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The following is the speech delivered by the Chief Executive, Mr Tung Chee Hwa, at the French Business Association Seminar today (Monday):

Ladies and Gentlemen,

Thank you very much for inviting me to speak at this particular seminar. It is now the last month of 1998. It is opportune that we review what we have gone through in this extremely difficult year for us in Hong Kong, the lessons we have learned, and the challenges and opportunities that lie ahead for us.

This year, we have experienced a very severe crisis, what is commonly known as the Asian financial crisis; and we have also witnessed this particular crisis spreading not only to many countries in Asia, actually way beyond to Latin America, Eastern Europe. Although the storm has seemingly come to a halt or at least temporarily stabilized, it is important that we look into the causes and the origin of this crisis to prevent future recurrences.

I think we must all admit, from the very beginning, we underestimated the severity of this crisis. The origin and the causes of this crisis are really very complex : but there are some very startling common factors that existed in the Asian countries which were the worse affected. They are, private sector over-borrowing, inadequate bank supervision, poor macro economic policies and poor corporate governance. But are these really the only reasons that have created this phenomena in Asia? I believe the answer is no. Indeed, as the crisis wore on, there is other evidence which pointed out a systemic problem in the international capital flow. The problem is also not unique in Asia, but is in fact international.

According to the Bank of International Settlement's Annual Report, over US$100 billion of short term capital entered Asia - and this excludes China and Japan - in the 12 months prior to 2 July 1997 when the Thai baht was allowed to float. Then, within the next six months, virtually the same amount left the region. Such rapid movement of short term capital created financial distortions in these affected economies in Asia. The short term movement of working capital was indeed one of the major reasons and causes of the financial turmoil.

The problem arose from short-term loans from international banks and other financial institutions of developed countries to emerging economies in Asia which were in turn then invested in long-term and sometimes unproductive projects. Once these banks and financial institutions lost confidence in these countries or economies, funds were withdrawn rapidly, thus resulting in a very severe credit crunch. Whilst people may blame these Asian economies for borrowing excessively and imprudently - and absolutely, they were imprudent and they were borrowing excessively - one also has to wonder why such loans ever took place in the first place. And why were the banks willing to make such short term loans? Why couldn't the problem be detected in advance? Clearly, this argues strongly for more stringent surveillance on both sides of the fence. Not just one side, but both sides of the fence.

I would also like to talk about the hedge funds whose operations have contributed to the swift flow of massive short term capital. Let me make myself clear. I do not object to the existence of hedge funds. Far from it. They are an essential part of a global investment fabric if it is for hedging. However, I believe we need to set up some rules of the game for the hedge funds and their lenders for the sake of maintaining the stability of the international financial market. At present, hedge funds lack transparency. Neither are they subject to supervision. Yet they take directional positions, creating a herd environment that attracted many, many individual and institutional investors and speculators to follow, causing havoc in many financial markets around the world, including Hong Kong. This together with their highly leveraged operation can generate short term capital flow which can be devastating to any economy. This is hardly satisfactory. No one seems to know and care about what the hedge funds are doing, but they are allowed, almost, to do anything! It is therefore important to protect the integrity of the global financial markets by putting in place a framework whereby short term capital and the operation of the hedge funds may go by some rules of the game, and at the same time, the short term capital flow can be allowed to move freely.

Having said all this, I wish to stress that in Hong Kong we remain fully committed to a free and fair market and a level playing field. We are not advocating capital controls but are looking for improved transparency, accountability and better supervision of hedge fund operations. We are also looking for better surveillance or warning system of short term capital flow. In this connection, we are most encouraged by the successful meeting of the G22 in Washington in October, and the subsequent pronouncement by the G7 leaders in support of a new international financial architecture. I wish to point out that the emerging economies affected by the current global crisis should be involved in the process of drawing up the new financial architecture, as we have first-hand experience of where the problem lies.

Since the beginning of the Asian financial turmoil, our linked exchange rate came under speculative attack time and again. Our futures market was also being manipulated. We took some very bold but necessary measures in August. We did what we did, we had to go into the market because of the serious risk at the time of a meltdown of our economy resulting from the breaking up of the linked exchange rate system. It was highly controversial but I just want to assure you it was necessary - it was a necessary effort at that time - and it was taken, really, only as a last resort defensive measure to restore order and stability in our financial markets. Looking back, I think the timing was very fortunate also.

Hong Kong's economy has been greatly affected by the turmoil around us. To be honest, high property prices, high inflation, negative interest rates through most of the 90's had created a bubble economy that needed to be adjusted if we were to remain competitive. The turmoil accelerated the pace of this adjustment. Our property prices have come down some 55%. Our costs, including wages, are adjusting. Unemployment, unfortunately, has almost doubled to 5.3% lately. And our economy, this year, will contract some 5% overall. The correction is very rapid, very painful, but I believe it is necessary.

