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Following is the speech by the Financial Secretary, Mr Donald Tsang, at briefing for members of the Provisional Legislative Council and members-elect of the first Hong Kong Special Administrative Region Legislative Council today (Monday):

Honourable Members and Members-elect,

As the Chief Secretary for Administration just said, the Chief Executive in Council has earlier this afternoon endorsed the Hong Kong Special Administrative Region (HKSAR) Government to implement a package of special relief measures in respect of Hong Kong's economic adjustment. These measures underline the commitment of the Administration to help the community in the current economic adjustment. We understand the difficulties they face and will do all we can to help them tide over this difficult period. In a moment, I shall outline to you the details of the measures. Some of these measures are targeted at specific groups, others are more general. In many respects, these measures reflect the views of the political parties and the areas they consider to warrant priority attention. In drawing up these special measures, I have also taken into account the factor that the economic prospects of the next two quarters are likely to remain unfavourable. Each one of the measures is the result of very careful consideration after balancing the pros and cons. More importantly, all of them are intended to provide immediate relief, and are addressing the most pressing issues. Together with the expenditure programmes and revenue concessions in my 1998 Budget, they provide a complete package which would serve the long term interests of Hong Kong.

Present Situation

Our economy is experiencing a severe and abrupt downturn. The storm we now face may be stronger than one would expect. But this is not unanticipated. The 1998 Budget package which provides extensive expenditure and public investment programmes and unprecedented revenue concessions is my response to help Hong Kong to ride out the storm. The package of revenue measures that I put forward in the 1998 Budget will cost revenue $13.6 billion in 1998-99 and nearly $100 billion up to 2001-02. The total Government expenditure for 1998-99 amounts to $233 billion, an increase of 9.9% in real terms over that of the preceding year. This rate of growth is much higher than in previous years.

That level of Government expenditure reflects very major investment in physical infrastructure as well as our commitment in better housing for all, quality education and care for the elderly, in line with the Chief Executive's declared policy objectives. As a result of these initiatives, over 100 000 jobs will be created in the public and private sectors over the next 18 months. These initiatives are aimed at providing relief to the community, increasing confidence and enhancing Hong Kong's competitiveness. However, the positive effects of these measures will take some time to materialise.

After the announcement of the 1998 Budget, the Asian financial turmoil has settled for a while, giving the much shattered Asian economies some relief. However, in April and May, due to the weakening Japanese economy and the political instability in Indonesia, undue pressure was again put on the markets. Investors are worried about the contagion effect on Hong Kong and an easing in investment became evident. In June, the Japanese yen fell rapidly, leading to greater volatility in financial markets and interest rates. As much uncertainty still prevails in the region, it appears that there will continue to be some turbulence across the region.

Hong Kong is continuously subject to the effects of the financial turmoil in the region. Various sectors in the local economy have entered an adjustment stage since late last year. The over-heated economy and huge asset appreciation that dominated Hong Kong in the past two years have reversed. The correction in the stock and property markets has led to a major contraction in local consumer spending and unemployment increases. In addition, the volatility and high levels of interest rates and the uncertain business prospects have considerably constrained investment and business activities. As regards exports, because of the strong US dollar and the setback in many East Asian economies, demand for imported goods and services as well as tourism have all slackened. Inevitably, Hong Kong's exports to the region dropped significantly.

As a result, the GDP growth for the first quarter of 1998 registered a 2% negative growth. The quarterly adjusted unemployment rate up to end May recorded a high rate of 4.2%. In order to reduce the pressure on different trades and the community as a whole, I announced separately two series of relief measures on 29 May and 3 June. I expect these measures to produce their desired effects before long.

As the economy worsens and unemployment rises, assets further depreciate and economic prospects for the future are uncertain. People's worries and anxiety heighten. They expect the Government to do more to help them. Political parties put forward various proposals on cutting taxes and raising expenditure. I am fully aware of their sentiments and feel duty-bound to respond.

