1. HONG KONG MONETARY AUTHORITY Briefing to the Legislative Council Panel on Financial Affairs 2 February 2004

2. 2 Review of 2003 Currency Banking Financial infrastructure Hong Kong as an international financial centre Exchange Fund PROGRESS IN KEY FUNCTIONS & RESPONSIBILITIES

3. 3 Monetary and banking stability notwithstanding heightened risks and volatility Investment return on Exchange Fund amounted to HK$89.6 billion Approval for personal RMB business in Hong Kong Euro Clearing System commenced operation Hong Kong’s credit rating upgraded to A1 Sharing of positive consumer credit data began REVIEW OF 2003

4. 4 CURRENCY STABILITY (1) Spot exchange rate (left) 1-month HK / US interest rate differential (right) 2001 1999 2000 1998 20032002

5. 5 CURRENCY STABILITY (2) Spot exchange rate

6. 6 12-month Hong Kong dollar forward points CURRENCY - MARKET EXPECTATIONS (1) 1998 1999 2000 2001 2002 2003

7. 7 CURRENCY - MARKET EXPECTATIONS (2) 12-month Hong Kong dollar forward points

8. 8 CURRENCY - MARKET EXPECTATIONS (3) 12-month Hong Kong dollar forward exchange rate

9. 9 CURRENCY BOARD RULES Aggregate Balance (crucial component of Monetary Base*) Interbank interest rates Capital inflow Capital outflow *The other components of the Monetary Base are banknotes and coins in circulation and Exchange Fund paper outstanding, the latter being convertible into the Aggregate Balance through the Discount Window.

10. 10 AGGREGATE BALANCE (1) Aggregate Balance brought onto the balance sheet of the Exchange Fund on the occasion of the introduction of RTGS Monetary reform through the introduction of the seven technical measures, including the Discount Window

11. 11 AGGREGATE BALANCE (2) Note: Figures on the Aggregate Balance are after Discount Window activities.

12. 12 POLICY OPTIONS (1) Continue to take US dollars passively and allow Aggregate Balance to increase, and wait for interest rate differential to reverse the inflow Enlarge interest rate differential by imposing a charge on large clearing balances of banks: negative interest rates Absorb large Aggregate Balance through issue of Exchange Fund paper: a transfer between different components of Monetary Base Introduce Convertibility Undertaking also on the strong side

13. 13 POLICY OPTIONS (2) Backing 364.6 assets Monetary Base*335.0 Certificates of Indebtedness151.1 Currency notes & coins 7.4 Exchange Fund paper123.9 Aggregate Balance 52.2 Currency Board Account (HK$ billion) AssetsLiabilities As of 21 January 2004 * Not equal to the sum of breakdown here because of exclusion of items such as interest payable on Exchange Fund Notes.

14. 14 NEGATIVE INTEREST RATES ? Aggregate 28.3 Balance HK dollar deposits 1,930.8 Demand deposits 226.9 Savings deposits936.3 Time deposits767.6 Balance Sheet of Banking System (HK$ billion) AssetsLiabilities As of 31 December 2003 *Based on an ad hoc survey in 2001, Hong Kong dollar time deposits of HK$0.5 million and above accounted for about 80% of the total value of Hong Kong dollar time deposits.

15. 15 External factors Global economic recovery Bottoming of interest rates External imbalances of the US Volatility in currency and equity markets Political pressure on RMB exchange rate Geopolitical issues CURRENCY - RISKS & VULNERABILITIES

16. 16 GLOBAL ECONOMIC OUTLOOK Source: Consensus Forecasts (January-2004) *Forecast by HKSAR Government in November 2003 200320042005 % yoy Mainland China8.98.37.6 US3.14.63.6 Eurozone0.51.82.1 Japan2.32.11.6 Hong Kong3.0*5.14.5 GDP growth forecasts

17. 17 US FED FUNDS TARGET RATE

18. 18 US CURRENT ACCOUNT DEFICIT

19. 19 EXCHANGE RATE VOLATILITY yen / US$ (left) US$ / euro (right, inverted scale) US$ depreciation

20. 20 EQUITY PRICES IN MAJOR MARKETS

21. 21 RENMINBI - MARKET EXPECTATIONS 12-month RMB non-deliverable forward points

22. 22 12-MONTH HONG KONG DOLLAR AND RENMINBI FORWARD EXCHANGE RATES RMB/US$ HK$/US$

23. 23 CURRENCY - RISKS & VULNERABILITIES Supportive factors Robust economic recovery Positive impact of policies facilitating economic integration with the Mainland Hong Kong’s strong external position Concerns and uncertainties Public finance Unemployment Deflation Possible re-emergence of SARS Domestic factors

24. 24 STRONG ECONOMIC RECOVERY (Seasonally adjusted quarter-on-quarter change)

25. 25 COMPETITIVENESS Note: * Constructed as the ratio of total wages of all employees to real GDP.

