C H A P T E R 10 NEGATIVE INTEREST RATES A Comparison of the Hong Kong and Swiss Schemes January–February 1988 It was not only the contributors to AMM who worried about the performance of the restored currency board mechanism. The authorities were clearly troubled by some elements of the new system. Although broader performance measures of the economy such as economic growth and inflation were satisfactory, in the foreign exchange market the system was not producing an exchange rate that was either stable enough or close enough to the official HK$7.80 parity to be able to leave things entirely to market forces. In 1986–87, partly due to the variability of the spot rate for the HK$/US$ relative to the official parity, and partly due to persistent weakness of the US$, there were periodic, unsettling speculative flows into Hong Kong in anticipation of a possible upward revaluation of the currency. One response of the authorities was to prepare legislation that would deter such inflows by imposing negative interest rates — effectively charging customers for maintaining large HK$ deposits. In fact the measures were never implemented, but the fact that such legislation was put in place shows that the authorities were not prepared to take the risk that increasingly large inflows of capital could be dealt with by means of automatic adjustment via market forces. The mechanism needed supplementing. Two aspects of the negative interest rates scheme are interesting. First, the Swiss authorities had imposed a similar scheme when the Swiss franc had been under upward pressure in 1977–78, so AMM’s comparison of the two schemes is useful. It would appear from these two cases that small, open economies with sound monetary arrangements are vulnerable to unwelcome speculative inflows whenever the currency to which they are pegged experiences a prolonged episode of weakness. The implication is that there must be enough flexibility in the smaller economy to absorb such pressures if the inflows are not to be permanently disruptive. Second, this was an interim attempt to deal with some of the side-effects of speculative pressure on the HK$ before the introduction of the new “accounting arrangements” in July 1988 that gave the authorities more direct control over the money markets and more influence on the spot rate (whether it was stronger or weaker than the parity). As with some of the other steps along the way towards the 1998 reforms, the negative interest rate scheme was significant but ultimately of second-order importance in the restoration of credibility in Hong Kong’s currency board. 218 Hong Kong’s Link to the US Dollar A S I A N M O N E T A R Y M O N I T O R Vo l . 1 2 N o . 1 J a n u a r y – F e b r u a r y 1 9 8 8 1. NEGATIVE INTEREST RATES — THE HONG KONG SCHEME Concerned at the continued speculation on an upward revaluation of the Hong Kong dollar, the Hong Kong authorities have devised and announced a scheme to impose charges on certain credit balances at banks in Hong Kong. As announced so far the scheme has two parts: (i) a charge payable to the Exchange Fund on incremental balances (relative to a base date) of licensed banks on credit balances at the Clearing House, and (ii) a charge on customers’ credit balances at licensed banks in Hong Kong dollars. The first part of the scheme was announced on Saturday, December 19th 1987, by the Committee of the Hong Kong Association of Banks. A new rule known as the “Specified Rate Rule” was introduced “as to the conduct of the business of banking by the authority vested in the Laws of Hong Kong, the Hong Kong Association of Banks Ordinance Chapter 364 Part IV Para 12.” The press release went on to give the text of the new “specified rate rule” as follows: “1. In these supplementary rules expressions and terms which are defined in the rules relating to the Clearing House (dated 29th March 1982) as amended shall have the same meaning when used in these supplementary rules. 2. (a) Each settlement bank (including the management bank in its function as a settlement bank for the purposes of this rule) shall promptly on the business day following the completion of settlement for each day upon which the...
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