At the same time, I am fully conscious that in putting forward any expenditure or revenue measures, the Administration's first duty is to protect the long term interests of the Hong Kong SAR. We are one of the least devastated economies in the region. Investors watch closely the actions we take. If international credit agencies have any doubts about our commitment to prudent financial management, or about our economic future, and come to the conclusion that the risks of investing in Hong Kong have increased, they would lower the credit rating of our companies. As a result, these companies would be subject to a higher interest rate in their financing from banks. Should that happen, whatever measures taken by the SAR Government to improve liquidity and relief hardship would be offset.

Against the above, any decision we make must fulfil three important criteria. First, we must uphold the principle of prudent financial management. Secondly, we must maintain investors' and international organisations' confidence and interest in Hong Kong, as sustained foreign investment in Hong Kong will create the jobs we need. And thirdly, we must ensure no adverse impact on the linked exchange rate system. That is to say, I have to take into account the aspirations of the community and the requests of Members on one hand and be mindful of the long term impact on Hong Kong's economic development on the other. Of course, I must also take into consideration the less than promising economic outlook in the coming quarters against volatility and uncertainties in the regional context.

My colleagues and I have carefully considered all the views sent to us about reviving the economy. I should add that some of those were debated rather fiercely internally. The two meetings we had recently with representatives of the political parties have been extremely useful in increasing our understanding of the political parties' request. The special measures that I am going to announce today at this briefing are the SAR Government's comprehensive response to the six-point proposal put forward by Members following very thorough deliberations.

Targeted and Pragmatic Measures

We consider that the most pressing problems we now need to address are : credit and liquidity crunch, falling property prices, business and domestic costs and weakening confidence.

In finding ways to address these problems, we have to follow several important principles. First, we must avoid using artificial means that would obstruct the economic adjustment process. Hong Kong is already into that adjustment, with moderation in rental and wages through effective market mechanisms. I believe that this adjustment process, though painful, is needed and will bring about a positive impact. If we try to abate or interfere with market mechanisms, this would ultimately slow down our economic recovery and weaken Hong Kong's adaptability.

Secondly, we do not believe that we could solve all problems by throwing money at them. The community would not benefit unless we use public funds wisely. Specifically, the SAR Government will continue to invest in physical infrastructure. This will create the jobs we need in the coming few years. In the long term, they provide the facilities that our economic development will require. Take the case of capital works, we will move ahead with all the existing projects and commence as quickly as possible 68 new projects with funds allocated last year at an estimated total project cost of $70 billion. We expect to be able to fund an equal value of new capital works in this year's resource allocation. The investment is great. But the return will be greater. The approach we have adopted is entirely consistent with the request put to us by the political parties.

There is recently another exposition that the Government should put aside the budgetary principle of ensuring that Government expenditure will not grow faster than the trend growth of the economy and instead expand public services and increase recurrent spending to revive the economy. This is both dangerous and ineffectual. In those economies where the public sector accounts for a relatively higher portion of the gross national product, increased government spending would probably have the effect of stimulating the economy. But in Hong Kong, the public sector takes up less than 20% of the GDP. Significantly raising expenditure would not have the desired result of stimulating the economy. On the contrary, it would send a very wrong signal to investors and undermine Hong Kong's long term interests. So, while we are pushing ahead with our intensive capital investment programme in the public sector, we must at the same time avoid bloating the public service establishment, thus increasing the taxpayers' burden for all the years to come. Signs of profligate recurrent spending to enlarge the size of the public sector will scare away investors and the permanent jobs they will bring. And this is why I have repeated these key messages so often.

Hong Kong cannot spend its way out of an economic crisis. Unlike many other countries, our internal market is too small to sustain our much larger economy. Our recovery must depend on the revival of local and foreign investments, and increased commodity and service trade, particularly tourist trade. Such revival will in turn depend on the success of our adjustments to achieve lower costs and greater competitiveness all round. Hong Kong has experienced similar cyclical economic downturns in previous years. Every time we emerged successfully and in even better shape. This is largely the combined efforts of the Government, the industrial and commercial sectors and the community at large with the benefit of favourable external conditions. If everyone of us picks up our confidence and perform our best, we would be able to ride out the storm.

I have spent much time on what we should not do. Let me now turn to those measures which we will undertake and undertake immediately to provide the much needed relief.

