FS's speech

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Following is a speech (English only) by the Financial Secretary, Mr Donald Tsang, at a lunch organised by the Hong Kong Economic and Trade Office New York and the National Committee on US-China Relations, New York, on Friday, October 9, 1998:

Hong Kong: Getting Rid of Godzilla

Distinguished guests, ladies and gentlemen,

It is always great to visit New York, a city with such a buzz that I have to say it is almost - almost - as exciting to live in as Hong Kong. The Stock Exchange, Broadway, Empire State, Statue of Liberty, Chrysler Building, Central Park - you see so much of New York on the TV that when you visit, you know your way around already. Last weekend, on my flight over from Amsterdam, I watched Godzilla tear the city to pieces. For one fleeting moment I even wondered if the monster would crash into the building where some of those aggressive hedge funds are based. Then I realised that in such a complex world, an attack by a mutant monster had probably been factored into a derivative formula somewhere. So despite the carnage, there were likely to be a few fund managers still smiling because they had the good sense - or luck - to invest in concrete futures.

That of course is just fiction. But sometimes the boundary between fact and fiction is blurred, and that is what I would like to focus on today. I want to rid Hong Kong of the Godzillas in our midst. I want to dispel a few myths, and reinforce a few realities about Hong Kong that have emerged in light of the Asian financial turmoil. You may at first find them disparate or disjointed but each and every point is a piece of the Hong Kong jigsaw - you need all the pieces to see the big picture.

I will start with the most controversial, and that was our government's decision in August to buy into the stock market. I won't go into the complexities of the incursion other than to say our actions were taken to protect our linked exchange rate and to stop a market manipulation, or anti-trust activities. The actions by a handful of over-aggressive investors threatened our very economic existence. It was a case of do nothing and die, or make a stand to ensure there was still a market in which to invest.

Herein lines myth number one: Hong Kong has abandoned its free-market policies.

The reality is that Hong Kong is still the world's freest economy. It is too simplistic - and also unfair - to judge our commitment to the free market by a single, extraordinary battle at a time of great economic turmoil, and when massive, secretive and destructive capital flows were creating havoc in the markets. So how do you judge our commitment to a free market?

A free market means 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. You can take on the government, as many do, and win. A free market means a level playing field for all who do business; it means a stable, freely convertible currency. You can change Hong Kong Dollars any time you want, into any currency you want. There are no restrictions on the amount of money or the type of currency you can bring into, or take out of, Hong Kong. You can buy and sell as much gold or silver as you want. There are no quotas, or duties payable, on virtually all goods coming into Hong Kong. There is a fast, free and unfettered flow of information. We have a vibrant and critical press. We have a small, efficient and corruption-free government which facilitates private-sector business, trade and investment. We have a low, predictable and simple tax system which allows business and individuals to keep most of what they earn. We have a maximum - maximum - 15 per cent salaries tax, but the vast majority of residents pay less than this. We have a maximum of 16% corporate profits tax. There is no sales tax, no capital gains tax, no withholding tax. And, importantly, you must also remember - Hong Kong has a constitutional duty under the Basic Law to develop its role as an international financial centre. In Hong Kong, a free market is not just policy - it is the law. You can not ask for any stronger commitment than that.

During and following our incursion another myth emerged: Hong Kong was working secretly in the market.

The reality is that from the moment Hong Kong entered the stock market on August 14, and until we left the market on August 28, the whole world knew what we were doing. And, the whole world was told why we were doing it. Since the beginning of September we have effectively not operated in the market. About a week ago we announced the establishment of a separate company, at arm's length from the government and market regulators, to professionally manage the portfolio of shares purchased during the operation in August. Once we are sure that the manipulators have left the market we will disclose of our holdings of shares. The management company will abide by all of the laws and regulatory requirements relating to the securities industry. The government does not wish to seek representation on the board of those companies in which it has substantial holdings. We will take a passive position in the market, and we are prepared to hang on to our stocks for quite a while if necessary. If and when we decide to liquidate some of our holdings it will be done in an orderly way, over time, so as not to disrupt the market.

Since the stock market incursion there has been a great deal of guessing about how much we spent. That guessing continues, and as I have just said we will disclose our share holdings in due course. What I can say is that the final figures are not as much as many have estimated. This has led to another myth and that is: Hong Kong will not have the resources to counter another concerted attack by currency speculators.

The reality is that we have both the financial, and regulatory, means to protect our linked exchange rate under our currency board system. Let me stress, that everything we have done, all the pain we have endured, has been to protect our linked exchange rate. At the end of August, we had about US$92 billion in reserves. That's our money, we have earned it and we are holding on to it. We cannot and will not allow aggressive investors to steal our nest egg and ruin our currency. The government has no external debt. The Hong Kong Dollar has remained firm, even under severe speculative attack.

Apart from stopping the manipulation, our actions also gave us the time we needed to move on the regulatory front to make it much more difficult for such an attack in the future. Immediately after the manipulative attack, we brought in a wide range of measures to bolster our currency board and to increase the transparency of our Exchange Fund. We have further strengthened the linked exchange rate by increasing liquidity in the banking system and making it less susceptible to manipulation. 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. And you may be interested to know that our regulatory framework is no more stringent than that which you have here in America, and in many cases less stringent.

During all these speculative attacks against the Hong Kong Dollar - in October last year and in January, June and August this year - there have been several recurrent myths aired in the market and media. One is that the renminbi will be devalued; another is that if the renminbi is devalued, then the Hong Kong Dollar link will go. Another that always comes up is that link must go to restore our competitiveness.

