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Following is the speech by the Financial Secretary, Mr Donald Tsang, at a lunch organised by the Hong Kong Economic and Trade Office Brussels and the Hong Kong Trade Development Council, The Hague, The Netherlands, today (Thursday, Hague time):

Distinguished guests, ladies and gentlemen.

Thank you for that warm welcome. I am very happy to be here in The Hague, a city synonymous with international law and justice. This is my first visit to The Netherlands for quite a few years and it is actually my first official visit as Financial Secretary. Back in the early-1990s my visits were a little more frequent because I was often in Geneva as our Chief Trade Negotiator for GATT and the WTO. It was a very interesting job and it was during that time that I came to really appreciate all that Europe has to offer - its fine cuisine and wines, its history, its diversity and also its unity.

It is also good to be here to give you all a first-hand account of the current economic turmoil in East Asia and how it is affecting Hong Kong. You will be reassured to know that the Dutch business community in Hong Kong is as determined as we are to ride out the current difficulties. I think it is fair to say that most Dutch businesses, most European businesses for that fact, take a long-term view of Hong Kong and of course, the fast-opening markets in China, which I am happy to say celebrates her 49th Anniversary today. These current difficulties also present us with opportunities. Within a few years you will see a new Asia emerge from this financial crisis and those companies and enterprises which are in Asia now - enterprises such as ABN Amro, Shell, KLM and Philips - will have that much of a head-start on the competition.

As you know, Hong Kong and the rest of East Asia has been hit by an economic crisis over the past year which is beginning to have far-reaching and severe consequences for the entire globe. And a global recession is a possibility if the current crisis can not be turned around. And for that to happen we need a concerted global effort.

To start with, the East Asian countries have to restore calm, confidence and order to their markets while they reform and rebuild their economies. This they are trying to do but it will be a slow process. To help them along they need the support, understanding - and investment - of our friends in Japan in Europe and America.

Together, we must take several steps. One is to devise a new set of international guidelines, or codes, which will facilitate smooth, sustainable growth rather than boom and bust cycles. Boom and bust cycles are, by nature, intrinsically destructive. Another is to formulate new rules and strategies to cope with the huge inflows and outflows of capital that are part and parcel of today's global trading and investment environment - indeed, this was part of the reason for European Monetary Union. If you cast your minds back six years ago you will remember that massive capital flows and divergent interest rates eventually led to the collapse of the ERM. So Europe has had a taste of the pain we are feeling in Asia where structural weakness, coupled with a sudden credit crunch devastated the economies of Indonesia, Malaysia, Thailand and South Korea. We must do something to prevent similar economic disasters.

We are not talking about a regionalised phenomenon. The US Federal Reserve chairman Alan Greenspan has cautioned that America can not to regard itself as "an oasis of prosperity unaffected by a world that is experiencing greatly increased stress". The Fed's interest rate cut on Tuesday is a sign that the pool of money within that American 'oasis' might just be starting to evaporate. Recent events in Russia will not only affect some European banks but have already impacted on Latin America, where four currencies have been devalued and stock prices are 30 to 50 per cent lower than at the beginning of the year. Brazil is facing a flight of capital which could lead to a devaluation. If this happens then Latin America will probably plunge into recession. This will of course affect the States because Latin America is the US's second-largest trading partner and US banks have significant exposures in Latin America - much higher than they do in Russia. And nobody quite knows just how much money LTCM has tied up in these emerging markets, so the US banking sector may be in for more shocks than it had originally foreseen.

In Europe, there are other factors coming into play. The introduction of the Euro may create additional pressures over the next few years as the European economies become more closely aligned. Interest rates, government spending, inflation will all come into play. So these are additional pressures in Europe which will probably impact on economic growth. Then there is the Japanese economy, which shows no signs of reviving. Asia will not fully recover until Japan starts prudently investing some of its massive reserves in the region to help floundering economies restructure huge debts or invest in new infrastructure.

We live in a global village and a sustained economic crisis of the magnitude now being experienced in East Asia - where the entire economies of not one, or two but four countries has collapsed - is affecting markets in the US and Europe. So, it is not just East Asia which is experiencing great turmoil and uncertainty. It is developed and developing nations the world over.

It is tiring just trying to keep up with the latest developments, let alone devise some magical economic formula which will balance all the books. I do not pretend to have all the answers. But I would like to share with you some of our experiences to give you a deeper understanding of the challenges in Hong Kong, how we are riding out the storm, and why it was necessary for us recently to take decisive action in our stock and money markets to stop the Hong Kong economy from imploding.

