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The following is the transcript of the question and answer session by the Financial Secretary, Mr Antony Leung, at the Foreign Correspondents' Club Luncheon today (January 27):

Question: Lately there have been a lot of complaints about the number of railings and pavings going on in the country parks. The question isn't about the Water Services Department or anything like this, but rather a mentality that seems to be prevalent in putting these things up. The attitude seems to be and we have yet to see anybody in the Government refute this, that Government agencies have to spend the money they get or in the next budget they will get that much less. This is not unique to Hong Kong, but I'd like you to talk a little bit about this and what you're doing to try to change the mentality.

Financial Secretary: Well clearly there are all kinds of complaints. I've seen also some agencies, including universities and schools being accused of doing exactly that, and that is, unless you spend the money, your budget for the next year will be cut. Now, under the Accountability System, as you know, we are changing the budgeting for future years to what we call a one-line-vote system. Every bureau and department will be given a financial envelope and the heads of departments and directors of bureaux are free to use it, obviously within certain prescribed guidelines, under his or her control.

Even when they underspend this year, their envelope next year will not be reduced because what we are working on is also an envelope that is not just covering one year, but envelopes for the medium range so that they know what to do in the medium term, like three to four years. The situation that has been criticised in the past may not happen under the one-line-vote meaning under the financial envelope system.

But it's not just the financial management system. I believe it is also the procedures of the Government that sometimes needs review. A lot of the work that you are seeing today had been planned many years ago. The situation may have changed. The Government may not be speedy enough in reviewing the situation to see whether some of those projects are still needed.

I've been seeing on the television reports about water pipes going to remote villages where the population of those villages has been reduced significantly from the time that the pipe was planned. I think these are the issues that the Government itself would have to tackle, and I hope that under the Accountability System, with the Secretaries now being more responsive to the community's needs, we'll be taking a look at some of these issues.

Question: A double-barrelled one, but I think they're quick. If you have to put a weighting or priority, which is greater in your mind, attacking the deficit or attacking deflation? Second out of the barrel, on the question of shared responsibility, if it's a fair proposal to take $500 a month out of the maids, shouldn't everybody who earns, let's say $6,000 a month or more be asked to pay $500 a month?

Financial Secretary: The second issue obviously relates to specific measures, and I'm not prepared to respond right now. I'll tell you probably on March 5.

On the first question, deflation versus deficit. On paper it sounds contradictory, but in real life especially in economics we are dealing with a very dynamic problem. It really depends on the size of the deficit. A lot of people have been telling me, 'look, America has been cutting tax even though they have a huge budget deficit. Why are you so keen on reducing the deficit?'

The answer lies in the magnitude. I believe that in America even after they approve the proposed tax reductions, we are talking about a deficit less than 2 percent of GDP. But as I said, we have been running an operating account deficit since 1998, over 3 percent of GDP every year. And the total deficit last year was about 5 percent of GDP and this year it looks like it is going to be even bigger.

We also know that in the EU, the European Union, countries would get a sanction if their deficit is above 3 percent, and we've been doing that at the operating account level since 1998.

So we believe that if we do not tackle the deficit problem now it will affect the revival of the economy and it may actually put further pressure on deflation. However, I don't think we need to choose one or the other. Because for a small economy like Hong Kong, the best way to tackle budget deficit is not to increase Government spending, because we have been spending a lot in the last few years and look at what is happening to the economy. Also, because of the very open nature of our economy, the impact on the economy from Government spending is actually rather limited. Our economists have estimated the multiplier effect of fiscal spending on the economy is 0.5, meaning for every dollar the Government spends, only 50 cents would appear in the increase in the so-called national account.

The best way to tackle deflation for an economy like Hong Kong is to increase the demand from outside of Hong Kong and that we have been doing a lot. There are at least four sources of external demand.

