Boosting demand best way to counter deflation, says Financial Secretary

The government is trying to counter the effects of deflation by increasing demand from outside Hong Kong, the Financial Secretary, Mr Antony Leung, said today (January 23).

Addressing the British Chamber of Commerce in Hong Kong, Mr Leung said many governments had been unable to successfully deal with the problem of deflation.

"But, for Hong Kong, we might be in a slightly better situation, given our relatively small and open economy," he said.

Mr Leung said there were a number of ways of increasing demand from outside Hong Kong. These included raising the city's attractiveness to foreign companies; through tourism; through the financial sector; and through investment immigrants.

He said Hong Kong's attractiveness to foreign companies to operate out of the city was its speciality in providing higher-value services.

"You know as well as anyone the added value that Hong Kong provides. This is also proven by the fact that the number of regional headquarters and offices of international companies in Hong Kong has more than doubled in the past decade, from 1,300 to 3,100," Mr Leung said.

In tourism, Hong Kong is continually upgrading its product. Last year it received a record number of 16.5 million visitors, nearly two and a half times the population. The largest increase came from Mainland tourists, whose numbers grew by over 50%.

The Financial Secretary said the third way new money was being brought into Hong Kong was through the financial sector.

"Last year, we had a record number of new listings. Together with secondary offerings, $108 billion was raised in our stock market, of which $70 billion was raised by the H-shares and the red-chips," he said.

"We welcome companies from China - indeed from all over the world - to be listed in our markets, which attract not only local investors but international ones as well. We certainly would like to see progress in other areas, such as QDII, which allows Mainland investors to participate in our financial markets in a regulated manner."

Mr Leung said the fourth area being looked at was expanding schemes for investment immigrants. These investors bring in not just money but their entrepreneurial flair and business skills.

He said the government would shortly announce new measures to attract these immigrants.

The full text of Mr Leung's speech to the British Chamber of Commerce follows:

Norman (Lyle), Chris (Christopher Hammerbeck), distinguished guests, ladies and gentlemen,

Thank you for inviting me back for a return engagement a year after I last spoke with you. I suppose that means last time I said enough of the right things, or the wrong things that attracted attention, to warrant a return invitation.

I also want to thank the British Chamber of Commerce for your carefully considered and wide-ranging Budget proposals. The government values the input of our friends in the international business community, not only because we know and appreciate how much you've contributed over the years towards Hong Kong's economic vitality and cosmopolitan way of life, but also because I know I am talking to a group who understand the strengths of Hong Kong very well, and who have been providing constructive input towards the shaping of policies.

I cannot discuss specifics of the Budget at this stage, of course. But I can tell you that the Government agrees with many in the international business community that Hong Kong's most pressing concerns are reviving the economy and reducing the deficit.

Strong reserves

Yes, we have our reserves to buffer us from the deficit problem. Our reserves mean we don't have to borrow to cover the deficit, at least for the time being. This has given us and the international financial community some comfort. Last week Fitch reaffirmed both Hong Kong's credit worthiness and our stable outlook. The agency recognised our still sizeable reserves, our healthy external accounts, our strong banking sector and our robust legal and regulatory framework.

However, while the reserves can buy us some time, they are not the ultimate solution to our deficit problem. Our recurrent account alone has been running a deficit of over 30 billion dollars per year for four years in a row. We cannot keep chipping away at our reserves. We cannot simply run down the coffers and leave them empty for future administrations. We must do the responsible thing, which means we must address the deficit now, no matter how unpopular it will be for the Financial Secretary. If we do not tackle the deficit, it will affect monetary stability and eventually the overall economy.

To tackle the deficit, we must do three things simultaneously - stimulate the economy, reduce Government spending and increase revenue.

