The HK$1 trillion Exchange Fund may be hit hard this year by a significant investment loss because of weaker local share prices, Hong Kong Monetary Authority chief executive Joseph Yam Chi-kwong has warned. 'I would not be surprised if the Exchange Fund suffered an investment loss this year,' Mr Yam told legislators yesterday. 'This year's Exchange Fund investment income will definitely be lower than last year's, as last year's strong stock market performance is unlikely to be repeated.' Last year, 93 per cent of the Exchange Fund's investment income was derived from an increased market valuation of the Government's HK$200 billion share portfolio. This portfolio makes up about 20 per cent of the fund's assets. During the market intervention in August 1998, the Government bought about HK$118 billion worth of blue-chip shares in an effort to fend off local-currency speculators. Even after it unloaded more than HK$36 billion of the portfolio via the Tracker Fund last November, the portfolio was still worth about HK$200 billion. The strong investment in the stock market allowed the Exchange Fund to grow 10 per cent year on year last year to more than HK$1 trillion with an accumulated surplus of about 20 per cent and 10.8 per cent gross investment returns during the year. Mr Yam said bond prices were expected to drop this year due to interest rate rises in the United States. The Exchange Fund has invested nearly 80 per cent of its assets in bond securities. Legislator Eric Li Ka-cheung pointed out the Government would be hit hard by a large Exchange Fund investment loss, as it was counting on receiving a HK$20 billion interest payment from the fund this year. 'The Government received HK$36 billion from the fund in 1998 and HK$44 billion last year, which is more than what it got from the salary tax and the profit tax in those years,' Mr Li said. 'A possible loss in the Exchange Fund this year would thus bring in uncertainty about the Government's income.' Mr Yam admitted there was a strong link between the Exchange Fund's returns and the Government's income. Under an arrangement adopted in 1998, the Exchange Fund is to pay an annual interest payment to the Government based on its total investment returns. The Government has about HK$400 billion invested in the fund. Mr Yam did not elaborate, but the arrangement would effectively indicate the Government could have no interest payments from the Fund should it suffer an investment loss - a situation which has never occurred since the monetary authority was set up in 1993 to manage the Exchange Fund. A government source however added that according to the 1998 arrangement, the Government could require the Exchange Fund to pay a special dividend to it when necessary, so it could still receive income from the Exchange Fund when it suffered an investment loss. Before the arrangement started in April 1998, the rate of interest payable to the Government was linked to the rate paid by local banks on large deposits, which was usually only about 5 to 6 per cent a year.