The Specific Measures

A : Easing the Credit and Liquidity Crunch

Measure One : Exempt interest income earned locally from profits tax from today onwards

According to an analysis by the Hong Kong Monetary Authority (HKMA), the current round of credit crunch is rather severe as measured by a marked slowdown or even contraction in HK dollar deposits and domestic lending, a rapid slowdown in credit growth and rises in both nominal and real interest rates. A significant portion of the current credit crunch is attributable to Japanese banks' cutback in their local lending. But this credit tightening is also evident in European banks and local banks, which reversed the liberal credit policies they pursued last year in order to restore their liquidity position.

To provide additional liquidity to the banking system, we will fine-tune our profits tax regime to exempt from profits tax interest income accrued on or after 22 June 1998 from deposits placed locally with authorised institutions under the Banking Ordinance by corporations and individuals other than financial institutions. According to an informal survey by HKMA, Hong Kong corporations hold offshore deposits in US dollar and Hong Kong dollar of an estimated total of about HK$200 billion. We believe that these deposits are booked offshore to avoid profits tax liabilities in Hong Kong. Removing the tax disincentive would encourage corporations to repatriate these funds to Hong Kong. This would improve the liquidity and lending appetite of banks in Hong Kong.

Measure Two : Help SMEs to obtain loans from lending institutions

Whilst the credit crunch is affecting all companies, small and medium enterprises (SMEs) are particularly hard hit under a credit tightening policy by banks. Despite their credit worthiness, good track record and business prospects, some SMEs are unable to obtain loans from banks or have their credit line cut. With their relatively low start-up costs and greater adaptability to changing business environment, SMEs are a significant force in developing the economy and creating employment opportunities. If SMEs with good business prospects and credit record are constrained from expansion and investment because of the general tight liquidity in the banking system, the pace of economic revival would be slowed down.

It is our established policy to support SMEs which constitute about 98% of companies in Hong Kong. We have recently introduced a pilot Credit Guarantee Scheme (CGS) to help SMEs obtain finances from lending institutions by providing guarantees for their loans. However, the pilot CGS is confined to pre-export guarantee and its beneficiaries are therefore export companies.

In view of the current credit crunch faced by SMEs, we have decided to set up a new scheme modelled on the CGS to cover non-export-related SMEs to help them secure bank loans to meet genuine commercially viable business needs. We consider that the new Scheme should adhere to the same underlying principles as for the CGS, including leaving it to the lending institutions (not Government) to evaluate the credit worthiness of the company and its business, requiring an equal sharing of risks by Government and participating lending institutions and imposing an appropriate maximum limit per loan for risk control and to ensure SMEs would benefit.

To encourage lending institutions to participate, we will offer participating institutions in the new Scheme as well as the CGS the choice of obtaining the Government's share of finance upfront (i.e. 50% of the approved loan amount) or having the Government guarantee half of the approved loan amount. To create the necessary impact, we believe a sum of $2 billion would be required for the new Scheme.

B. Stabilising Property Prices

Measure Three : Suspend all land sales by auction or public tender for the remainder of the 1998-99 financial year and freeze PTGs for Sandwich Class Housing sites

Since the latter part of last year, property prices have dropped by about 40%. Moderation in an over-heated property market is in Hong Kong's long term interest. However, a drastic correction has hurt a lot of people and adversely affects other sectors of the economy. The banks are also put under exceptional pressure as a result of the depreciation of the assets they are holding against loans. We must not allow the situation to deteriorate. We have therefore considered it necessary to take decisive and responsive action to stabilise property prices. This will help to restore people's confidence.

In the current financial year, we have so far sold eight sites by auction or tender. According to the published tentative land sales programme, there are another 29 sites for auction and 26 sites for tender. Amongst these are residential sites which will produce some 30 000 flats. In addition, there are 26 sites being processed under Private Treaty Grants (PTG). These include six Airport Railway related land grants for commercial/residential purposes and another six sites for granting to the Housing Society for Sandwich Class Housing producing about 9 000 flats.