Cutting expenditure

Let me first talk about cutting expenditures. We have set the target to reduce projected recurrent Government spending from 220 billion to 200 billion dollars by 2006-07. This will be achieved partly through reducing 10% of the civil servants. These targets might sound trivial to you in the business sector. Actually I thought the same before I joined the Government. But when you take into account the rigidities in the public sector, such as the need to maintain essential services, our contractual and statutory obligations, and the process required to consult stakeholders before major changes can be made, this is actually a fairly respectable target. This could be achieved only if all sectors of the community, including our civil service colleagues and recipients of public services, are prepared to help shoulder the burden. I believe that, by and large, Hong Kong people recognise the need for every one of us to tighten our belts. It's a painful process, but it is absolutely essential for us to grasp the nettle and bring the deficit under control.

I should point out that reducing Government spending has another effect of giving the private sector more room to flex its muscles. As I told you a year ago, I firmly believe that Hong Kong's resources are best used when they are subject to market forces. So we are pursuing what I call three Rs and one M. That is, we are Reprioritising our work, Reorganising government structures, Re-engineering processes, and, under M, making use of the Market to provide services. By that I mean we are outsourcing as well as considering corporatisation and privatisation. We are hopeful that these initiatives will not only help us reduce costs, but also make the economy stronger and more flexible.

Raising revenue

Turning to the subject of raising revenues, which I am sure all of you are very interested in, I note that the British Chamber has put to me quite a number of
recommendations, though a very noticeable omission is an increase in profits tax rate. Joking aside, I am now still listening to views from various quarters of the community and have not made a decision on revenue measures. But I fully agree with the Chamber's view that we should maintain a simple and low tax regime. As the Chief Executive has stated clearly in his Policy Address, we are proceeding cautiously to strike the right balance between maintaining financial discipline on the one hand and the need to revitalise the economy on the other. Indeed I am mindful that the community may resent significant tax increases when many are still struggling through the present economic difficulties. We should not simply look at ways to balance the book without having full regard to the prevailing sentiments of the community. The ultimate success will depend on a collective goal commonly shared amongst our people.

But, while we cut costs and increase revenues, the foremost method of dealing with the deficit is to reinvigorate the economy. To do that, we must further
improve what is already an exemplary business environment, and remove existing rigidities in our economy. As the Chief Executive announced in his Policy Address this month, the Government will establish a high-level task force to put forward policy recommendations on how to cut red tape, streamline procedures, de-regulate and generally help business run more smoothly. When this task force is set up, your suggestions will be most welcome, as always.

Economic stimulation

Stimulating the economy also involves grasping the opportunities presented to us in our friendly and thriving hinterland. That's why we have done a lot to facilitate the flow of people across the boundary and increase economic co-operation with the rest of the Pearl River Delta. We will be doing more to ensure that Hong Kong continues to be the best business hub in the region. Many major companies are already manufacturing or sourcing in the Mainland with a base in Hong Kong, including those from Britain. They are taking advantage of the low cost and high quality of production facilities in the Pearl River Delta, while using Hong Kong as their headquarters and a quality place to live.

I still recall when I visited London last November, I saw the business community there so upbeat about the booming China market, including Hong Kong and our
neighbouring Pearl River Delta. Many multinationals have entered the China market in one form or another and are creating enormous business opportunities for themselves. Now we're telling small and medium-size enterprises from all over the world that if they want to compete, they too should come to China. But for SMEs, investing or operating in China is not so easy. The surest way to succeed there is to partner with Hong Kong businessmen, who have decades of experience in China. At the same time, we are also inviting Mainland companies to use Hong Kong as their base to interact with the rest of the world.

Costs

On the other hand, greater economic integration with the Mainland, together with global overcapacity, has created enormous pressure on the price front. Deflation has been with us for over four years now. It is true that Deflation has its merits. We were far too expensive before 1997. Lower prices reduce the costs of doing business in general. Property prices and rentals, and to a lesser extent labour costs, have come down significantly, making Hong Kong a much more competitive place for doing business.

The Government has done a survey on the costs of living for expatriates in seven major cities - Hong Kong, London, New York, Tokyo, Singapore, Shanghai and Taipei. Our most recent findings showed that the most expensive is Tokyo, which is 40% more costly than Hong Kong. New York and London are second and third respectively, at 36% and 26% more expensive than us. Hong Kong comes in fourth, with our gap over Singapore at less than 10%.

