Following is a speech by the Financial Secretary, Mr John C. Tsang, made at the Foreign Correspondents’ Club luncheon today (12 September 2007) (English only)

Ladies and Gentlemen,

First up, I would like to thank the Club for laying on lunch today. It is always good to meet old friends and make new ones in the convivial atmosphere of the FCC.

As you know, the economy nowadays is in pretty good shape. We’ve had sustained, healthy growth, with inflation remaining benign so far.  Unemployment is edging down. All in all, the figures are enough to keep a smile on this Financial Secretary’s face.

But, it’s at times like these that we can’t afford to be smug or complacent. When the going is good, we need to crank up our awareness of any sign that could transform a ‘good’ into a ‘goodness me!’

Because our economy is in such robust condition, now is the time to be thinking about how we can upgrade our workforce, improve our efficiency and boost our productivity. That way, we’ll be better prepared for the economic bumps and dips that we will inevitably encounter in the future.

And because Hong Kong is such an open and externally oriented economy, we are always at risk from outside factors. If there is a slowdown in demand globally – especially in the US or Europe – we will feel that in Hong Kong.  If the Mainland’s economy starts to slow down, we will feel that in Hong Kong. The unraveling of the subprime issue is a recent example of how a global financial centre, such as Hong Kong, can be caught up in problems not of our own making, especially as far as investor sentiment goes.

I would like to mention another risk.  We have not heard too much of this potential issue in these past few years, but it was actually the bane of our economy in the early and mid-1990s. Remember when durians and hairy crabs were luxury items, like Japanese grown melons? Remember high rents, high wages and high property prices? Remember inflation? That’s one of the things that features prominently on my radar screen at the moment – that “I” word. Inflation. And that’s what I would like to talk about today.
 
Rising prices are a natural occurrence during any economic upswing. As demand increases and consumers could bear to pay more, prices will edge up.  You will agree that a little bit of inflation is not necessarily a bad thing, but we must be careful of its continuous creep.

In Hong Kong, inflation up to end-July stood at 1.5 per cent. It would rise to 2.5 per cent if we take away the one-off effects of various measures that we have  implemented, such as rates concession.  But, even 2.5 per cent is still rather modest by most standards, what we would refer to as benign – particularly with an economy our size growing at an enviable rate of  6.3 per cent in the first half of this year.

No doubt you have seen the headlines and news reports about the Mainland’s steaming economic growth, and what it means for Hong Kong. Rising food prices in the Mainland are often highlighted as an area of particular concern for us.

That’s logical enough given that we import about a quarter, actually 26 per cent, of our food from across the boundary. In fact, it is not just food prices that are going up – everything from the Mainland is costing us more because the Renminbi has appreciated against the Hong Kong Dollar.  

So, let’s look at these two factors – food prices, and Renminbi appreciation. Taken together, it seems that the cumulative effect should create a huge impact on our economy, but our figures suggest that the impact on Hong Kong’s inflation rate so far has remained moderate.

Food prices across the boundary rose 7.6 per cent during the first half of this year. When you take into account the 5 per cent cumulative appreciation of the Renminbi against the Hong Kong Dollar, we should in theory be paying about 13 per cent more for our food imports from the Mainland. But instead, they rose by just 3.1 per cent in the first half of this year.

Why? There are technical reasons such as the use of different weightings in measuring inflation. For example, the ‘basket’ of goods to gauge inflation across the boundary is different from ours, and the weightings given to food are higher in the Mainland.

Furthermore, competition in the market helps to prevent upstream price increases from being fully passed on. Our food imports come from all over the world and there is a lot of competition. Indeed, market forces have helped to keep prices in check at both the wholesale and the retail levels.

If we look further afield, world food prices have risen by about 10 per cent in the first half of this year. The price of our food imports from Thailand for example, rose  by 8.3 per cent on the back of a 18 per cent appreciation in the Thai Baht against the Hong Kong Dollar. That’s the biggest rise we have had from our food imports.

Australian produce, on the other hand, rose by a more modest 3.6 per cent, even though the Australian Dollar has appreciated by about 10 per cent against the Hong Kong Dollar. In other words, Hong Kong has been blessed by the cushion of market forces against the full effect of food price inflation in the Mainland, or from elsewhere in the world. But given the persistent increase in the Mainland’s inflation rate, we can expect even more pressure on the price of food in the future.

The International Monetary Fund says the current trend of higher food prices is due to a couple of interlocking factors. Several poor corn crops, coinciding with growing demand for crop-based fuels such as ethanol, has diverted crops away from being earmarked for livestock. This pushes up the cost of raising cattle, pork and poultry – and ultimately leads to higher prices for produce such as meat and eggs, and even soft drinks that use corn syrup as a sweetener.

The weakness of the US Dollar vis-a-vis other currencies is also likely to impact on the price of imports such as food, oil and services. So far, however, imported inflation has been moderate. Overall import prices rose 2.2 per cent in the first half of 2007 year-on-year. The volatile exchange rates we have seen recently are also something we are keeping a close eye on.

Although external influences will have some impact on our inflation rate, history has shown that in Hong Kong’s case, inflationary pressures come mostly from local factors, such as rents and wages.

Between 1991 and 1997 annual inflation averaged 8.5 per cent. Workers demanded higher salaries to pay for rising rents, among other things. At the same time, companies were struggling to retain staff because of a “brain drain” of talents leaving Hong Kong during that period – so there was added wage pressure because supply was short, and demand was high. Our competitiveness suffered because costs were simply rising too quickly.