Renminbi policy is of course a matter for our sovereign power. But I am certain - and our national leaders have said time and again - that the renminbi will not be devalued. Why? Because it simply does not need to be. Despite the regional turmoil, the Chinese economy has a trade surplus of US$30 billion for the first half of the year. It has foreign exchange reserves of US$140 billion - the world's second-largest such holdings after Japan. The Chinese economy is growing by about 7 to 8 per cent. But more significant than strong economic performance, is the determination of our leaders to maintain regional stability. China is taking a long-term view. If the renminbi were devalued, it would trigger round after round of devaluation throughout Asia. This would impact strongly on exports from the US, Europe and Japan. There is nothing to be gained from a renminbi devaluation except greater instability and uncertainty in global markets. I also firmly believe that the exchange rate stability of the Hong Kong Dollar and renminbi is now the currency anchor for the region. Our currency stability will help pave the way for recovery in Asia, and we should not overlook the significance of this.

Then there is this myth that if the renminbi was devalued, the Hong Kong Dollar link would come under serious pressure. Since the link was introduced in October 1983 - almost 15 years ago to this day - parity with the US Dollar has been solid, actually on the strong side of the linked rate of HK$7.80 to US$1. During that time the renminbi has devalued several times, four times that I can think of, and its exchange rate against the US Dollar is about is half of what it was a decade ago. We have two systems operating under two completely different sets of conditions. We have different currencies with different economic backdrops. We are a small, externally-oriented economy of 6.5million people with 85 per cent of GDP related to services. The Mainland has 1.2 billion people with very divergent development, manufacturing and natural resources. Our country has a relatively industrialised and prosperous eastern and southern seaboard, but overall it is still a poor country, with a per capita GDP of about US$300 per annum. If look at the issue rationally then speculation on the future movement of the renminbi is useless and futile on its pronounced so-called effect on the Hong Kong Dollar. The two currencies are not like the Siamese twins that people - speculators in particular - try to portray.

Another 'Godzilla' in our midst is that the linked exchange rate has hurt our competitiveness. Yes, we may be more expensive than some other places but we are on a par with say New York, Paris, London, Frankfurt, Tokyo - good locations come at a cost. Big business doesn't just look at how much it costs to rent a house or office. Big business looks at the bottom line - is there a reasonable return on investment for me. Quite clearly, in Hong Kong, there is. There are thousands of overseas companies based in Hong Kong, many with regional headquarters or offices. Why? Because they see the value of the place. They see the merit of investing in a city which already has its feet firmly planted in the 21st Century. Our communications, our infrastructure, our location are unrivalled in Asia. We have the expertise, know-how, entrepreneurial flair and connections to facilitate trade in the Mainland for US and European business; Asian, African, South American - anyone - who wants to trade or investment in the Mainland.

Also consider that housing and office accommodation prices have dropped by 50 per cent in the past year; inflation is at a 15-year low; US$30 billion in new infrastructure projects are coming on line over the next five years. Now is a time of opportunity in Hong Kong. I suggest you come and look, see for yourselves and start planning for what will happen five or 10 years down the track, and not so much five months down the track.

Now, to the global financial turmoil - the Asian contagion which has turned pandemic. Four Asian economies have collapsed; governments have toppled. Russia and Latin America are in trouble and with that consequences for Europe and the United States. So here is another myth, which relates to the rest of the world as much as it does to Hong Kong and that is: as long as there is good government, balanced budgets, sound monetary and fiscal policy then things will be alright.

The reality, unfortunately, is that the size and speed of global capital flows pay no attention to sound economic fundamentals. Cash is pumped into emerging economies at times of growth; then sucked out at the speed of lightning at the first hint of trouble. Such huge and wild swings in capital flows have become as dangerous as they were beneficial. That the Hong Kong market was attacked and manipulated was basically due to the fact that our markets had contracted so much we were ripe for speculative attack. That is, a much smaller injection of capital into our stock and money markets produced a disproportionately larger and disruptive affect than the same amount of money would have caused a year ago. Thankfully this issue is now being addressed with a greater sense or urgency following this week's IMF/World Bank meetings, and after the special meeting of Finance Ministers - the G-22 - attended by US President Bill Clinton and co-chaired by Robert Rubin and Alan Greenspan on Tuesday night. We really need to codify the degree of transparency required of financial institutions generating such capital flows. We also need to establish greater discipline in the extension of credit to these institutions. If not even the best managed, best regulated, most open and financially sound economies - economies like Hong Kong - will be vulnerable to attack from rogue capital flows and aggressive investors.

Now, back to Godzilla. Those of you who saw the movie will remember that near the end of the film the three heroes were being chased by hundreds of hungry, baby Godzillas. That's a bit like how we felt in Hong Kong when our markets were being threatened by anti-trust activities back in August. So we called in a tactical strike to rid the market of this aberration. Just like the F-16 jet that dropped a bomb on Madison Square Garden to stop the nest of baby Godzillas from running amok in ruined New York. Exceptional times require exceptional measures. It was a question of survival.

Having said that, I ask that when you judge our commitment to the free market, look at the big picture rather than one piece of the jigsaw. We thrive on a free market; we will not impose capital controls; we have no intention of taking a covert position in the stock market; we will not devalue or delink the Hong Kong Dollar. And, importantly, we have a constitutional duty to maintain and promote Hong Kong as an international financial centre. These are the realities. Forget Godzilla - stick with the facts.

Thank you.

End/Saturday, October 10, 1998

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