Cross-Border Fund Flows and Hong Kong Banks' External Transactions vis-a-vis Mainland China

The paper explores what information on cross-border fund flows between Hong Kong and the Mainland can be extracted from existing statistics on banking transactions. As the stock of gross liabilities has been larger than claims since mid-1999, the Mainland remains a net supplier of funds (in terms of both Hong Kong dollar and foreign currency) to the banking system in Hong Kong. Hong Kong ran a current account surplus with the Mainland in the past few years, thereby contributing to a rise in claims by Hong Kong banks on the Mainland (or a decline in liabilities), assuming that all transactions are effected through the banking system. Separately, Hong Kong was a net investor in the Mainland in terms of direct investment and portfolio investment, implying an increase in liability of Hong Kong banks vis-a-vis the Mainland. Adjusting for the fund flows that were related to current account, direct and portfolio investment activities, Hong Kong banks maintained a net "residual" liability to the Mainland. This residual can be interpreted as unexplained fund flows between the two economies. It appears that placements of funds abroad by the Mainland arising from an accumulation of foreign exchange reserve was likely to be a key reason behind this. Although net Hong Kong dollar liabilities vis-a-vis the Mainland have remained a small proportion of total Hong Kong dollar funding of our banking system, they accounted for a significant part of the movements of the latter. This can be an important influence on local interest rates and hence monetary conditions.