First is tourism, I just told you that the number of visitors have increased by 20 percent last year. Looks like this year the trend may continue. The second one is to introduce, or to relax further, the investment immigrants, because these are the demand from coming outside of HK. The third area is to attract foreign companies to come to Hong Kong, to use Hong Kong as their regional base. And that, we are also very successful. Since 1997, we have seen the number of foreign companies using HK as a regional base increase by a third. The last area is in the financial markets. That's why the Government has been working very hard to increase the number of overseas companies using Hong Kong as the market to list in and to introduce schemes such as QDII so that investors from outside including the Mainland can invest in our markets.

So we are tackling deflation, but on the other hand, we must address the deficit problem. Because I'm a firm believer that if the deficit problem is not addressed, people may attack the currency and under the pegged exchange rate, interest rates would rise, and if interest rates rise, it is going to affect everybody, not just the corporations but the individuals as well.

Question: Hong Kong has vast fiscal reserves ramped up over many years to which you still have access. Why not go out and spend some of those reserves, possibly on big infrastructure projects to improve communications with the Mainland. That would have an impact on external demand. That would have an impact on the economy. Could you not revive the economy by spending more money rather than by spending less.

Financial Secretary: We have been spending, we have been drawing down on our reserves. We have pulled down our reserves by more than $170 billion in the last four years already. Secondly we have not really cut back on those infrastructure that can generate economic returns to Hong Kong. I've told the Legislative Council that the planning, at least, the planned amount for infrastructure for the next five years will not be reduced. In reality, the average numbers we have planned are still higher than the average for the last five years. However, there is a difference. If you draw down reserves, or as somebody would have suggested, if you borrow to finance infrastructure, it is very different from borrowing to finance operating deficit. An operating deficit as you know is largely composed of taxes and also spending on the Administration. The biggest problem is not that we are running short of money to finance infrastructure. We have, as you said, still a lot of cash in the fiscal reserves to do it. We don't even need to borrow right now. The problem is the operating account. The operating account before investment income has been running over 3 percent since 1998, and this is the problem that we all have to address.

Question: You said there are no plans to remove the peg. On what basis do you justify keeping it at the moment?

Financial Secretary: As I said in many public forums before, any discussion on the merits of either keeping or abandoning the peg would be risky, so I'll just tell you my one-line answer: we have no plan to change the peg.

Question: My question relates to air pollution. I know the Government has been spending money on conversion of taxis and other measures, but the net result is the air is still getting worse here. To the extent that you're trying to increase tourism and corporate headquarters to come here, not to mention the quality of life for people who live here full year, what is the Government's view on increasing this important part of our own infrastructure in Hong Kong.

Financial Secretary: Firstly, a factual situation that I would like to present to you. At least according to our data, the number of clean days, or actually, put it in reverse, the number of dirty days, or very polluted days, has actually come down significantly from a few years ago, before we turned all the taxis into LPG and so on and so forth. We've actually done a lot domestically. As you know, all the taxis now, almost all the taxis now, are running on LPG. All the diesel vehicles are on the "Euro 3" standards, for those who are not, we somehow asked them to put on converters. And we've done a lot locally. But we also know that we share the same air shed with the Delta, the Guangdong side of the Delta. That's why Sarah Liao, Secretary in charge of Environment, is proposing to do emission trading with Guangdong on this very important issue. We recognise how important clean air, clean water and a clean environment is to Hong Kong being Asia's world city. Afterall, talents, professionals would come not just to make money but also to enjoy a good way of life. I think a clean environment is critical. That is an issue we'll continue to work on.

Question: As a sort of follow up, two things, is it a good opportunity to for us to get,if we are going to have to broaden on that the tax regime, the user pays or sometimes polluter pays principles in some of these areas in waste, etc. The second question is, since a good deal of our pollution is seasonal, it does come across from the boundary, is it a good opportunity, and you have not mentioned the Pearl River Delta much for Hong Kong to be reaching out into the Pearl River Delta to find ways we can help improve our economy. One of those being providing technologies in the environment to reduce air pollution and water pollution. Would you like to address the Pearl River Delta?

