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1. What is the Linked Exchange Rate System (LERS)?

The LERS was adopted in Hong Kong in October 1983. The objective of the LERS is to maintain currency stability, defined as a stable external exchange value of the currency of Hong Kong – in terms of its exchange rate in the foreign exchange market against the US dollar (USD) – at around HK$7.80 to US$1.

The structure of the monetary system is characterised by currency board arrangements, requiring the Hong Kong dollar (HKD) monetary base to be at least 100 per cent backed by the USD reserves held in the Exchange Fund at the fixed exchange rate of HK$7.80 to US$1 and changes in the monetary base to be matched by corresponding changes in the USD reserves.

The HKD monetary base comprises the following components:

• certificates of indebtedness and government-issued notes and coins;
• the sum of balances in the clearing accounts maintained by licensed banks with the HKMA (i.e. the aggregate balance); and
• the outstanding amount of Exchange Fund bills and notes.

Under the currency board arrangements, the stability of the HKD exchange rate is maintained through an automatic interest rate adjustment mechanism.

Specifically, when there is a decrease in demand for HKD assets and the HKD exchange rate weakens to the weak-side convertibility rate of HK$7.85/US$, the HKMA will purchase HKD from banks in response to their demand, leading to a contraction of the monetary base.