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Money and Banking
FIN 243
Sec 1 (Group 1)
Challenges encountered and prospects
towards
Hong Kong Linked Exchange Rates System
Members Lists: Yip Sai Keung, Kenneth 053065
Liu Hoi Yan, Veronica 053140
Cheung Yiu Hong, Keith 053143
Yip To Chun, Kev 053148
Tsang Ka Ho 053155
Content
 Introduction
 The importance and mechanism of HKLERS
 The impact of Renminbi reform towards HKLERS
 Whether Renminbi, RMB replace the role of USD
 The future towards HKLERS
 Conclusion
 References
Introduction
 The linked exchange rate system (LERS) in Hong
Kong is a currency board system
 The monetary base can be divided into three parts
• (1) Certificates of Indebtedness and coins issued
• (2) The net balance of clearing accounts of the licensed
banks held with the Hong Kong Monetary Authority
(HKMA)
• (3) The outstanding amount of Exchange Fund Bills and
Notes
Introduction
 Hong Kong dollars (HKD)
is officially linked to the
US dollar at the rate of 7.8
HK dollars to one dollar
since 17 October 1983
HK Dollars to 1 USD in 2006
Average Rates
January
7.75351 HKD (21 days average)
February
7.7593 HKD (19 days average)
March
7.75909 HKD (23 days average)
April
7.75614 HKD (20 days average)
May
7.75393 HKD (23 days average)
June
7.76359 HKD (22 days average)
July
7.77341 HKD (20 days average)
August
September
October
7.7762 HKD (23 days average)
7.7823 HKD (21 days average)
7.78493 HKD (22 days average)
November
7.7818 HKD (22 days average)
December
7.77343 HKD (21 days average)
Introduction
 LERS plays an important part in supporting Hong
Kong’s role as a trading and financial center
 The resources of monetary base for backing up with
US dollars are kept in Hong Kong’s Exchange Fund
 LERS enables Hong Kong's economy to adjust to
external shocks without the damage and volatility of a
sudden currency collapse
The Mechanism of HKLERS
 A Currency Board Arrangement (CBA) to fix the
exchange rate at HK$7.8 per U.S. Dollar
 Banks must deliver to the Exchange Fund an amount
in U.S. dollars that is equivalent to the local currency
issued
 Keep the market rate in line with the linked rate
 Through an automatic interest rate adjustment
mechanism to make HKD Exchange Rate Stability
The Mechanism of HKLERS
 Automatic interest rate adjustment mechanism
Demand for HKD
↓
Demand for HKD ↑
Exchange Rate
↓
Exchange Rate ↑
HKMA purchase HKD from bank
Bank purchase HKD from HKMA
Monetary Base ↓
Monetary Base ↑
Interest rate (i) ↑
Interest rate (i) ↓
Exchange Rate Unchanged
Exchange Rate Unchanged
The Mechanism of HKLERS
E.R.
E.R.
S
S
$8.0
$7.8
$7.8
$7.6
D
0
D
0
The Automatic interest rate adjustment mechanism of
HKLERS
The Importance of HKLERS
 Improve external competitiveness of Hong Kong
 The monetary financing of fiscal policy bring no
effect to the exchange rate
 The highest ratio of foreign currency reserves all over
the world
 Hong Kong dollar exchange rate remained stable
facing several various shocks. (1997 Asian Financial
Crisis)
Impact of RMB reform towards HK LERS
 The reform of RMB exchange rates
mechanism on 21 July 2005
•
•
•
central government re-valuated the currency by
2% against the USD to 8.1100
un-pegged the Yuan from the US dollar
referred the Yuan to a basket of currencies
Impact of RMB reform towards HK LERS
 The impact towards
HK linked exchange
rates system
•
•
Raised a problem
whether pegging with
RMB or USD
Trade between China
and Hong Kong is
inevitable
Visible trade between Hong
Kong and the Mainland
Impact of RMB reform towards HK LERS
 External trade
•
•
•
HK$ ↓ → Import$ ↑ Export$ ↓
boost to economic growth
higher inflation
Impact of RMB reform towards HK LERS
 Hong Kong domestic exports to the
Mainland only 1.6% of Hong Kong's total
exports
•
•
Offset of re-export
The appreciation will be neutral for export
Imported inflation
•
•
seventy percents of Hong Kong's food is
imported from the Mainland
HK government need to minimize food price
volatility caused by factors
Impact of RMB reform towards HK LERS
 Gain in consumption market
•
•
Mainland tourists: purchasing power bolstered
Hong Kong consumers: become more inclined
to stay in the home market
Impact of RMB reform towards HK LERS
 Speculation about possible revaluation of
RMB
 Huge funds flows into HK last 2 years
 H-shares → options for investor gain
exposure to Mainland
Whether RMB replace the role of USD
RMB vs USD
Renminbi ’s viewpoints
 Mainland’s economy becomes one of the
largest in the world as the size of population
already rank first
 the fourth largest in terms of GDP since 2005
 the amount of foreign reserves ranks first
 economy currently growing around 10% a year
in real terms that is faster than many developed
economies
Renminbi ’s viewpoints
The GDP of China ranks the top three in 2006
Renminbi ’s viewpoints
China ranks first in the amount of foreign reserves
Renminbi ’s viewpoints
China economy grows faster than U.S.
Renminbi ’s viewpoints
 Economic and Financial integration factors
•
Mainland shocks explain over one third of
Hong Kong's price movements
 Mainland’s economy (stock market) affects HK
economy (stock market) but not so apparently
• the Hong Kong market tends to follow the
trends of mainland rather than the US in the
future, but not now
Renminbi ’s viewpoints
 the Mainland is developing into one of the major
economic powerhouses of the world
 strengthen its own ability and power
 make RMB becoming a vital reserve currency,
just like the role of US dollars in HK LERS
USD ’s viewpoints
 HK: small and highly open economy
it offers exchange rate stability > Hong Kong's
primary first choice
Enhance the trade and investment between HK
and other countries
overseas traders trade with HK without worrying
the fluctuation of exchange rate
 HK rate will always stay stable toward the USD