Financial Secretary: Thank you. For the Delta obviously, it is very important and lately there are a lot of discussions of how we can work closer with the Guangdong side of this great Pearl River Delta. And, indeed, you the private sector have been working with the Guangdong side and actually in the Delta much more actively than the government in the past and after all in Hong Kong the market has been leading the way. I believe the Federation of Industries have come out with a survey that indicated that there are now eleven million workers in the Delta working for Hong Kong based manufacturers. So the integration is happening. We believe that we have to continue and will probably strengthen our work to make the two sides work closer. In the last two years or so, we have been working very hard to improve the connectivity with the Mainland, particularly with the Pearl River Delta. And that is in extending the two-way flows of people, cargo, capital, information and services. Now there are still a lot work that we need to do. Such as hoping to introduce the QDIIs in the Mainland so that the capital can come over; CEPA, so that Hong Kong services can trade freely with the Mainland. I will continue to work on connectivity particularly with the Delta and that's why yesterday we have seen the 24-hour opening of passenger flow with the Mainland. And the cargo flows have increased a lot and hopefully the cost will come down. But we have to also work on other issues besides improving the connectivity. Last year we have somehow work closer with the Mainland side on what we call joint promotion and joint marketing, and that is to promote the Delta as a whole. For various reasons in the past years, the Yangzi River Delta has been promoting itself much better than the Pearl River Delta. Partly because Hong Kong was promoting itself and Guangdong side was promoting itself. Last year we started to promote jointly. Officials from both sides working together. We have promoted and we have organized seminars targeting at the Taiwanese investors; and TDC and Guangzhou have gone to Tokyo to promote the Delta together. More will be done this year along these lines and there will be others to work on as well.

Environment is another issue that we are working on and there are issues that clearly we have to do better. But we a firm believer that in this age, competition is not amongst cities, it is amongst regional economies and we believe that the Pearl River Delta which is still the area that exports more than any other regions in China, also, with the combination of a manufacturing power house in Guangdong and a world class service economy in Hong Kong, we are determined to promote ourselves even better among foreign companies and make our region even more competitive.

Question: As you just mentioned, of course a lot of manufacturers are in the Delta and Hong Kong has been focusing on its financing strength, its legal services, ITs and logistics and so on. But you have 6.8 million plus people in the city, a great many of whom are qualified mainly to work in manufacturing and not in these high skilled areas, what is the economic future for these people in Hong Kong in the future?

Financial Secretary: For this issue, we have been thinking a lot. As I said, cost has been coming down. We are now, according to one survey, number 18 to the world now in the rental of offices compare to, say, a few years ago we were number two or number three. But on the other hand, we also recognized that with the improving business environment, we have to provide employment to our people, and as you said, a lot of people have not really been giving the opportunity to educate themselves, 46 percent of our population have only grade nine or Form 3 or below education. So, what do we do with these people. That's why this Government on one hand has been promoting the development of higher value-added sectors, such as financial services, professional services. And this is the right route for Hong Kong because Hong Kong, the cost is still higher than the rest of China. We cannot pursue low cost, labour intensive industries in Hong Kong. But on the other hand, we have to provide employment, and that's also why this Government has been promoting sectors such as tourism and local community economy.

If you don't understand the word read personal services, community services. These are the sectors that can provide employment to the lesser educated and lesser skilled. And along these two sectors, we have seen great improvements. Last year, the number of visitors had increased by 20 percent. There are a lot of initiatives in the local community economy. They are doing quite well and are providing employment. So, these sectors together with what I called the trigger down effect and that is with the higher value-added sectors developing, the employees in these sectors would require personal services and other auxiliary support services, we can create enough opportunity for the people that may not be engaged in the higher value-added services. But this is mainly the employment issue, it is one issue we have been thinking a lot within the Government.

Question: Mr Financial Secretary, I am going to ask you what many would consider a naughty question in polite society, but asking it doesn't mean to see I condone it. But Looking what Macau is doing, I am just wondering whether Hong Kong should follow suit. In other words, would or could the Government promote gambling and legalise prostitution, it makes a lot of money and employment?

Financial Secretary: You are very naughty. I also would have to ask Mrs Ho how she feels. It is a highly controversial topic. I believe the community should debate it. But on the other hand, I believe this is also an issue that may not receive widespread support. At least I think I would have to ask Mrs Ho first before I give you the official answer.