I will tackle the most controversial action first, and that is the Hong Kong SAR Government's decision to buy into the Hong Kong Stock Market in August. Our decision to buy stocks has split financial community opinion fair down the middle - the investment banks, hedge funds and the economic scholars see it is a betrayal of our free market policy; commercial lenders, long-term investors and the Hong Kong public see it as a pragmatic move to ensure that there is in fact still a market in which to freely invest. On the other hand, a comprehensive package of regulatory and structural changes which were released after the buy-in has been generally and widely accepted, and indeed welcomed.

Our actions were taken with the following objectives in mind:

First and most importantly, we had to protect and reinforce the integrity of the Hong Kong Dollar's linked exchange rate with the US Dollar under our currency board system. I can not stress too strongly our absolute determination to maintain our linked exchange rate;

Second, we had to stop the manipulation of our stock and money markets by some over-aggressive hedge funds;

And third, we had to reintroduce stability and a level playing field into our markets which were in dire danger of over-correcting.

I want to stress several points clear, namely:

There is no intention to delink the Hong Kong Dollar from the US Dollar. Our actions were first and foremost designed to protect the link which has served us well since it was introduced in October 1983. In a highly-externally oriented economy such as ours - with a trade to GDP ratio of more than 250% - currency stability is of the utmost importance, and indeed a necessity. The link is here to stay.

The Hong Kong SAR Government did not buy shares to support the market at any particular level. We bought shares to stop a contrived manipulation by hedge funds which was creating severe instability in the stock, futures and currency markets. The stock and property markets in particular could not find their true levels in such an unsettled environment.

Our actions do not signal the beginning of an interventionist era for Hong Kong or a departure from our commitment to free trade and open markets. We are still probably the world's freest and most open market.

In August, we reacted to a fast evolving and extraordinary situation which, if unchecked, would have compromised the ability of our economy to continue adjusting smoothly, and in an orderly way, to the current downturn. In other words, we took pragmatic steps to keep our economy intact rather than see it overwhelmed by manipulative market activities and suddenly implode.

There is no doubt Hong Kong has lost a bit of its shine. Our free market reputation has suffered in the eyes of economic theorists and the big investment houses, whose criticisms have been mainly driven by the promotion of dogma and profits, respectively. Those with a more pragmatic appreciation of the situation have been very supportive and I believe they accept, as does the Hong Kong SAR Government, that there is still the possibility that asset prices might continue to fall. But to push them down to rock bottom in one giant, contrived manipulative fracas was not the best way. It's like standing at the top of a cliff, looking across a deep rift to the other side. We know we have to climb down into the valley before we can start the slow climb back up. But then somebody comes along and wants to take away all our money by pushing us off the cliff. We will certainly get to the bottom of the valley immediately, but there's not much hope of ever getting back up again.

To fully understand why we acted let me just explain how fast and severe the economic adjustment has been in Hong Kong. Our stock market capitalisation is half of what it was a year ago. At the end of August this year, capitalisation stood at HK$1,960 billion (US$251 billion) compared to HK$4,335 billion (US$555 billion) at the end of August in 1997. Daily turnover recently has been in the range of HK$4 billion, when back in August and September last year daily turnover of HK$20 billion was not uncommon.

This gives you a clear picture of just how much liquidity has gone out of the Hong Kong market. It also shows how smaller inflows of funds can have a disproportionately larger impact on market movements and sentiment. For example, a HK$3 billion inflow into the markets in August this year would have been 75% of average daily turnover. The same HK$3 billion in August last year was only 10% of market turnover, or about 15% of daily turnover in September and October. So the markets were ripe for manipulative attack.

That is just the stock market. Property prices have dropped by more than 50%. Rents are down by about the same percentage, back to levels they were seven or eight years ago, and still dropping. Our GDP contracted by about 4% in the first half of the year - and that is after real growth of 5.3% in 1997 and average annual real growth of 5% over the past decade. Unemployment is about 5% - our highest level for more than 15 years. And although not high by international standards it is a great concern in Hong Kong where an unemployment rate of 3% or less is the norm. So Hong Kong is hurting, and hurting badly. And Hong Kong has taken the pain in its stride. I can not think of too many economies that would still be functioning normally and smoothly after such a drastic turnaround in economic fortunes over such a short space of time. In fact, the speed at which the Hong Kong economy has adjusted actually reflects its flexibility, efficiency and robustness.

I believe most people in Hong Kong, most long-term investors and certainly most of the international business community understand the dynamics at work. Things will probably get worse before they get better, but in the long-run Hong Kong will emerge leaner and more competitive than before and all the wiser for the experience. So it is a trifle unfair when I hear people say that the reason the Hong Kong SAR Government bought into the stock market was because we could not take the pain of economic adjustment. That is simply not true - we have been taking the pain for more than a year, and are prepared to take more pain if that is the price to pay for economic recovery and leadership.

