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Following is a transcript of the question-and-answer session given by the Chief Executive, Mr Tung Chee Hwa, at the International Institute for Strategic Studies/Financial Times Conference this (Thursday) morning:

Mr Tung: Thank you very much indeed. I am very pleased to be here, very honoured to be invited by the International Institute for Strategic Studies and the Financial Times to share with you some of my thoughts about Hong Kong. I think the IISS and FT's choice of time is just marvellous that not only it is right after the election but we are in the midst of financial turmoil in Asia of which Hong Kong is very badly affected. So I'll be very pleased to exchange views with you. I have thought about making a 20-minute speech. Then I decided that it is probably time better spent if I just answer your questions. You can probably ask a whole lot more things, with a whole lot of variety of issues you would like to cover. So before I close, I would say welcome you all for those who are from overseas. I hope apart from working very hard for two days, you will have time to enjoy this city, this really quite dynamic city. Thank you very much.

Mr John Ridding: I just wondered if you can give us some indication of how severe the economic downturn in Hong Kong is going to be and what are the implications for the exchange rate mechanism? There is some belief now that we are looking at a recession. Does that in any way change your view of the role of the currency system?

Mr Tung: John, we met only a few weeks ago and my views really have not changed. Firstly, that we are, in Hong Kong, in a period of structural adjustment that years of very high property prices, inflation close to 10%, a negative interest rate, rather higher wages than there should be, have created a bubble which needs to be corrected. The Asian financial turmoil accelerated this correction. We are in this very painful process right now and as I said, it could be prolonged. The economy will slow down and these are the facts.

But I think, if you ask me, I will tell you this, that the adjustment is a good thing for Hong Kong. Our property prices have corrected very substantially from its peak, and I think correction in other aspects will now begin and you will see unemployment rising but this is a necessary correction for us to move ahead and be competitive again and to regain our economic vitality.

There is always this question asked of me: Do you need to re-look at the linked exchange rate? The answer is no, because the linked exchange rate has served us well in the past, it will continue to serve us well in the future. But the adjustment which is now taking place, as a deflation adjustment, is very, very important.

I would also like to add that cost is important - we are going through an adjustment period - but competitiveness is not just about cost alone, especially, we are so involved in the service sector. Competitiveness is also about the rule of law, is about the right of people to speak their minds, is about a government which is accountable, which is clean, and is about people's safety on the streets. And these are areas in which Hong Kong has done very well, and we will keep it that way. But as a whole, I think after the adjustment period we will come out strong and fighting.

And let me say one more thing, that we are going to go through a difficult period and this may last one quarter, two quarters and it may last even a little bit longer, but our fundamentals are still there. We have a huge foreign exchange reserve, we have a huge fiscal reserve. And China is moving ahead, its economy continues to expand and we are moving under 'one country, two systems', and we can leverage on the 'one country, two systems'. So there are all these strengths there which is very fundamental for our future. So, yes, the adjustment is here. It will take a bit of time. It is going to be painful. But at the end of the day, we will come out stronger and better.

And if I may, John, just make one other point which is this, that John Ridding just mentioned about recession. And I hate to use that word because the economists' definition of recession is one thing, ordinary people's interpretation is one thing, so I just would like to say, yes, there will be a slow down in the economy, there might be negative growth in the first quarter. But whether this is a recession depends on how you frame your definition but I will say that the economy is definitely slowing down - slowing down very substantially.

Question: Mr Tung, you have talked about the need for asset prices to adjust but you have also spoken, in the past, of the government's interest in not having property prices fall too abruptly and I wonder how, perhaps, you could reconcile those two views, given that the property prices here are still the highest in the world from a foreign investor's point of view. The gap is widening as the Yen falls. And I wonder if you have an actual floor beyond which you would not like to see prices fall any longer.

Dr Gerald Segal (Director of Studies): Mr Tung, you have talked about the need for asset prices to adjust but you have also spoken, in the past, of the Government's interest in not having property prices fall too abruptly and I wonder how, perhaps, you could reconcile those two views, given that the property prices here are still the highest in the world from a foreign investor's point of view. The gap is widening as the Yen falls. And I wonder if you have an actual floor beyond which you would not like to see prices fall any longer.

Mr Tung: I have said that property prices were too high; the Government, really, would not want to see those very high property prices. Equally, I have said that property prices must be prevented from a total collapse because that would not be good for Hong Kong as a whole, and also for our banking system. Since the correction began some six months ago we have seen our property prices corrected very substantial. The residences for ordinary homes must have corrected about 35% - 40%. And office building values have come down very substantially, in some cases more than 50%. I think these corrections have been painful to many but they are necessary. I think, at the end of the day, after these corrections we will be much healthier and better.

Are these the right levels? I would say that they are pretty close to where they should be now and if we can get the stability back at this sort of level we would be very happy.

Mrs Noriko Hama (Mitsubishi Research Institute Inc): If I may ask a couple of very quick points. One, with regard to this issue of adjustment, you referred to a couple of quarters or perhaps longer. Do you see any elements which you see as requiring a more medium to longer term response as opposed to the immediate issues that you raised with regard to the adjustment of Hong Kong to the new situation if you like?