Question: You mention that we're on track predicted GDP growth down in 2002. What are you expecting for 2003, do you think we can surpass that or will it be slower? Also I want to ask you about deflation, it eased quite a bit in September. Do you think we're on track that isn't deflation going forward and maybe inflation?

Financial Secretary: I think all of you are trying hard to get a glimpse of what I am going to say in March. I'll give the official forecast in March. But at least looking at the raw numbers, export should continue to perform very well, at least at the first two quarters. Thereafter obviously it depends on what is going to happen in the Middle East. Deflation should perform better this year, meaning that we are not going to be at the minus two and a half or three per cent range for CPI and deflator this year. Because deflation itself, according to the economists, is a self- adjusting process. Secondly, part of the deflation last year was caused by the tax and fees relief that the Government provided last year. I believe you will have a reasonable guess for you to assume that may not be as much relief this year.

Question: I want to ask you Mr Secretary about Article 23. There is a feeling particularly among the international community and those of us who work with information on a daily basis that the Government seems held bent to push its version of the law through without taking the time needed to listen carefully and cope with those reservations that have been expressed. This is partly because the Government seems unwilling to publish a white paper. Can you please talk about Article 23 and what seems to many to be a rush to legislate that into law?

Financial Secretary: Well, I believe you have in your question put your fingers on the most important issues and the core of the issue and that is whether this Government is willing to listen. It is not about the speed. It is not about a lot of the other things. It is whether this Government is willing to listen, has a open mind. It is not about whether we should legislate because I believe most people in Hong Kong agree that it is something required in the Basic Law. Protecting national security is the responsibility of any country's citizen. So it is about whether the Government is willing to listen. Instead of arguing on a lot of what I called "minor issues" or the symptoms, the most important is to see when the Government publish the compendium of the consultation exercise comes up with our responses, is to see whether in our responses, they are concrete proof that the Government has listened. So there is really no point for me to assure you that we are going to listen. The key is look at the result and I hope that when you see the result, when you see our responses, you will be satisfied that this Government is sincere and open and will be ready to listen to the views of the public.

Question: In any well managed family, there is always got to be a balance between income and expenditure. If I was head of household of Hong Kong, I would be very very perturbed by the fact that there is about 70 per cent or just down there, my expenditure is spending on the civil service. Do you think that we would be able to run Hong Kong equally as efficiently with a considerably reduced civil service? Unless this is not the case, bear in mind that seems to be a big imbalance between the financial remuneration of the civil service, on the one hand, and a private sector individual, on the other hand, is the government prepared to look at drastically reducing the income taken by the civil service?

Financial Secretary: I believe that you should be in my position explaining all of these to the public. Indeed, we are faced with a situation that is very tricky. As you said, the operating deficit has been running at 3 per cent of GDP since 1998. And the expenditure size is largely relating to the salary, not just of civil servants, but actually of the subvented sector as well, meaning the public sector in general. Now, we all know that the government is a service organisation, and service organisation is people. And, we also believe that because of deflation and because of the rigidities of our pay adjustment system in the past, the salary of some of our colleagues maybe a bit out of line with that of the private sector. But in reality, we do not know. That is why we want to do a pay-level survey. Now, pay-level survey for you would be something that is quite common. Because most of you would do it every year. This government have not done pay-level survey for almost 15 years. So, we recognize that we need to review the situation. And we have the practice, I believe it is a good practice of consulting our colleagues in the unions and with the colleagues in general. And that is why we are discussing with the unions representatives about the pay adjustment and the pay adjustment mechanisms.

But, your point is well taken. If you are a household that cannot have enough recurrent income to meet its recurrent expenses, and if that situation is a structural one, not a cyclical one, that is worrying. And that is why we are urging the public to work with us to see how we can reduce the deficit to put our house in order. Otherwise, the international investors, the local investors, the speculators would begin to doubt whether our currency, our value of currency can hold. And if, as I said again, if there is pressure on the monetary system, there will be interest rate hikes, and it is not going to be conducive to economic revival.

End/Monday, January 27, 2003

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