We have a clear and consistent message from the markets that because of the tight liquidity, some developers are viciously under-cutting each other in the prices of their properties being put on sale, in order to strengthen their cash position and to get rid of their stock as soon as possible before another major fall in prices. There is thus the likelihood of land being withdrawn from sale for lack of a taker in the market. Also, in a rapidly falling property market, an upset sale price reflecting the latest market sentiments is likely to be deflationary. Selling land "cheap" would further dampen market confidence. This would trigger the negative chain-reaction from banks, home-buyers, developers and other sectors of the economy, particularly consumption and employment.

Taking all factors into consideration, we have decided to suspend all auction or public tender of Government land from now till end March 1999. We will also stop processing the earmarked six PTGs to the Housing Society for development of Sandwich Class Housing (SCH). We will however continue with other PTGs including those relating to the Airport Railway, lease modifications and land exchanges where the initiative rests with the private owner. We believe that this measure would send a strong signal that the Government does not wish to see any further rapid decline in property prices. With improved market sentiments, we should expect a pick-up in the interest to buy as the potential demand is clearly there. Improved sales may encourage more developers to offer assistance to those who bought at the peak and require a second mortgage for completion. Revenue reduction in 1998-99 is estimated at $30 billion.

Measure Four : Increase the 1998-99 allocation for the $18 billion "Home Starter Loan Scheme" from $3.6 billion to $7.2 billion

In January 1998, Finance Committee approved a total commitment of $18 billion under the Loan Fund for the Housing Society to operate a "Home Starter Loan Scheme" for the next five years. The Scheme provides low interest loans of up to $600,000 or 30% of the purchase price of property, whichever is lower, for households earning no more than $70,000 a month which have not owned any residential property over the last ten years. The policy intention is to help first-time home buyers. As approved by Finance Committee, the Scheme can only draw down $3.6 billion every year which will benefit 6 000 households based on each applying for the maximum loan of $600,000. In this year's application, the Housing Society has received over 12 000 applications.

According to the current arrangements, no more applications can be entertained once the first annual instalment of $3.6 billion from the Loan Fund has been exhausted. Unsuccessful applicants will have to re-apply in next year's annual exercise. To allow potential first-time home buyers to take advantage of the current market conditions, we will seek Finance Committee's approval to double the number of beneficiaries under the "Home Starter Loan Scheme" (from 6 000 to 12 000) by increasing the first year drawdown from $3.6 billion to $7.2 billion. This measure does not involve additional expenditure but will have cash flow implications for 1998-99.

Measure Five : Housing Authority to increase the quota for its "Home Purchase Loan Scheme" from 4 500 to 10 000 in 1998-99

The Housing Authority will consider a proposal next month to significantly raise the quota for its "Home Purchase Loan Scheme" from 4 500 to 10 000 in 1998-99. The increase in quota of 5 500 together with the additional 6 000 households who will benefit under our plan to double the first year allocation to the "Home Starter Loan Scheme" will bring a significant new demand to the private sector, whether from new developments or the second-hand market.

C. Easing Costs of Families and Business

Measure Six : Reduce duty on diesel by 30% up to 31 March 1999

I now turn to the issue of diesel duty which for two consecutive years I have not been successful in persuading Members to support an inflation increase. Members will be familiar with the revenue and policy reasons supporting an increase in diesel duty which I explained at length in previous debates. Against that background, any reduction in duties as requested by Members is unacceptable to my mind. But it has been put to me, rather forcefully, that the present economic difficulty and its impact on the transport trade, particularly on taxis, would warrant an exceptional measure to provide some temporary relief.

With a duty of $2.89 per litre, the current retail price of diesel oil is $6.58 per litre. Fuel represents about 51% of the average monthly operating costs (excluding driver's wages) of a taxi and 35% of that of a public light bus. The contraction in consumer spending has affected the patronage of both, with taxis more hard hit. A significant reduction in diesel duty will reduce considerably the cost of business and provide some relief to drivers of the 18 000 taxis, and 4 300 public light buses. It will also significantly reduce the transportation costs of doing business as over 127 000 goods vehicles are currently diesel-driven. After much soul-searching, I have decided to reduce diesel duty from $2.89 per litre to $2 per litre from today till 31 March 1999. Revenue loss during 1998-99 is estimated at $450 million.

