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The following is the transcript (English only) of a question and answer session given by the Financial Secretary, Mr Antony Leung, at the APEC Business Advisory Council Luncheon today (August 9):

Question: In the context of this deflationary environment that you have had to manage and given that some commentators in the world think that this deflationary phenomenon might spread, what sort of advice would you be giving to people managing major economies in the world to try and deal with this in the forthcoming period?

Mr Leung: I was hoping that you can give me advice on how to deal with deflation in Hong Kong. Well, let me point out a number of facts.

The first is that as you said, deflation may be here to stay. But the fact that Hong Kong is deflating - as I said we have been deflating for about 40 months now - and yet in the process of deflating we are keeping overall financial and social stability, is something that you should give credit to Hong Kong.

Say, for example, our property prices have deflated - you can say decreased - by more than 60 per cent and unlike some other Asian economies our banking system remains very much intact. As a matter of fact none of the local banks' capital adequacy has fallen below the international standard. The fact that we are deflating means that our system is extremely flexible and in a way that is the advantage of Hong Kong.

Now back to your question of giving advice to the major economies - I would say that I have none. But on the other hand, bearing in mind the difference between Hong Kong and some of the other larger economies, Hong Kong is a very small economy and a very open one. With deflation there is one major drawback and that is we may actually be seeing what I call a vicious circle. And that is, when people see that the price may be lower in future they would delay their investment and delay their consumption which will further depress the price and then the circle would go on and on downwards.

To break the circle, my thinking is to somehow attract new economic activity, new investment and new spending into Hong Kong because just to deal with inflation in a closed economy clearly would not work. But the beauty is that Hong Kong is such a small economy, to attract outside money, outside investment and outside consumption in Hong Kong is much easier than in many of the larger economies.

Now, there are three sources of outside money, outside investment and outside consumption - and you may be able to think of others. But the three major ones that I can think of, firstly is exactly what Peter Woo and his colleagues have been doing and that is to attract the foreign companies to use Hong Kong as their base to invest in China and to attract the Mainland companies to use Hong Kong to interact with the rest of the world.

Now let me elaborate a little bit further on this one. We all know that most of the major companies are already finding advantages in dealing with this part of the world, particularly sourcing from the Mainland of China. As I said, the Mainland of China is one of the largest manufacturing centres in the world and these major companies that are sourcing from China or already manufacturing in China are finding tremendous competitive advantage. The price of these goods is lower and the quality is actually very high.

Now for the other not so large companies that are not already in China, I believe they will have to come to China, including Hong Kong, unless they don't want to compete. So Peter and his colleagues are now going around the world to actually talk to small and medium size enterprises to say: if you want to survive, if you want to compete successfully, please come. But we all know that for the small and medium size enterprises, investing in China or operating in China may not be as easy because it is a very different economic entity and the surest way to be successful is entering into either alliances or joint ventures with Hong Kong businessmen who have decades of experience in dealing with the Chinese businesses. This is the role that Hong Kong can play.

Now assuming with all of these foreign companies coming to Hong Kong - and by the way, since 1997 we have seen an increase of more than a third of foreign companies using Hong Kong as their base as regional headquarters or regional offices, so it is in a way a proof positive of the role of Hong Kong. But with these foreign companies growing in size in Hong Kong, growing in numbers in Hong Kong, we are also attracting Mainland companies to use Hong Kong as their base to interact with the rest of the world, and that is indeed the role of Hong Kong being the regional services hub serving this part of the world. Not just the Mainland but actually the rest of the world. And that is the first foreign investment, foreign money that we are attracting.

The second source of foreign money that we are attracting is actually tourists. Hong Kong is a major tourist hub and our colleagues - I think Clara is here - we are doing everything we can to build up Hong Kong as a better tourist destination. Even in the very difficult period like last year, the number of tourists arriving into Hong Kong increased in double-digits. Particularly, we are attracting tourists from the Mainland because as we all know, the numbers of middle-class in the Mainland are increasing by leaps and bounds and they are dying to spend money overseas and Hong Kong is a natural destination. So that is the second area that we are attracting new money into Hong Kong.

The third area that we are attracting new capital into Hong Kong is obviously through our financial sector. We are attracting a lot of companies from all round China - and obviously hopefully from all around Asia - to be listed in our markets. And our markets attract money not just from our residents but actually from all over the world.