Following our incursion into the stock market, which lasted less than two weeks, we introduced a series of measures to restore stability and a level playing field to our money and stock markets. We bought into the stock market on August 14 and told the world immediately and publicly what we were doing. We remained a net buyer until August 28, the last day of futures trading for that month.

The whole process was transparent. We have just announced the setting up of an independent company - at arm's length from he government - under the Hong Kong Exchange Fund to manage these holdings and to dispose of them in an orderly way over time so as not to create market distortions or volatility.

The result? Well the extraordinary traders have left the market for the time being. I hope they stay away. The stock market is much less volatile although it continues to go up and down, as markets do. The Hong Kong Dollar has remained firm, and there has not been any selling pressure on our currency. We have brought in a wide range of measures to bolster our currency board, to increase the transparency of our Exchange Fund and to further strengthen the linked exchange rate by increasing liquidity in the banking system and virtually eliminating the need for banks to sell Hong Kong Dollars in the market. We have tightened stock market rules and regulations, especially in regards to short selling and borrowing shares, and the settling of positions. We are confident the new measures will not affect genuine investors.

I would also like you to consider just how free a market we have in Hong Kong and what it is that makes a free market. In Hong Kong, a free market means being able to rely on the rule of law upheld by an independent judiciary. You are free to fight for your corporate rights in the courts any time you wish. A free market means a level playing field for all who do business in Hong Kong. A free market means having a stable, freely convertible currency which you can change any time you want into any currency you want. A free market means no restrictions on the amount of money or the type of currency you bring in to, or take out of, Hong Kong. There are no restrictions on gold and silver trading.

A free market means no quotas apply, and no duties payable, on virtually all goods coming into Hong Kong. A free market means having access to as much information as you need - probably more than any business executive in the world - at the click of a button on a computer, or by flicking through the hundreds of magazines and newspapers published every day and every week in Hong Kong. A free market means having a small, corruption-free government which facilitates private-sector business, trade and investment by building the transport and communications infrastructure needed for success in the 21st Century. A free market means a low, predictable and simple tax system which allows business and individuals to keep most of what they earn - 16 per cent corporate profits tax and a maximum - maximum - of 15 per cent salaries tax for individuals. All of these you will find in Hong Kong. So despite what recent critics would have you believe, despite their focus, there is much, much more on which to judge our commitment to free markets than a single stock market battle.

There are other factors helping Hong Kong to ride out these present difficulties. One is that our banking and financial system continues to operate normally - our banks have been prudently managed, have very good capital adequacy ratios and are not in any danger of being dragged under by mountains of bad debts. Another is currency stability - despite speculative attacks in October last year, in January, June and more recently in August, the Hong Kong Dollar's exchange rate with the US Dollar has remained steady. So too has China's renminbi exchange rate. And I believe this stability in the Hong Kong Dollar and the Chinese renminbi will eventually help pave the way for a recovery in Asia. I would like you to consider our solid financial position - we have more than US$57 billion in fiscal reserves, while total reserves at our disposal, including foreign exchange, are well over US$100 billion. The government has no debt. We are not bailing out the banks.

Our solid reserves are allowing us to press ahead with important infrastructure projects which will create 100,000 jobs and consolidate our position as the premier transport and communications hub of Asia. At a time when most East Asian economies are in austerity mode, we are pushing ahead over the next five years with an impressive US$30 billion investment in new railways, roads, bridges, new land and housing - that's $10 billion more than was spent on our new airport and related projects over a seven-year period.

As someone who has lived and breathed the Hong Kong success story all of my life the current economic turmoil sweeping through East Asia has been a somewhat sobering - and also enlightening - experience. Initially, I have to admit, we underestimated the intensity, speed and duration of the economic problems besetting the region as well as their impact on Hong Kong. With the benefit of hindsight it is right to say that most advanced economies underestimated the impact too. So I say sobering because the events of the past year have made us all sit up and take a long, hard look at our fundamental strengths, but more importantly our fundamental weaknesses.

This is why I have also found the past year to be equally enlightening. When an economy contracts as much and as fast as ours has, it exposes weaknesses which would otherwise have gone unnoticed. As a result we have been able to make our stock and money markets more transparent and less susceptible to manipulation. We have been able to strengthen our currency board mechanism. We have reaffirmed the importance of our linked exchange rate as the central pillar of our economic policy. And, most importantly, I think we have proved that even during such difficult times we are still the best place in Asia in which to do business. And when the storm is over, we will be even better.

Thank You.

End/Thursday, October 1, 1998

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