USD ’s viewpoints
 The most stable currencies in the world
 USA is the world largest financial and economic center
However..If Hong Kong LERS link to the RMB….
 overseas traders have less confidence to trade with HK
 most worry about the linked exchange rate in HK
 they afraid the chance of HKD being fluctuated all the
time
 RMB does not provide them a stable image till now
USD ’s viewpoints

The acceptance level
of USD is higher than
RMB all around the
world


most countries accept
USD more than RMB
USD has a stable rate
that do not have great
fluctuation so easy
Country
USD
RMB
France
80%
50%
Malaysia
75%
60%
Scotland
90%
60%
Indonesia
70%
65%
Mexico
70%
40%
Denmark
85%
40%
Brazil
65%
35%
Philippines
65%
50%
Japan
70%
80%
Russia
80%
50%
USD ’s viewpoints
 Developments in the US affecting both China and HK
 co-movements of business cycles
 60% of shocks in the US affect over 45% of the variations
in price changes in Hong Kong
 little correlation between the business cycles attributable to
domestic shocks in Hong Kong and the Mainland
 this data refutes the results that are in RMB’s viewpoints
USD ’s viewpoints
Foreign Exchange Reserves from 1995-2006
The future of linked exchange rates
system in Hong Kong
The future of linked exchange rates system
 Now, RMB appreciation brings out an effect to HK
linked exchange rates system
 RMB can respond on Hong Kong linked exchange
system in some different ways
• link a basket of currency with HKD
• only link with RMB and replace U.S dollar
• can all use RMB in Hong Kong > reduce the
transaction cost of currency exchange
The future of linked exchange rates system
 So RMB is the future trend of HK exchange system
development
 However, RMB still have many problems
• can’t freely exchange with other currencies
• since the economic development in China is not stable
• If the bubbles explode again, it can certainly affect HK’s
exchange system
• so suitable period to have changes for HK exchange rates
system should be considered carefully
The future of linked exchange rates system
China’s trade surplus and the US trade deficit
The future of linked exchange rates system
 In the foreseeable future,
•
•
the US remains the largest economy in the world
the USD is still the primary reserve currency
 As a result, RMB simply will not be able to replace
USD
 There is a comprehensive advantage of USD that still
exists
The future of linked exchange rates system
Exchange trends between RMB and USD in 2006
The future of linked exchange rate system
 Hong Kong needs to maintain its uniqueness
 to avoid being marginalized as well as to maintain
and leverage on our own advantages
 such as high degree of internationalization and
economic freedom
 so Hong Kong linked exchange rates system could
be a symbol of our characteristics:
Internationalization and Economic freedom
The future of linked exchange rate system
 HK will not have a great change between 2047
and even 2097
 Old : ‘one country, two systems’
 New : ‘one country, two currencies, two monetary
systems and two monetary authorities’
Conclusion
 Since LERS was established in 1983, it faced many challenges
and difficulties to now
 Because of reform and appreciation of RMB, starts to discuss
 “Should RMB replace the USD in Hong Kong ‘s linked
exchange rate system soon?”
Comparing the advantages and disadvantages between the
RMB and USD:
 Hong Kong should not change LERS in the foreseeable
several years
 It is workable after the RMB exchange rate system getting
mature and well developed all around the world
References
 http://www.yearbook.gov.hk/2003/english/chapter03/03_01.
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html
http://www.news.gov.hk/en/category/businessandfinance/060
921/html/060921en03004.htm
http://www.news.gov.hk/en/category/businessandfinance/061
130/html/061130en03013.htm
http://webpage.hssc.edu.hk/~hkcung/ExchangeRateSystems
http://www.newsobserver.com/business
http://www.xinhuanet.com/politics/
That’s the end
Thank you very much