The shortage of Exchange Fund paper to aid smooth interbank real time gross settlement clearing shows the need for flexibility in its supply, Monetary Authority Chief Executive Joseph Yam says.

In his latest Viewpoint article published on the authority's website today, Mr Yam said demand for Exchange Fund paper remains unusually high, even in a relatively quiet period in the interbank market.

Noting banks may welcome a rise in the supply of Exchange Fund paper, Mr Yam said: "What we have to decide is whether we treat the intended increase in Exchange Fund paper as an internal transfer between different components of the Monetary Base, in which case no additional US dollars are required for backing purposes; or an increase in the Monetary Base, in which case there will need to be a corresponding increase in US-dollar backing.

"Given there is quite a lot in the Aggregate Balance at the moment, we prefer the former; in other words, an internal transfer between different components of the Monetary Base. This will be done by debiting the clearing accounts of the successful bidders at a special tender of Exchange Fund paper. The reduction in the Aggregate Balance should not have significant effects on interbank interest rates or the exchange rate."

In the unlikely event the interbank market tightens and the exchange rate strengthens significantly as a result, Mr Yam said these movements can be countered by using part or even all of the Hong Kong dollar proceeds of the special issue to purchase US dollars, thereby increasing the Aggregate Balance again.

He said the transferability of the Aggregate Balance into Exchange Fund paper makes a lot of sense, given Exchange Fund paper is already transferable into the Aggregate Balance through intra-day repurchase arrangements and end-of-day discounting through the Discount Window.