To provide immediate relief and in line with the established practice for duty measures announced in the Budget, we will implement the reduction with immediate effect under a Public Revenue Protection Ordinance issued today. We will later on introduce a LegCo resolution to amend the schedule to the Dutiable Commodities Ordinance to reduce the diesel duty rates to $2 per litre up to 31 March 1999. Let me repeat that this concession is valid till 31 March 1999 only because I stand by the principles that we should maintain the real value of the duties and the real effect of the policy measures.

Measure Seven : reduce declaration charge for imports from 0.035% to 0.025% and for domestic exports from 0.05% to 0.025% from 1 August 1998 onwards

The annual subvention provided by Government to the Trade Development Council (TDC) is equivalent to the net yield from the import and domestic export declaration charges, currently at 0.035% and 0.05% of value respectively. Pursuant to an agreement relating to the Hong Kong Convention & Exhibition Centre Extension, we will shortly commence formal discussions with the TDC with a view to reducing the annual subvention and opening the scope for reducing the declaration charges. Taking account of the TDC's projected income and expenditure and its healthy reserve of over $1 billion, we consider it feasible to reduce annual subvention by some $200 million. To pass on the benefits entirely to exporters and importers, this would translate into a declaration charge of 0.025% for both imports and domestic exports.

To ease business costs, we have decided to reduce both the import and domestic export declaration charges to 0.025% with effect from 1st August this year. This will be welcomed by importers and exporters. We believe that we should be able to persuade TDC to bear fully the loss of revenue, estimated at about $130 million in 1998-99. Because of its sound financial position, TDC should be able to continue to provide its existing level of services without any increase in its fees and charges after the reduction. We will formally obtain the agreement of TDC before seeking an amendment to the Import and Export (Registration) Regulation to put this into effect.

Measure Eight : to give a rebate of the first quarter of rates paid in 1998-99

All the above measures are targeted at particular groups. We consider it necessary to have a general relief measure which will benefit the greatest number of people. Given that Rates represent the most widely based source of revenue, affecting some 1.93 million domestic units and 0.34 million non-domestic units, we have decided to provide a rebate of one quarter Rates payment. This would mean returning some $3.88 billion to ratepayers, with an average of $540 for a public housing unit, $5,600 for a large domestic unit and $5,100 for a commercial unit. The rebate will be credited against the 1998-99 third quarter Rates bill of those who had paid Rates in respect of a certain tenement in the first quarter.

A quarterly rebate works out to be a 1.125% reduction in the overall Rates charge for one year, currently at 4.5%. This is even more generous than the 1% cut put forward by the political parties. A rebate will avoid tinkering yet further with the Rates percentages in 1998-99. The loss in Rates revenue to the two Councils is estimated at $1.5 billion for the Provisional Urban Council and $1.1 billion for the Provisional Regional Council. My colleagues in the Finance Bureau have met with the Chairmen of the two Councils and their initial reaction is that the Councils will not be able to live within the reduced Rates revenue. To ensure that we can effect this relief measure, which tops the priority list of relief measures put to us by the political parties, we have agreed to apply to Finance Committee of the Legislative Council for additional funds to make up for the Councils' loss in Rates revenue.

Effects of the Measures on the 1998-99 Budget

The measures we intend to take will have a direct and substantial impact on the budget surplus/deficit for 1998-99. Barring other deviations in revenue and expenditure in the course of the year, implementation of all the measures will turn the 1998-99 estimated outturn from an estimated surplus of $10.7 billion to a projected deficit of $21.4 billion. However, taking this with last year's surplus of $80.9 billion (which was $3.9 billion above the revised estimate of $77 billion in the 1998 Budget Speech and $49.2 billion higher than the surplus of $31.7 billion originally estimated in the 1997 Budget), a budget deficit of $21.4 billion in 1998-99 (which is less than 5% of the total budgeted revenue and expenditure), required to give a much needed relief to the economy shaken by unforeseen circumstances cannot be regarded as Government loosening its fiscal position or undermining its prudent financial management.

