Hong Kong Monetary Authority
When Hong Kong revived the currency board arrangements in October
1983, it faced a financial world that was vastly different from that earlier in the century when currency boards flourished in British colonies and protectorates.1 Bank deposits had taken over currency notes as the predominant medium of exchange.
mobility had been significantly enhanced: large sums of money could be transferred across national borders within a fraction of a second. Moreover, following the demise of the Bretton Woods system, most major industrialised economies had floated their currencies, and sharp volatility was seen in the international foreign exchange market from time to time. Furthermore, indigenous banks had grown along with foreign banks, requiring more attention to issues such as the provision of support as a lender of last resort.
Hong Kong presents an interesting case study not only because it has a relatively long history in operating a modern-day currency board. The structure of the economy, characterised by a high degree of openness, complete absence of exchange controls, and sizeable financial flows, makes it particularly prone to challenges of the present-day financial system. Our experience in tackling these problems may be of relevance to other currency board economies.
The rest of the paper is organised as follows: the next section describes the circumstances under which the linked exchange rate system was adopted in 1983. This is followed in section III by a discussion of the reforms undertaken to strengthen the system from 1988 up to the period before the Asian financial turmoil in 1997. Section IV recounts salient aspects of our experience during the turmoil, while section V discusses further technical reforms to enhance the resilience of the monetary arrangements. Section VI turns to the economic adjustment process in the post-crisis
period, examining adjustments in the corporate sector, banking sector developments and fiscal policy. The final section highlights some of the challenges ahead.
LEADING TO THE ADOPTION OF THE LINKED EXCHANGE RATE
In the history of Hong Kong, a fixed exchange rate system has been a norm rather than an exception. This largely reflects the characteristics of Hong Kong as a highly externally-oriented economy, which desires a firm anchor for the external value of its currency.2 In this respect, Hong Kong differs from most other currency board economies that in recent years adopted the system as a strong commitment to halt hyper-inflation.
As seen in Table 1, the Hong Kong dollar floated for only nine years, from 1974 to 1983. The economy performed well in the early part of this period: it recovered speedily from the oil crisis, achieving impressive growth (of over 10%) with moderate inflation (of 4-6%) in 1976-78. However, signs of overheating emerged in late 1970s, fuelled by public construction projects and the booming property market. Growth of broad money supply and domestic loans escalated to average annual rates of 35% and 43% respectively between 1979 and 1982. Consumer inflation surged to over 15% in 1980-81, and the exchange rate of the Hong Kong dollar depreciated by over 20% during the period from 1979 to 1982 (Charts 1 & 2).
Before 1935, the Hong Kong dollar was based on the silver standard. It was only after the abandonment of the silver standard in China that the Hong Kong dollar was fixed against the pound sterling under the currency board arrangement. See also table 1. Visible and invisible trade accounted for about 300% of GDP in 2000.
Exchange Rate Regime
1863 – 4 November 1935
Silver dollars as legal tender
December 1935 – June 1972
Link to Sterling
£1 = HK$16
(December 1935 – November 1967)...