Many would like to know when Hong Kong's economy will start to recover now that stability has returned to our financial markets. Indeed, many would like to know when the economies in Asia will start to recover. My view is this: that the economic recovery of Japan is really essential for us all to move out of this difficult situation. The continued growth in the economy in the United States and in Europe is also very, very important to us here in Asia.

Of course, equally important for us in Asia is that we must go ahead with all the structural reforms - stronger banking supervision, better corporate governance, better surveillance systems, better macro economic policies. All these - from the impression I gathered in the APEC meeting - all these, the countries in Asia are very determined to achieve. But we are now in an inter-dependent world and therefore the continued economic health of Europe and the United States of America, and the recovery of Japan, are really critical.

Of course, in Asia, there is one more thing which is very important - which is the restructure of private sector debt of many of the economies in this region. Until the private sector debt is restructured, the credit crunch will continue and that will delay the date of recovery of many of these economies.

What about Hong Kong? Where are we now, you might like to ask? Our economy is so externally oriented that it is difficult for me, at this time, to be very definitive. For the same reason that we are hoping that Japan will start to recover, we are hoping that Europe and America, next year, will continue to have positive economic growth. These are somewhat still uncertain, but what is working for us in Hong Kong is this, that our prices have adjusted, we are becoming more competitive, and that our banking system has always been very sound and continues to be very sound, and that our corporate bodies in Hong Kong have always been very conservative in managing their balance sheets, and that the Hong Kong Government has always been very conservative in managing the balance sheet. So, I believe we are in a much better position than many of the other Asian economies, to get the recovery going. A full recovery, unfortunately, may still be some time away as far as Hong Kong is concerned - we rely so much on the external environment - but I believe the worst is now behind us.

Looking forward, we are very confident of our future. Hong Kong is fortunate, as we are the gateway of the fastest growing economy in the world. The very first thing we should do is therefore to position ourselves properly to take advantage of the tremendous opportunities on the Mainland, under the framework of "One Country, Two Systems". We should grasp the opportunity to expand further our links and economic co-operation with the Mainland. We, as the Government, will continue to play a leading role in creating an environment that is conducive to this.

Concurrently, Hong Kong should also strive to keep up its international cosmopolitan features: diversity, dynamism, and an expanded and global horizon for our people. While we will not lose sight of the importance of our traditional economic strongholds such as financial services, tourism and a centre for multinational companies in Asia, we will also focus on creating an environment in which innovation and technology can flourish. This will help us to improve our competitiveness in fields such as information technology, entertainment and telecommunications, as well as helping us develop new fields such as the development and certification of Chinese medicine.

But most important of all, we will continue to be fully committed to sound macro economic policies, a free and open market, a free and open economy, with no capital controls. We welcome competition, provide a level playing field for everyone, and we believe strongly in upholding the rule of law here in Hong Kong.

In order to ensure competitiveness we will continue to invest heavily in infrastructure projects such as building railways, roads, and we will continue to invest heavily in education. We recognise the importance of information technology and we are committed to make Hong Kong a knowledge based society.

Now another word about Asia. Many are beginning to question whether growth in the region hasn't been as a result of a miracle now gone bust or merely built on the back of speculative and short term capital flows. The answer is no. It has been built on the hard work, the thrift, the skills and ingenuity, and the determination of the people in the region to develop and to reap the benefits of economic growth. It has also been built on the various Asian countries policies in developing the infrastructure and systems necessary to support and nurture such economies. Those qualities, skills and infrastructure remain in the region. I am certainly very confident of Asia's future once the adjustment is completed.

Ladies and gentlemen, France is today the 4th largest economy in the world. You are not just renowned - as we in Hong Kong all know - for your brandy, for your fashion, but also renowned for your remarkable achievements in aerospace, electronics, telecommunications, banking, and other technological and knowledge-based advances.

And with the advent of the Euro, starting January 1, next year, Europe will become increasingly important economically to Asia, and indeed to the entire world. France is of course playing a core leadership role in the future development of Europe. We in Hong Kong recognise and understand how important France is to us in Hong Kong.

Hong Kong is already on the way to recovery. So will be Asia. I am sure, with your wisdom, you will want to continue your heavy involvement in Asia and Hong Kong to take advantage of Asia's future recovery. Where else, ladies and gentlemen, to base your headquarters in Asia, but right here in Hong Kong. I know you will find Hong Kong always the most attractive city for you. Thank you very much.

End/Monday, December 7, 1998

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