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Budget Speech by the Financial Secretary (9)

Fiscal Reserves

76. It is expected that by March 31 this year, our fiscal reserves will stand at $365.8 billion.  Over the next five years, the fiscal reserves will be maintained at a level between $390 billion and $580 billion.  When I took up office as Financial Secretary, the fiscal deficit problem was very serious, with the Consolidated Account running a deficit of over $60 billion for two consecutive financial years, and the fiscal reserves expected to shrink further.  In view of this, I set the target level of fiscal reserves at an amount equivalent to about 12 months of government expenditure.  The current fiscal reserves have exceeded this level.  However, opinions are divided over whether this target should be maintained.

77. Hong Kong's fiscal reserves serve two main functions.  First, they help cope with fiscal pressure arising from economic downturns, unforeseen events or structural changes in the community.  Second, they assist the Exchange Fund in maintaining the stability of Hong Kong's monetary and financial systems.  I do not consider that the reserves need to keep expanding, but rather they should be maintained at an appropriate level with a view to providing adequate resources to meet our needs.

78. At the end of last year, the International Monetary Fund (IMF) analysed Hong Kong's financial position.  While recognising that Hong Kong's economy had benefited from our skilful macroeconomic management, the underlying flexibility of our markets and our sophisticated financial market infrastructure, the IMF remains concerned that our narrow tax base, revenue volatility and ageing population will bring pressure to bear on government expenditure over the medium term.  The IMF is of the view that, in the absence of any policy change or reform, the levels of reserves needed to anticipate fluctuations in revenue could be around 30 to 50 per cent of GDP, while those aimed at anticipating fiscal pressures arising from population ageing could mean putting in an additional 30 per cent of GDP by 2030.  I think the IMF's suggestions can be used as a frame of reference.  Since our fiscal reserves are of crucial importance in maintaining a healthy public finance system, the Government needs to listen to more views from the community in this regard before coming to a decision.

Investment Income of the Fiscal Reserves

79. The investment income of the fiscal reserves is another important source of revenue for the Government, yet it is extremely volatile.  It has represented between 0.5 per cent and 18 per cent of government revenue over the past decade.  Meanwhile, we have noted calls from the community for higher returns from the fiscal reserves.  After careful consideration and with a view to increasing the Government's investment income and enhancing its stability, I have decided to revise the income-sharing arrangement between the fiscal reserves and the Exchange Fund, subject to the principle that the Fund's ability to defend our currency and stabilise our monetary and financial systems should not be undermined.

80. Effective from April 1, the return on the fiscal reserves will be calculated on the basis of the average rate of return of the Exchange Fund's investment portfolio over the past six years.  Under the new arrangement, the rate of return on the fiscal reserves for 2007 will be 7 per cent.  I will also include the guarantee of a minimum return so as to ensure that the annual investment return in any year will not be lower than the average yield of three-year Exchange Fund Notes for the previous year.

(To be continued)

Ends/Wednesday, February 28, 2007
Issued at HKT 11:55


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