The Government will need to draw on its fiscal reserves to meet expenditures in the next few months, Monetary Authority Chief Executive Joseph Yam says, adding that the authority will make arrangements to fund these drawdowns in the most economical manner.

In his latest Viewpoint column on the authority's website, Mr Yam said the Government's spending will greatly exceed its revenue in the next few months even counting the $20 billion proceeds from the issue of government bonds.

"This means the Treasury will need to draw on the fiscal reserves deposited with the Exchange Fund," he said.

As the assets of the Exchange Fund are mostly foreign assets, the authority has to find the necessary Hong Kong dollars to fund the drawing down of fiscal reserves by the Treasury.

Various ways to find HK dollars

Mr Yam suggested two possible and less controversial ways to solve the problem - selling US dollars to raise the Hong Kong dollars required by the Treasury; and borrowing Hong Kong dollars from the market

Noting that both ways have been used, quite satisfactorily, in the past for this purpose, he said the choice between them is principally a matter of dollars and cents.

"Currently the investment return of the US dollar assets we are holding, for example US dollar deposits, is significantly higher than the cost of borrowing Hong Kong dollars. Hong Kong dollar interest rates in the interbank market are very low because of the large size of the Aggregate Balance.

"For overnight money, the interest rate is near zero, while we are earning over 1% for liquid US dollar assets. Our current strategy is therefore to borrow Hong Kong dollars in the interbank market to fund the drawdown of fiscal reserves while continuing to enjoy a higher return for those US dollar assets."

Authority to minimise the cost of borrowing

To maintain flexibility and minimise the cost of borrowing, the authority will tap the short end of the market while being careful in the management of the maturity mismatch.

If the cost of borrowing Hong Kong dollars is higher than the rate of return on the US dollar assets in the Exchange Fund, the preference will be to sell US dollars instead, Mr Yam noted.

Hong Kong's transparent activity in this area in the past few years - in which there have been substantial drawdowns of fiscal reserves due to the budget deficits - has led to such borrowings standing at around $44 billion at the end of 2003.