Of course, our costs will never come down to the level of the rest of the Mainland, just as prices in London, New York and Tokyo are higher than those in their neighbouring areas. The magnitude of this price differential depends largely on our ability to provide higher-value services, which is our speciality. You know as well as anyone the added value that Hong Kong provides. This is also proven by the fact that the number of regional headquarters and offices of international companies in Hong Kong has more than doubled in the past decade, from 1,300 to 3,100.

Tackling deflation

But, deflation is hitting us hard because it affects public revenue, undermines investment confidence and depresses asset values. Even though our economy is growing at a decent rate in real terms, and exports are booming, the economic benefits are not being enjoyed by all. Particularly, the negative wealth effect caused by declining property prices has produced a psychological cloud that is difficult to dispel. We all know Hong Kong has successfully restructured before. We all know our fundamentals are sound. But it will take some time to restore the 'feel-good effect'.

Many people have asked me how we could tackle deflation. Actually, not many governments have successfully dealt with this. But for Hong Kong, we might be in a slightly better situation, given our relatively small and open economy. We are trying to counter deflation by increasing demand from outside Hong Kong. There are a number of ways. Increasing our attractiveness to foreign companies to operate here is one. I already mentioned the progress so far.

Another source of outside money is tourism. Last year, we received a record high number of 16.5 million visitors, or 2.4 times our population. The largest increase came from Mainland tourists, whose numbers grew by over 50% last year.

The third way we are bringing new money into Hong Kong is of course through our financial sector. Last year, we had a record number of new listings. Together with secondary offerings, 108 billion dollars was raised in our stock market, of which 70 billion dollars was raised by the H-shares and the red-chips. We welcome companies from China - indeed from all over the world - to be listed in our markets, which attract not only local investors but international ones as well. We certainly would like to see progress in other areas, such as QDII, which allows Mainland investors to participate in our financial markets in a regulated manner.

The fourth area that we're looking at is expanding schemes for investment immigrants, who bring not just money but their entrepreneurial flair and business skills. The Government will announce the new measures shortly.

Asia's world city

I should emphasise that while we continue to integrate economically with the Pearl River Delta and capitalise on the combined economic strengths of the region, Hong Kong will remain Asia's world city. Our greatest strengths lie in our differences from, rather than our similarities with other cities in the Mainland of China. Our positioning will continue to be as an international financial and business centre servicing the whole of Asia and beyond.

With this in mind, I can assure you that we will not be distracted by the current hardships, or ignore the fundamentals contributing to our success in the past. We are mindful of maintaining and indeed enhancing our institutional strengths - the rule of law, a level playing field, a low and simple tax regime, clean government, and the free flow of information and capital. In that context, I'm well aware that another issue is on the minds of international business people - Article 23 of the Basic Law.

As a former banker, I know very well the importance of the free flow of information to the operation of the financial markets and the conduct of businesses. The Government is well aware of the need to maintain the existing lifestyle and way of doing business in Hong Kong. The Security Bureau will soon publish a compendium of the consultation results and suggested improvements
on the proposal. The Government will continue to listen to the views of the public even after the draft legislation is published. We are keen to ensure that the concerns of the local public and the international business community are fully heard and considered.

Ladies and gentlemen, we do not underestimate the difficulties and challenges faced by our economy. We are working hard to implement concrete measures, and we are determined to deliver. I can tell you that we will wrestle the deficit into submission. I can tell you that we will help stimulate economic growth. And I can tell you that we will do everything in our power to strengthen our partnership with you, the international business community. Our vision is of a lean government and a muscular private sector, working together to lead Asia's world city into an exciting and prosperous future.

At the risk of jumping the gun, an early Kung Hei Fat Choi, and I wish you all a prosperous Year of the Ram. Thank you, and I'd be happy to take any questions you may have.

End/Thursday, January 23, 2003