This was immediately followed by an entirely different set of problems. What went up came down with a crunch. The Asian Financial Crisis burst the property bubble – and prices plummeted. A new problem, negative equity, sapped consumer and business confidence. Unemployment edged up. Hong Kong slipped into a long deflationary cycle that lasted more than five-and-a-half years.

We should learn from the lessons of the past. What goes up, must come down.  Not quite rocket science. When irrational exuberance fuels inflation, the flip side of the coin can be a painful and prolonged correction.

The indicators at present do not suggest a return to high inflation. But, we must remain vigilant.

Today, there are, in fact, many positive signs. Businesses are expanding. There is a growing demand for office space. Productivity is keeping pace with salary increases. The workforce is growing. Unemployment is dropping.

Property prices and rents are one area we are keeping a close eye on. Although average retail rents are about 10 per cent below their 1997 peaks, the top-end office sector is facing upward pressure. In some cases, rents are about the same or slightly higher than levels 10 years ago. This is a concern because, just like the mid-1990s, we don’t want high business costs to undermine profits and affect Hong Kong’s overall competitiveness.

It is a similar situation in the private property sector. Prices and rents are rising, though in most cases we haven’t seen a return to 1997 levels … yet.

The high-growth, low-inflation era of the past few years is our best economic performance in recent history. But, as I mentioned earlier, now is not the time to sit back and relax, or let down our guard.

One reason we are determined to avoid a return to high inflation is because it strikes hardest at the lower-skilled workforce, not just in their pockets but also at their collective psyche. So, that is why we are devoting considerable resources to training, retraining and education to re-equip them for future challenges. By doing so, we can boost the capacity of our workforce and enhance competitiveness. A skilled and highly productive workforce is a valuable resource that can also help fight inflation.

The Government has helped to keep a lid on inflation through the implementation of various fiscal measures, such as rates and other concessions. As I mentioned earlier, such efforts have managed to shave about 1 per cent off our inflation rate.

Maintaining prudent lending practices by our financial organizations would also help to cut the inflationary spiral.  And I have every confidence that our banks will do just that. This will not only help maintain price stability in the property market, it will also boost confidence in our banking system in this uncertain interest rate environment.

The Central Government has raised interest rates four times so far this year to help cool rapid economic growth. On the other hand, the US Federal Reserve is toying with a rate drop. Because of our currency link to the US Dollar, there will be implications for us. With our economy so strong and with so much liquidity, we need to be careful that cheaper borrowing does not boost demand so much that prices will begin to rise, pushing up inflation as a result.  

The outlook at the moment is quite positive. The fact that more companies are setting up offices in Hong Kong is a clear sign of confidence in our economic policies as well as our economic potential.

We can and we will continue to facilitate trade with the Mainland. Upgrading infrastructure, cutting red tape and improving interfaces between our financial systems are just some of the measures we are working on. These, too, will enhance competitiveness as well as lubricate the wheels of trade.

Promoting economic development helps to enhance productivity growth, and this is the ultimate strength of our economy in tackling inflationary pressures. If rents and wages were to go up, and productivity of the workers and the firms are also rising in tandem, then the increased costs are shared out by a large amount of goods and services, resulting in little inflationary pressure. Having a high rate of growth in productivity in recent years is an important reason why our strong economic growth has not been accompanied by a higher rate of inflation.

In the longer term, attracting more high calibre individuals to work in Hong Kong helps to ensure a stable and efficient workforce, and to reduce wage pressure. There is also room to further improve our various immigration schemes for talented people and investors. Another way to draw the best and brightest individuals to Hong Kong is to develop our capabilities as an education services provider. This will also expand the horizons of our own students and better prepare them to tackle the challenges of the outside world.

Ladies and Gentlemen, we can all play a role in maintaining a moderate inflation rate. Banks through their lending policies, workers by upgrading skills and the Government by continuing to invest in education and training, facilitating trade and investment, and streamlining procedures.

Inflation can also be a self-fulfilling prophecy. The US Federal Reserve Chairman Ben Bernanke noted on July 10, 2007 that the public’s expectations of inflation greatly influence actual inflation. So, if inflation expectations are well anchored, that is, if we are confident of sustaining a low inflation rate, then it is easier to deal with any shocks, such as a spike in oil or food prices.  So help me out, and repeat after me our new mantra: low inflation! low inflation! low inflation!

Today, the risks of high inflation in Hong Kong does not appear to be great.  We believe the inflation rate for 2007 will be close to our forecast of 1.5 per cent. A low, stable inflation rate will not be bad for Hong Kong because low inflation in a high growth environment engenders confidence in the sustainability of our market. Companies become more confident to invest when they see a low inflation environment. More investment means more jobs, and even more growth.

Similarly, we do not want to fall back into the deflationary gloom that beleaguered us for 68 months – a period characterised by low consumer confidence, lower wages, lower rents, lower investment and high unemployment. A period that was precipitated by high inflation.

History has shown that challenges can come out of left field, impossible to predict. But there are other challenges we can prepare for, which is why I’m keeping an eagle eye on inflation.

Thank you very much.

Ends/Wednesday, September 12, 2007
Issued at HKT 14:49

NNNN

News Archives | Yesterday's News