The HKMA is finalizing the preliminary half-year accounts of the Exchange Fund. The results are not expected to be positive due to the weak market conditions. Bloomberg

Hong Kong's Exchange Fund - reserves backing the Hong Kong dollar - probably posted a loss in the first half, the Hong Kong Monetary Authority (HKMA) said yesterday.

"We have to take the rough with the smooth and shouldn't be surprised by short-term losses at times of high market volatility and uncertainty," Joseph Yam, head of the city's central bank, wrote in his weekly column yesterday.

The investment of the fund in Hong Kong equities may post a giant loss.

Yam said that a movement of 1 point in the Hang Seng Index (HSI) means a valuation gain or loss of between HK$6 million and HK$7 million for the Exchange Fund, and a loss of 1,000 points means a HK$6 billion to HK$7 billion loss for the fund.

Based on yesterday's closing of 21,821 points, the HSI has fallen nearly 6,000 points since the end of last year. That may translate to a loss of as much as HK$42 billion, according to Yam's estimations.

But he emphasized that the important thing is for the long-term performance of the Exchange Fund to be able to fulfill its primary purpose.

In 2007, the Exchange Fund posted a record gain of HK$142.2 billion, with about HK$55.8 billion coming from gains in Hong Kong equities. But the picture was totally different in the first quarter, when the fund posted a HK$14.6 billion loss.

Although Yam had told the Legislative Council in April that the gains in that month could offset the losses, the rebound in April was short-lived.

"A more-bearish sentiment has set in since April," he said in the column.

He cited recent press reports that the global equities markets - measured by the MSCI world equity index - will see their worst first-half decline in 26 years.

Analyzing the first-half equity markets, Yam said the Hong Kong market was concerned about two main factors contributing to the decline.

The first was the persistent tension in credit markets in the US and Europe, with financial institutions continuing to make large writedowns with consequential strains on liquidity and capital adequacy.

He noted that the second factor was the clearer determination of the mainland authorities to curb inflation, through stronger macro-economic controls, using both market and administrative means.

Global equities markets slumped in the first half, the stabilizing effect usually provided by the much-larger bond portfolio was not much help in the second quarter, Yam said.

"Bond prices reacted to the possibility that interest rates might start to increase again," he added.

(HK Edition 07/11/2008 page2)