Now there's the last area that a lot of people are talking about and the Government soon, hopefully, will be introducing, and that is enlarging the schemes for investment immigrants. Investment immigrants bring not just money, which is obviously needed to deal with deflation, but they also bring entrepreneurialship and also their business skills, which will further make Hong Kong a better regional service centre. As I said, we have to rely on new money, outside money, outside investment and outside consumption to somehow give Hong Kong the boost to break out of the deflationary environment. But since Hong Kong is such a small and yet open economy I am very confident that we can take Hong Kong out from the current economic situation.

Sorry for a very long answer to a very short question. But don't be scared by the very long answer, I'll promise to be shorter.

Question: May I ask your future policy on the exchange rate, which is very famous around the world?

Mr Leung: Well, I've promised that I will give you a very short answer. I'll give you a very short one and that is we have no plan to change the current exchange regime.

Question: Do you see any change in the Mainland exchange rate policy?

Mr Leung: Under the 'One country, Two systems' they don't interfere with our economic policies and we don't interfere with theirs, so I can't really give you a definitive answer. But with all the economic indicators in the Mainland showing that the foreign direct investment is still growing, which is a very healthy sign, and that the trade position in China is also very healthy, and with a very large foreign exchange reserve, I believe they would like to maintain a very stable exchange regime.

Question: You have a very large deficit. What do you think your guess for next year's will be?

Mr Leung: I think it will also be very large. Having said that, I mean the prediction is actually quite easy. With the economy deflating and fiscal management counted in nominal dollars not in real dollars, a deflationary environment will mean that the revenue that we can collect will not increase substantially and with high unemployment the expenditure cannot go down very easily. Now having said that it will be very large, I am determined to meet the three targets that I have set in my last Budget Speech and that is: by the year 2006-07 we will achieve a balance in the operating account as well as in the consolidated account of the Budget. And then on top of that we would like to see that the public sector expenditure accounts for no more than 20 per cent of the GDP which is a reduction from the current over 23 per cent.

Now let me explain why it is important to achieve the last goal. In the market economy we believe that the private sector can provide jobs and give economic activities a boost much better than the government. If the Government occupies too large a share of the economy we are actually squeezing out the opportunities for the private sector.

I will also explain why we are confident in meeting the targets. The most effective goal in meeting all three targets is in containing the growth of public sector expenditure. With the new batch of politically appointed secretaries I am sure they will strive very hard to manage the growth in public sector expenditure while delivering the expected services to the community. Because with the re-prioritising of what they are doing, with a reorganisation of the Government as well as re-engineering the processes, I am quite confident that they can deliver the services to the community while keeping the government expenditure essentially flat and that is something that we are working very hard on. It is not an easy process but I believe with all of your support and the support of the rest of the community we can achieve that. It is an interesting problem for the Financial Secretary but I am confident that we will be able to deliver the results that you want.

Question: Financial Secretary, a visitor to Hong Kong who has had the opportunity to listen to its many eloquent advocates is struck by two contrasting images. On the one hand the image of a very difficult present: deflation, growing loss of competitiveness - partly as a result of the currency peg, growing unemployment, growing middle-class discontentment. On the other hand a picture of an extremely rosy future: Hong Kong as the gateway to the Pearl River Delta, Hong Kong as the service hub for China, Hong Kong as a global city. Great promise! The key is the journey from this very difficult present to that very rosy future. The question is, how long is this journey going to take? What is the length of this current deflationary period? What is the key challenge that Hong Kong faces?

Mr Leung: Well, a very good question Mr Chiang. I believe exactly what you have described is what is facing not just the government but the community. I believe most people in Hong Kong believe that there is a bright future, especially those who have listened to, if you may recall, the economic model that I have just outlined a bit earlier. On the other hand I believe the entire community by now recognises that economic restructuring is not easy; it is painful. So the question is, how do we get from where we are, which as you said is a bit gloomy, and where we want to be.

There are a number of things that I believe we must do. The first one is the Government, particularly those of us in the so-called senior positions, will have to communicate the vision to the community, to our people, and let them know that there is a bright future. And I am a firm believer that there is a bright future.