Conclusion

As Members will see, the measures we now put forward are intended to offer further relief to help Hong Kong people to ride out the storm after having thoroughly considered the present circumstances. As I have pointed out earlier, all these measures will have an immediate impact.

Some of you will recognise that many of the measures are in fact very close to the suggestions that you have given us in the last couple of weeks. This reflects how much we treasure Members' views. There are, however, some requests which the HKSAR Government cannot accede to, such as reducing fees and charges or delaying payment of provisional tax. We have already frozen all Government fees and charges for the year 1998-99. Any reduction would undermine the "user pays" principle. As regards salaries tax and profits tax, they are the subject of very significant concessions in my 1998 Budget. Before the effects of these major concessions kick in, it would be inappropriate to contemplate any further concession.

Moreover, by suggesting a delay in the payment of provisional tax, Members are merely deferring the payment liability to a subsequent year. As a result, taxpayers would end up with accumulative tax payments in one year. This would create a heavy burden on them and could hardly be regarded as an attractive proposition to solve the problems they are now facing. Members may wish to note that the Rates rebate, in monetary terms, works out to be a 1.125% reduction in the overall Rates charge for the year 1998-99. It provides relief and would not create problems for the future.

Overall speaking, I am hopeful that the measures we now introduce would effectively provide relief to the most pressing problems in the near term whilst not breaching our prudent financial management principle or raising doubts amongst international investors. The package in many areas reflect a consensus between the Government and Members. I am confident that they will be well received in the community. I look forward to Members' support when we submit the necessary legislative and funding proposals for Members' approval.

We are proud of Hong Kong's achievements over the years. The success of Hong Kong is the result of hard work of our people, but it is also in no small part due to our having an open and external-oriented economic system, benefiting overseas investment and trade. Such an economic system means that we cannot be isolated from regional and international conditions and are significantly affected by changes in the external environment. When the overall economic climate worsens, even economic systems much larger or relatively less open than ours would be adversely affected. Obviously, we cannot expect Hong Kong to turn the tide by its own efforts. This is a reality that we must accept.

According to our observations and analysis, the regional context will remain volatile and fraught with uncertainties in the foreseeable future. This is particularly so in the case of Japan. The special measures I announce today have therefore not only addressed the immediate difficulties, but have also taken into account what may be a more difficult situation to come. I have a duty to make it clear that against the important principles I have stressed, and the constraints underlying the management of our public finances, the SAR Government has completely exhausted its remaining capability in 1998-99 in both revenue and expenditure to come up with these special relief measures to address our economic difficulties. There is no more room for any new expenditure or revenue concession measures. In practice, it requires matching developments in various sectors to revive the economy. One cannot look to the Government to do so by introducing initiatives after initatives. These measures will not be able to shield Hong Kong from the impact of any further economic crisis in the entire Asian region.

Finally, because implementation of these measures has turned the 1998-99 Budget from a surplus to a deficit of over $20 billion, I feel obliged to share with you my view on this topic. As I have said on some public occasions previously, deficit budgeting is a means and not an end. A deficit budget should not be used as a political slogan. This would only cause serious damages to Hong Kong. However, ignoring the practical circumstances and steadfastly refusing to accept a deficit would be an unwise move against the current economic conditions. This year is a very exceptional year and it justifies exceptional treatment. Dipping into our reserves to provide the relief much needed by our economy and community is understandable. Also, if we take into account the surplus of over $80 billion in the immediately preceding year, the finances of the SAR Government are in extremely good shape.

Article 107 of the Basic Law stipulates that the SAR Government shall follow the principle of keeping expenditure within the limits of revenues in drawing up its budget, avoid deficits and keep the budget commensurate with the growth rate of its gross domestic product. These principles are what we have been practising for a long time and are the cornerstone of Hong Kong's success. The SAR Government will continue to follow the provisions in the Basic Law. We will practise prudent financial management while not ignoring what we should properly do in face of special circumstances. By so doing, we will be able to renew our strengths, enhance our competitiveness and reach higher goals in prosperity and stability into the next century.

End/ Monday, June 22, 1998

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