26. 26 BALANCE OF PAYMENTS ACCOUNT 2003 2000 2002 2001 Current account surplus

27. 27 FISCAL DRAWDOWNS Net quarterly changes in fiscal placement with the Exchange Fund 2000 2002 2001 2003

28. 28 LABOUR MARKET Note: * One-quarter lag.

29. 29 CONSUMER PRICE DEFLATION

30. 30 CONSUMER PRICE DEFLATION

31. 31 CONSUMER PRICE DEFLATION

32. 32 CONSUMER PRICE DEFLATION

33. 33 BANKING STABILITY - REVIEW OF 2003 Economic downturn Worsening problem of negative home equity Sluggish loan growth Increased diversification of banks’ business Increased popularity of electronic banking

34. 34 % BANKING SECTOR PERFORMANCE Capital adequacy ratio of all locally incorporated authorized institutions Period-end figures. There is a break in series at end-December 2001 owing to a change in the reporting population.

35. 35 Asset quality of Retail Banks Classified loans as % of total loans Net of specific provisions BANKING SECTOR PERFORMANCE Period-end figures.

36. 36 BANKING SECTOR PERFORMANCE Personal bankruptcy petitions (quarterly figures)

37. 37 There is a break in series at Q4 2001 owing to an increase in the number of surveyed institutions. BANKING SECTOR PERFORMANCE Credit card asset quality Charge-off ratio (%) Delinquency ratio (%)

38. 38 Period-end figures. There is a break in series at December 2000 owing to an increase in the number of surveyed institutions. Combined ratio is the sum of delinquency ratio and the rescheduled loan ratio. BANKING SECTOR PERFORMANCE Residential mortgage lending asset quality (%)

39. 39 Residential mortgage lending in negative equity Period-end figures. * Preliminary figures. # Separate data on secured and unsecured loan value as at end-Sep 2001 are not available. BANKING SECTOR PERFORMANCE

40. 40 BANKING SECTOR PERFORMANCE Volume growth for Retail Banks’ customer deposits and loans (year-on-year % growth) Month-end figures.

41. 41 BANKING SECTOR PERFORMANCE Net interest margin of Retail Banks

42. 42 WORK PROGRESS Deposit protection scheme –under the scrutiny of a Bills Committee Positive data sharing –banks have launched more products with interest rates based on individual customers’ creditworthiness Commercial credit reference agency –finalising operational details for implementation in second half of 2004

43. 43 New Capital Accord –preparing for implementation by end-2006 Fraudulent bank websites –stepping up surveillance and issue of circular and press statements to alert banks and the public ATM frauds –monitoring banks’ progress in upgrading the security safeguards of ATMs WORK PROGRESS

44. 44 Clearing and Settlement Systems Bill –Bills Committee is being formed New banknotes –new HK$20, HK$50 and HK$1000 banknotes to go into circulation in second half of 2004 FINANCIAL INFRASTRUCTURE FOR DOMESTIC FINANCIAL ACTIVITIES

45. 45 US$ RTGS Avg. daily value in 2003 : US$5.0 bn No. of Direct Participants : 67 No. of Indirect Participants : 160 Value (in million) Period Turnover of US Dollar / Euro RTGS Clearing Systems in Hong Kong (daily average) EUR RTGS Avg. daily value in 2003 : EUR0.8 bn No. of Direct Participants : 23 No. of Indirect Participants : 22 FINANCIAL INFRASTRUCTURE FOR INTERNATIONAL FINANCIAL ACTIVITIES

46. 46 Turnover of Cross-border Payment Linkages between Hong Kong and the Mainland (daily average) January 1998 One-way HKD joint cheque clearing with Shenzhen October 2000 One-way HKD joint cheque clearing with Guangdong December 2002 HKD RTGS link with Shenzhen November 2003 USD RTGS link with Shenzhen June 2002 Two-way HKD joint cheque clearing with Guangdong and Shenzhen FINANCIAL INFRASTRUCTURE FOR CROSS BORDER FINANCIAL ACTIVITIES