And the other point is, if you could actually for a brief moment cast your eyes on Japan and its adjustment problems, from your point of view how would you like to see Japan dealing with its, what I see to be very profound problems at this moment?

Mr Tung: Difficulties in Japan of course affect us all. Japan's difficulties, of course, are different from all the other nations who have problems in this region, such as Indonesia, Korea and Thailand, because Japan is the largest creditor nation in the world, so it has a different problem. Asia is going through a very difficult period and it is this sort of time when we want to see the Japanese, with such a strong base, to really come forward and - using an American term - bat for everybody else. But unfortunately, this has not been forthcoming. We have seen a substantial curtailment of activities of the Japanese banks which obviously have added to the problem of availability of credit here in Hong Kong and one of the issues we in Hong Kong are facing is the availability of credit and the fact that some of the Japanese banks - and not all - some of the Japanese banks withdrawing from Hong Kong really does not help us at all. And this is where I said I wish the Japanese banks or Japanese can come back and bat for everybody else because at the end of the day, a stronger Asia must be in the interests of Japan also. So we keep our fingers crossed. We hope Japan will soon be there and I know there has been a huge package of stimulus that has been announced. I think we need to give it time to work through - I hope it will work through - and we look to some future date when Japan will come and step in.

In the meantime, of course, the worry is that the Japanese Yen will get weaker and would that create another competitive round of devaluation in some of the Asian nations. I mean these are all the worries we have. There is still uncertainty surrounding us here in Hong Kong and these uncertainties somehow need to go away before we can talk about a real timetable for a full recovery. If you ask me, I have said a number of times that I think in Hong Kong our difficulty is going to be prolonged. It does not mean that we have quarter after quarter of negative growth but it is going to be a difficult period for us. And I hope you don't mind if I am not pinned down on a specific timetable because, honestly, I can't tell you.

Professor Dr Paul Dibb (Australian National University, Canberra): Mr Tung, I just heard you talk about the great uncertainty surrounding Hong Kong and we have just discussed the weakness of Japan. When you mentioned that you thought China was going ahead, clearly that is a central issue, not just for Hong Kong but for many other parts of the region. Within the constraints of our environment here, what are the downside risks of China not going ahead? Zhu Rongji and others at Davos and elsewhere have proclaimed that China is not going to devalue. And yet, as you know better than me, China faces enormous problems with its banking liquidity and with the transformation of the state-owned enterprises. Would you care to address that issue from your perspective?

Mr Tung: Yes, Paul, let me say this. The quality and strength of leadership of any nation is the ability to see far, to have a vision of what needs to be done and to be able to very honestly define the difficulties one faces and the corrective measures being taken. In the process, of course there will be risks and challenges but it is better to be up front, to be honest, to tell it as it is.

I think what China has done, the leadership in the Central Government has done, is to explain to everybody in China and around the world, what are the problems facing the country, what needs to be done, and I think it is very widely supported by the citizens.

And let me say a second thing, that if you look at China's macro economic management, its budget deficit as a percentage of GDP is less than one per cent; its national debt is less than 20% of GDP. These are really astounding numbers. So you have to look at the macro economic management of the country. Of course there are problems. But they are problems that the leadership openly admit and also tell you how they are going to tackle them, and that in itself is a very, very important point. There are other countries in this region that until the house is burning still refuse to admit there are problems.

Let me say one more thing. The first quarter's trade figures in China show there was a surplus in foreign trade of US$7.5 billion. I read the FT one day and it reported that China's foreign direct investment, inward direct investment, increased by 9.8%, by $8.7 billion. These are numbers which do not tell you there will be a depreciation of the currency.

Let me say one more thing. I could be wrong but I believe it is the Economist Magazine - is there an intelligence unit or something like that? There was a survey - I think it was that unit. The survey showed China's labour cost is still the second-lowest in Asia after Indonesia. So these are the numbers we have and I can't imagine China devaluing under these sort of circumstances. And I speak with a great deal of confidence and with a great deal of conviction because I just look at all these numbers. So when I say that Hong Kong will benefit from China's continued economic expansion, I believe in it. I think it is important to China. It is important to Hong Kong. I think it is important to the rest of Asia that China can continue to move forward well, and I believe they will.

Dr Robert James (President, Enterprise Asset Mgt Corp): With real estate values down, say, 40% and other businesses also having trouble, any government would have to decide whether to let the weak banks go under or assist them. So, what is likely to happen in Hong Kong, or more important probably, in the Mainland?

Mr Tung: I think insofar as Hong Kong is concerned, one of the good things about Hong Kong is that the Government's financial management is very prudent, very conservative, and this by and large applies to all the companies in Hong Kong. There are, of course, exceptions here and there. If you look at the balance sheets of all the big companies - very conservatively managed, the leverage is very low. And if you look at our banking system it is very tightly supervised, the capital adequacy ratio, all very, very good. The Basle, Bank for International Settlements (BIS) talked about 8% adequacy ratio. I mean we are not 10%, we are not 12%, we are not 14%, I think we are averaging 16%. So, no, Hong Kong is fine.

