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The One-way Convertibility Undertaking The absence of a formal Convertibility Undertaking on the strong side of the Link does not make the commitment to the Link any less firm. Nor does it affect the HKMA's ability to deliver on the monetary policy objective. As envisaged in my Viewpoint article published on 2 October 2003, the strengthening of the Hong Kong dollar in recent weeks has drawn comments again on the asymmetric manner in which we operate the Currency Board system. While there is the well known, formal Convertibility Undertaking for us to sell US dollars against the Hong Kong dollar clearing balances of licensed banks at the fixed exchange rate of 7.80, there is no formal Convertibility Undertaking on the strong side of the Link to buy US dollars. I doubt whether this rather technical aspect of monetary management in operating a Currency Board system in modern times is of interest to members of the community. I also doubt whether there is much concern in the community about a small deviation in the market exchange rate from 7.80, particularly when this reflects strength, rather than weakness, in the Hong Kong dollar. This is so even though the Hong Kong dollar is, for the great majority of the community, the currency used for day-to-day transactions and for denominating their pay and savings. What would be of concern to them, I believe, is the firmness of the policy objective to maintain the Linked Exchange Rate and the ability of the HKMA, as the agency tasked with the responsibility, to deliver that objective. This policy commitment remains as firm as ever, notwithstanding shifts in market sentiment, which are rather unpredictable and not necessarily based on economic fundamentals. On this occasion, the recent weakness of the US dollar and the international political pressure being put on the Mainland authorities to introduce greater flexibility in the determination of the exchange rate for the renminbi were the main reasons for the sudden shift. Neither of these two factors has any bearing on our policy commitment. The renminbi will remain stable. As Premier Wen eloquently pointed out, while in Bali for the ASEAN Summit meeting, a stable renminbi exchange rate is helpful to the stability and development not only of the Mainland economy but of the regional and global economy as well. And the weakness of the US dollar is a welcome development for Hong Kong, given the opportunity of further enhancing our competitiveness and given the significant deflation that Hong Kong is still experiencing. As to the ability of the HKMA in delivering exchange rate stability, I invite those who may still have doubts to examine our track record and take a considered view. They may also wish to note that, technically speaking, it is a lot easier to defend the fixed exchange rate of a currency when there is a tendency for the currency to strengthen rather than to weaken. And for those with academic, pecuniary or other interests in the subject, they may wish to note that there is no limit on our ability to create Hong Kong dollar base money, or more precisely the clearing balance of the banking system, as long as there is a continuous inflow of funds. And there is nothing to stop us from enforcing a disincentive against the holding of large clearing balances by banks. The fact that we pay no interest on the clearing balances of banks is already a disincentive, as banks do not get any return on those assets. But that disincentive can be made a lot more significant, should there be a need to do so, by our imposing a charge on large balances held in clearing accounts that is punitive enough for individual banks not to hold on to those balances. And the only way, for the banking system as a whole, to get rid of the large aggregate clearing balance is to sell Hong Kong dollars back to us, at 7.80 to the US dollar - the level of the exchange rate at which the Convertibility Undertaking kicks in. It should, however, be noted that such a decision would only be taken in extreme or exceptional circumstances. These are the rules of the game that have been laid down clearly for a long time and I hope a more general understanding of them will obviate the need for us to take those unusual steps. I am sure, however, that there will still be those who continue to feel unhappy, for whatever reason, about the asymmetry of our Currency Board system, as reflected in the one-way Convertibility Undertaking. I would recommend that they re-examine the published records of discussion of the meetings of the Sub-Committee on Currency Board Operations of the Exchange Fund Advisory Committee held on 8 October 1999 and 5 July 2000. Members of the public, however, may not want to bother themselves with all these technicalities. I wish to assure them that in Hong Kong we do have a robust system that ensures exchange rate stability and I thank them for their confidence in the Linked Exchange Rate system over the past twenty years. What they are hearing now is market noise. What they are seeing now is a mere blip in the market. Things may not have turned out well for a few market participants, but all is well on the monetary front for Hong Kong.
Joseph Yam 16 October 2003
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