47. 47 RMB business in Hong Kong –RMB debit and credit cards issued by Mainland banks used in Hong Kong since 18 January 2004 –preparation of other types of RMB business on schedule and expected to be launched in phases Asian Bond Fund –local currency denominated ABF being studied Hong Kong’s credit rating –continuing discussions with rating agencies HONG KONG AS AN INTERNATIONAL FINANCIAL CENTRE

48. 48 EXCHANGE FUND - MARKETS IN 2003 Volatile markets: weak H1 but strong H2 Fluctuating bond yields Strong equity markets Exchange gains from the euro

49. 49 EXCHANGE FUND PERFORMANCE 200320022001 (HK$ billion) Gain / (Loss) on Hong Kong equities*21.2 (11.8)(27.1) Gain / (Loss) on other equities*26.8 (22.7)(3.3) Exchange gain / (loss)22.9 27.2 (13.0) Total return from bonds, etc 18.7 54.3 50.8 Investment income89.6 47.0 7.4 * including dividends

50. 50 EXCHANGE FUND CHANGE IN ACCUMULATED SURPLUS I 2003 I2002 (HK$ billion) Full year Q1 Q2 Q3 Q4 Full year Investment income89.6 6.7 41.1 8.4 33.4 47.0 Other income0.2 0.0 0.1 0.0 0.1 0.2 Interest and expenses(6.4) (1.4) (1.5) (1.3)(2.2)(7.0) Net investment income83.4 5.3 39.7 7.1 31.3 40.2 Treasury’s share(25.7)(2.1) (13.0) (2.0)(8.6)(15.6) Increase in EF Accumulated Surplus 57.7 3.2 26.7 5.1 22.7 24.6

51. 51 (HK$ billion)2003*2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 Investment income89.6 47.0 7.4 45.1 103.8 93.8 35.6 25.4 46.7 8.9 19.2 Other income 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.3 0.2 4.5 Interest and expenses(6.4) (7.0)(10.5)(11.0)(10.0)(16.0)(18.4)(12.9)(12.6)(8.2)(5.4) Net investment income/(loss)83.4 40.2 (2.9)34.3 94.0 78.0 17.4 12.7 34.4 0.9 18.3 Treasury’s share(25.7) (15.6)(1.6)(18.1)(45.4)(26.0)0.0 0.0 0.0 0.0 0.0 Increase/(Decrease) in EF Accumulated Surplus 57.7 24.6 (4.5)16.2 48.6 52.0 17.4 12.7 34.4 0.9 18.3 EXCHANGE FUND HISTORICAL CHANGE IN ACCUMULATED SURPLUS * unaudited figures for 2003

52. 52 EXCHANGE FUND ABRIDGED BALANCE SHEET (HK$ billion) 2003 2002 Change ASSETS Deposits60.151.58.6 Debt securities760.8764.8(4.0) Hong Kong equities71.250.920.3 Other equities99.463.136.3 Other assets19.724.8(5.1) Total assets1,011.2955.156.1 LIABILITIES AND ACCUMULATED SURPLUS Certificates of Indebtedness134.2118.515.7 Government-issued currency notes & coins in circulation6.35.90.4 Balance of the banking system28.30.5 27.8 Exchange Fund Bills and Notes123.5122.90.6 Placements by other HKSAR government funds252.3301.7(49.4) Other liabilities81.778.4 3.3 Total liabilities626.3627.9(1.6) Accumulated Surplus384.9327.257.7 Total liabilities and Accumulated Surplus1,011.2955.156.1

53. 53 EXCHANGE FUND PERFORMANCE AGAINST INVESTMENT BENCHMARK * Investment return computed in accordance with AIMR Global Investment Performance Standards

54. 54 INVESTMENT RETURN* OF THE EXCHANGE FUND # Hong Kong CPI-A at end-November 2003 * Investment return computed in accordance with AIMR Global Investment Performance Standards

55. 55 OUTLOOK FOR 2004 Uncertain and difficult environment: –where are interest rates heading? –where is the exchange value of US dollar heading? –where are equity markets heading?

56. 56 Briefing to the Legislative Council Panel on Financial Affairs 2 February 2004 HONG KONG MONETARY AUTHORITY