But then secondly, we have to assist those people that may have to suffer in the restructuring so that they would not lose hope, and that is also what the Government is trying to do. Now luckily, even though we are suffering from a very large Budget deficit which is about 5 per cent of GDP we still have some savings. We are still sitting on a very healthy fiscal reserve which means that even if we have to run a budget deficit for the next, say, five to eight years, we do not have to borrow and so we are not, hopefully, going to experience what Latin America is experiencing. And with these fiscal reserves we can provide an adequate social safety-net for those needy, and we have still money to invest for the future, including in infrastructure, including in human capital which is through education, lifelong learning as well as the importation of talents.

But the key really is to make sure that our people share a vision, they know that we have a strategy for each of the pillar industries and that we set the milestones. And on top of that we will demonstrate that we are making progress along the route that we have set out to do. As long as people believe that there is a future, as long as it is seen that we are making progress, then I believe people will work together to go for the vision.

Now, in order to make those progresses it requires a tremendous amount of work. Clearly, the Government will have to deliver quite a bit. In delivering a small government, in delivering that the economic flows between Hong Kong and the Pearl River Delta in people, cargo, capital, services and information is getting freer and freer while keeping the 'One country, Two systems'. But on the other hand, the community as a whole will have to share the burden as well.

Firstly, the people will have to admit, will have to accept that they have to change and that in the meantime they will have to probably take a bit of suffering, meaning have to work a bit harder, have to adapt to a new environment and may even have to change jobs. But on the other hand, the businesses - a lot of people in this room - will have to work with us to make sure that when you are restructuring your company to become more competitive you would also pay attention to the human side of the equation. And that is, as much as possible place employment as one of your priorities because while you have to increase productivity, laying-off people is just one of the options and there may be others that you can make yourself more productive.

I hope, also, the media would also be able to report not just the challenges facing Hong Kong but also the opportunities. And I am seeing that, I must say, in the last one year. A lot of newspapers, a lot of TV channels are reporting a lot of the very encouraging stories that our people are kind of somehow doing, working - to work for a better future. And I believe that if all sectors of the community work together we will have a very bright future.

Question: Hong Kong's strength has always been a very creative, a very vibrant private sector and we survive by not being fed but trying to find our own food. What has been disturbing in the last few years is that people are looking onto the Government for every problem that they bring home. And just to tell you a joke, when we go to church every Sunday we begin, not to pray for our own well-being but to pray that the Government will do something for our well-being.

There is tremendous pressure on the part of government on exerting on government to do something and yet from the private sector we fully realise the value of having a small and skinny and efficient government. How do you think you will stand up to that political pressure?

Mr Leung: Well, for me to stand up to the political pressure is not difficult but I think I clearly need help from two areas. The first one is I need help from God not to answer the calls that 'Please help the Government to help the people'. But more importantly I need help from the entire community, including in particular the businessmen because businessmen or businesswomen will understand that the Government, while we can enable the market it is indeed the private sector of the market that can create jobs, that can create economic prosperity.

We all realise that in a democratic society - which Hong Kong is - especially for the politicians in the opposition they will call on the Government to do more because by getting a lot of these government services they can demonstrate to the voters that they have done something for the voters. However, we all recognise that the Government can only do so much. So if the entire community, including the business sector, can also give a bit of a balancing voice that the Government obviously has a role but the Government's role is to enable the market to allow you to create jobs for the people, then I think Hong Kong would have a much better future and the community would have a more balanced view and a much more positive culture.

Question: When the economy is doing well all the civil servants would be asking for a pay-rise. When you have a big deflation do you have any plan to reduce salaries for the civil servants?

Mr Leung: Well, I hope you didn't see the scar on my back. I became Financial Secretary in May last year and I did something that I believe the Government has almost never done - but indeed it has done once about sixty-odd years ago - and that is to reduce the pay of the civil service as well as the public sector. It was obviously a painful experience but we were successful in reducing the wage bill of the public sector by about 2.5 per cent. Obviously, the question is: what are we going to do in future? We will communicate with the staff side, we will communicate with the community to see what we should do next but we have successful reduced the salaries by 2.5 per cent.

Now whether that is or is not enough is up to people to judge but I certainly do want to achieve the three targets of fiscal management that I set out and that is to achieve a budget balance in both the operating account and in the consolidated account by 2006-7, as well as to reduce the size of the public sector expenditure to 20 per cent or below. We believe in fiscal prudence because if we cannot control the budget deficit I am sure the economic future of Hong Kong is not going to be bright.

Well, once again thank you very much.

End/Friday, August 9, 2002

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