EF3461The Economies of Mainland China and Hong Kong Tutorial 7Hong Kong’s Bond Market City University of Hong Kong Dr. Isabel Yan
1. Should the Hong Kong Government Issue Bonds to Finance the Fiscal Deficits? • In the 2003-2004 budget speech, HK’s Financial Secretary Anthony Leung tried very best to balance the budget (e.g. he increased the standard rate of the salary tax from 15% to 16% and the profit tax from 16% to 17.5%). Are these all necessary? Should the HK Government issue Government Bonds to finance the fiscal deficits?
1.1 Background of Hong Kong’s Bond Market • In March 1990, the HK Government undertook new policies to enhance operations of the Exchange Fund by allowing it to issue Exchange Fund Bills and Notes . These bills and notes are used to facilitate the maintenance of the Linked Exchange Rate System of HK. These bills and notes also form part of HK’s domestic debt market. • Nevertheless, in the budget speech of the Financial Secretary on March 1989, he was very clear that the goal of issuing Exchange Fund Bills and Notes was NOT to finance fiscal deficits but to provide an instrument for carrying out the “open market operation” to maintain the linked exchange rate system: “Intervention [in the foreign exchange market] so far has taken the form of direct buying and selling of foreign currency, the same effect can beachieved through the buying and selling of HK dollar financial assets. …… [However], I must emphasized that the proceeds could not be used to finance fiscal deficits.”
Hong Kong has no restrictions on foreign companies issuing debt in either Hong Kong dollar or foreign currencies. • Hong Kong’s domestic debt market is predominantly composed of private sector issuance. The size of the debt market was HK$ 530.8 billion at March 2002, with private sector bonds accounting for 77% of the total.
Government HK Exchange Fund Bills <1 years • Types of Domestic Bonds in Hong Kong: (as at end of 2001) 113.7 HK Exchange Fund Notes 1-10 years Quasi-government Fixed Rate Note of: Mass Transit Railways (MTRC), Kowloon Canton Railways (KCRC), HK Mortgage Corporation (HKMC), Airport Authority (AA) 2-5 years 36.2 Bank/ Corporate Fixed Rate Bond/ Floating Rate Bond/ CD (e.g. Sun Hung Kai Properties, Hutchison Whampoa) Mainly 1-5 years, some >5 years 343.7 493.6
1.2 The Use of the Exchange Fund Bills/Notes to Affect the Monetary Base through the Open Market Operation • Open market operation:purchases and sales of government bonds in the open market by the Central Bank (or the Exchange Fund in the case of HK) to control the monetary base. • The mechanism behind the Exchange Fund Bills Market is straight forward. For instance, if there is an upward pressure on the exchange rate of HK$ in the market, the Exchange Fund can ease the upward pressure on the HK$ exchange rate by increasing the monetary base of HK$ in the market. This can be achieved through a buy back the Exchange Fund Bills/Notes. Such action will lead to a rise in the Balance of the banks held in the Exchange Fund and hence increases the liquidity in the market.
An increase in demand for HK$ Upward pressure on the exchange rate of HK$ The Exchange Fund can ease the upward pressure by increasing the monetary base in HK. This can be done through a buy back of the Exchange Fund Bill/Notes by the Exchange Fund from the market: Buy Exchange Fund Bills from Bank X Exchange Fund Bank X Assets Liabilities Assets Liabilities 2) Bank X’s HK$ Balance at the Exchange Fund 2) Bank X’s HK$ Balance at the Exchange Fund Increase the liquidity of the banking sector Capital Inflow 1) Exchange Fund Bills 1) Exchange Fund Bills
Advantages of Issuing Government Bonds 1. The Exchange Fund Bills/Notes provides an additional instrument for HK to carry out the open market operation and hence control the monetary base in HK 2. It gives the government an inter-temporal choice: the government can issue bonds now to provide funding for capital works project (e.g. building infrastructure). By doing so, the government is effectively borrowing resources from the future generation to increase the income generating capacity of the HK economy.The increase in the investment of the government can lead to the crowding in of private investment.
Disadvantages of Issuing Government Bonds 1. HK lacks a mature bond market
2. The interest costs will become an additional expenditure item of the government 3. High government debt will lower the credit rating of HK