In light of changed market conditions, there is now a case for introducing a strong-side convertibility undertaking for the Aggregate Balance in addition to the existing weak-side, the Exchange Fund Advisory Committee says.

Its sub-committee on Currency Board operation recently considered a paper re-examining the convertibility arrangements for the Aggregate Balance.

Members noted the Hong Kong dollar has been under strong-side pressures since late 2003. These are likely to persist as the Hong Kong dollar continues to be used as a vehicle for speculation on a revaluation of the yuan.

Taking into account recent experience, the sub-committee said there is room for strengthening the operations on the strong side of the Linked Exchange Rate.

It advised to introduce a strong-side convertibility undertaking for the Aggregate Balance in addition to the existing weak-side convertibility undertaking.

Symmetrically positioned

The two convertibility undertakings should be symmetrically positioned around the Linked Rate of 7.8, taking into account the monetary policy objective of achieving a stable external exchange value of the Hong Kong dollar at around $7.80 to US$1.

This would involve shifting the existing weak-side Convertibility Undertaking above 7.8. To address possible market concerns, the shift could be carried out in a gradual manner, members said.

The actual width between the two convertibility undertakings should be set having regard to the desire, on the one hand, to avoid excessive exchange rate volatility by imposing too great a width, and, on the other hand, to avoid displacing foreign exchange business involving the Hong Kong dollar by imposing too small a width.

Conducting market operations

Members said within the Convertibility Zone bounded by the two convertibility undertakings, it would be appropriate for the Monetary Authority to conduct market operations to promote the smooth functioning of the Linked Exchange Rate system.

These operations should be conducted in strict conformity with the following principles:

* both the stock and changes in the Monetary Base would be fully backed by foreign exchange reserves at the level of the Linked Exchange Rate; and,