives and strategies of the EF are different from other investment funds, it is inappropriate to directly compare the investment performance of the EF with other government managed funds.
A more appropriate approach to assess the performance of the EF is to refer to its long-term investment performance in terms of its ability to maintain adequate liquidity, and to preserve its capital and purchasing power.
The EF began to diversify its investment in order to enhance medium- and long-term return in 2008 while ensuring adequate liquidity for maintaining monetary and financial stability. The new asset classes being invested include emerging market bonds and equities, private equity, real estate and renminbi assets. As at the end of September 2012, total investment in these new asset classes amounted to HK$131 billion while funds committed but not yet invested amounted to HK$69.5 billion.
(f) The EF consists of the Backing Portfolio, which provides backing to the Monetary Base, and the Investment Portfolio. Under the Currency Board arrangement, we are required to provide full backing to the Monetary Base with US dollar assets. The Backing Portfolio holds high quality and highly liquid US dollar-denominated debt instruments, which are predominantly US treasuries. Most of the debt instruments in the Backing Portfolio are of short-term maturity and their prices are relatively less affected by changes in market interest rates.
Although the Investment Portfolio has more diversified asset classes than the Backing Portfolio, it has to maintain a high level of security and liquidity so as to provide sufficient resources that will enable the EF to fulfil its statutory objective of maintaining monetary and financial stability. The Hong Kong Monetary Authority (HKMA) will regularly review market developments and adjust our investment strategies to minimise market risk.
As mentioned earlier, in order to manage risks more effectively and increase medium- and long-term investment return, the HKMA has begun to diversify part of the EF's assets into other asset classes in a cautious and incremental manner.
The HKMA will continue to closely monitor market developments and prudently manage the EF according to the investment objectives laid down by the Exchange Fund Advisory Committee.
Ends/Wednesday, December 5, 2012
Issued at HKT 15:29
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