Mr Tung: Obviously, we need to watch out very carefully how much the property prices may fall because that may eventually have an impact on the banks. But we are comfortable, we are confident at this moment things are going well. Robert, I am sorry I can't really speak for China but I think from what I read in newspapers that China is very determined to reform the banking system, and they will.

Mr Martin Wolf (Asst Editor/Economics Commentator): Mr Tung, the people of Hong Kong, in the last election, seem to have indicated rather strongly a desire for democracy. Is this one that you can satisfy?

Mr Tung: I think we all want democracy. Democracy is not something which is unique to one political party or the monopoly of any particular nation. We all want democracy. People have come to me and congratulated me on how well we did on the election. I think we really did well. And some people have suggested to me: CH, I congratulate you but you know the turnout is so good because they don't like you or your policies. So I say, well, that's fine. Others have said the Government has issued these commemorative cards and that people voted because of the commemorative cards. I say, fine, that's fine too. There are other people who tell me that they voted because they want more democracy. That's fine too. And partly they may all be true.

But let me tell you one thing: people voted in Hong Kong because for the first time they were exercising their rights as citizens of Hong Kong, under 'one country, two systems', being masters of our own destiny, choosing political leaders. And that is what they were doing. There are a couple of polls in the newspaper which I hope you noticed, that people asked, "Why did you vote?" and the majority of the answers were: they were happy to exercise their responsibility as citizens of Hong Kong.

Speaker: The obvious follow-up which Martin Wolf no doubt might have made himself is, do you feel under any more pressure now than you might have done before to accelerate the otherwise stately approach towards full democratic franchise anticipated by the Basic Law which would not come before 2007, or do you feel that you can keep to that schedule?

Mr Tung: John, the straight answer is I do not feel any more pressure than before. We are doing the right thing for Hong Kong. We are moving forward in a very steady, very prudent manner, to ensure the long term continuous success of Hong Kong, and I believe we have the support of the people of Hong Kong.

Mrs Marta Dassu (Director, Centre of Political Studies, CESPI, Rome): Mr Tung, going back to the issue of China from another viewpoint, how do you see the prospects for China's accession to the WTO? And what could be the consequences, in your view, for China's industrial development strategy?

Mr Tung: I think we, from Hong Kong's point of view, very much hope for early admission of China in WTO. I know the discussion has been very tough and from my point of view it is not a question of whether China will join, it is a question of when. And I am sure that at the end of the day there will be agreement because China is too big an economy not to be part of the world trading system. But there will be some tough bargaining ahead and at the end of the day China will become a member, and I hope they will do it quickly. It will be good for China, it will be very good for Hong Kong, including, I am sure, for the industries in China.

Ambassador Linda Tsao Yang (Asia Development Bank, Manila): I think the timing of this conference is perfect, it came right after this massive popular exercise of their voting rights. What message do you think the voters are sending you, other than they want to take this opportunity to exercise their rights? And you want to run a government that is accountable to the will of the people, so from your reading, in what way do you think it might affect the policies of your administration?

Mr Tung: Linda, you know before I answer that, can I also just say this, that people equate democracy with universal suffrage and, yes, this is quite right. But let me say this, that democracy is also about the rule of law, about the right to organise political parties, about the right to speak one's mind, about making sure the Government is accountable, and it is about a whole lot of things. I have seen many countries where they have universal suffrage and nothing else and that does not work and you and I all know it. What we need to be doing over the next ten years is building and continuing to build to ensure all these institutions become stronger and stronger and our people can move forward proudly, as they will do, I am sure, for the time to come, in that particular direction.

Linda, you know I spend a greater part of the day meeting people from all walks of life. You would be surprised how many people I meet every day. You would be surprised how often I, without advance warning, go and visit the districts and talk to people on the street to understand what they feel and what they want from the Government. And there is a tremendous advisory committee network which the Government has set up - over 400 advisory committees. We are engaging people from all walks of life to understand what they want. We have the District Boards who tell us what they feel we need and we have the Legislative Council who, in addition to enacting laws and looking after and scrutinising public expenditure, they will be holding us accountable too. So as policies are formed we are looking at all these things, making sure that what we do is in the long term interests of people at large. And we will continue to do that.

Speaker: Mr Tung, I think I speak on behalf of everyone in this room. Thank you very much for the depth of the answers you have provided to questions, the wit with which you accompanied those replies, and your general grace on the occasional bits of pressure that were put on you to answer very complex economic or political questions. We are very pleased that you honoured your extremely generous pledge of 13 months ago to attend this conference, to help stimulate our own thinking. We are inspired to think through these issues by your remarks, over the next two days. We hope we can come up with ideas that are of general interest to your administration and to the people of this region. - If so, they might be reported even in the Financial Times. - Thank you very much for coming here.

End/Thursday, May 28, 1998

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