No one thought that it should be abandoned. And we have received a few suggestions on how we should improve upon the operation of our system. We welcome these discussions which have sharpened our own thinking in the process of debate and analysis. Whilst one or two of these idea may have some psychological but possibly only short term value, they also carry considerable downside risks of undermining confidence in a well tried system. I am also pleased to say, therefore, that we have indeed been quite thorough in our monetary reform in the past ten years. (a) Role of interest rates 36. One school of thought promoted by a group of academics in Hong Kong with specific proposals for various schemes, which I must confess I have found difficult to appreciate, seems to be based on the notion that one could maintain stability in both the exchange rate and the interest rates at the same time. No matter how these schemes are dressed up, involving insurance products, guarantees, options or other fancy derivatives of one type or another, I fear that they have very little likelihood of success. Keeping interest rates artificially down when there is capital outflow amounts to providing cheap funding to those who are shorting the currency. It requires massive intervention in the forward market or a contingent commitment of foreign reserves that even those with very large foreign reserves would find the situation difficult to hold.
This situation was rectified in 1988 through the so-called Accounting Arrangements which required the Hongkong and Shanghai Banking Corporation Limited, as the Management Bank of the Clearing House of Hong Kong Association of Banks, to maintain a clearing account with the then Monetary Affairs Branch of Government for the account of the Exchange Fund. Thus the monetary base was only clearly defined then. The Accounting Arrangements were subsequently replaced by another arrangement, on the occasion of the introduction of Real Time Gross Settlement for interbank transactions in Hong Kong BIS Review 19/1998  -6any change in the monetary base has to be matched by a corresponding change in the amount of US dollar reserves held by the HKMA, and the change brought about by the HKMA rather passively converting Hong Kong dollars in the monetary base into US dollar reserves and vice versa at much the initiative of the banks. 19. The advantage of such a requirement is that whenever there is capital outflow, which would take the form of the sale by the banks of Hong Kong dollars to the HKMA for US dollars at the fixed exchange rate, there will, on settlement of the deals, be a shrinkage of the clearing balance of the banking system. This will lead to Hong Kong dollar interest rates in the interbank market increasing. The greater the outflow, the larger will be the fall in the clearing balance of the banking system and the higher will be the interest rates in the interbank market.