OBJECTIVES

The overriding objective of Hong Kong’s monetary policy is currency stability. This is defined as a stable external exchange value of Hong Kong’s currency, in terms of its exchange rate in the foreign exchange market against the US dollar, at around HK$7.80 to US$1. The structure of the monetary system is characterised by Currency Board arrangements, requiring the Hong Kong dollar Monetary Base to be at least 100 per cent backed by US dollar reserves held in the Exchange Fund, and changes in the Monetary Base to be 100 per cent matched by corresponding changes in the US dollar reserves.

The Monetary Base comprises

• Certificates of Indebtedness, which provide full backing to the banknotes issued by the three note-issuing banks
• Government-issued notes and coins in circulation
• the Aggregate Balance, which is the sum of clearing account balances of banks kept with the HKMA
• Exchange Fund Bills and Notes issued by the HKMA on behalf of the Government.

The stability of the Hong Kong dollar exchange rate is maintained through an automatic interest-rate adjustment mechanism. When the demand for Hong Kong dollars decreases and the market exchange rate weakens to the weak-side convertibility rate of HK$7.85 per US dollar, the HKMA stands ready to purchase Hong Kong dollars from banks. The Aggregate Balance will then contract, driving up Hong Kong dollar interest rates to induce capital inflows to restore exchange-rate stability. On the other hand, if there is an increase in the demand for Hong Kong dollars and the market exchange rate strengthens to the strong-side convertibility rate of HK$7.75 per US dollar, the HKMA will sell Hong Kong dollars to banks for US dollars. The Aggregate Balance will expand to push down Hong Kong dollar interest rates, creating monetary conditions that counteract the original inflows.