"Hong Kong - A Bridge in Sino-British Bilateral Relations"

Ladies and gentlemen,

Bridges make strong metaphors. You remember that broken bridge in Bosnia at Mostar? It conveyed in a single picture the disintegration in that land. In April this year, there was a different picture from Hong Kong, with the opening of our beautiful new suspension bridge - The Tsing Ma Bridge. That was a product of an international co-operation, an Anglo-Japanese joint venture. It gave Hong Kong the means to link itself yet more strongly to the rest of the world, as the territory was about to be reunited with China. That picture summed up the hopes and expectations that we all have for Hong Kong : for it to be an enduring bond in the international economy. Then came October's tempest on the financial and stock markets. And the heavy seas that have followed from it. Everyone is asking whether our bridge of hopes and expectations has become a bridge of lamentations.

The short answer is no. Just as we have designed our new Tsing Ma Bridge to stand up to all the stresses and strains that time, tide and typhoon may throw at it, so too have we knit our economy, currency and financial management together in a strong and enduring structure, well able to cope with the stresses and strains the markets may throw at us.

What I would like to do is to spend a few minutes setting out for you what has been happening in Hong Kong over the last few months, and what our prospects are. You can then judge how well Hong Kong will retain its strength to carry trade, to encourage investment, and to service economic development in the years ahead.

As the financial turmoil in Asia was sweeping up Hong Kong over the past couple of months, we have seen three things happening : speculative attacks in the financial markets against the Hong Kong dollar; a volatile movement in the stock market, and a slowdown in our property market. All are related - sentiment about one has fed into the others - but we can look at each of them separately to clarify what is going on.

The attacks on the Hong Kong currency have been a consequence of a number of perceptions. First was the gut feeling that because other Asian currencies had fallen, Hong Kong should follow suit, forgetting that the Hong Kong dollar is unique in Asia in not being pegged arbitrarily and dependent on the credibility of a central bank, but is linked firmly to the US dollar by an autonomous currency board. Second was a belief that because the Hong Kong Monetary Authority that manages our currency board also manages our financial reserves and is engaged in banking supervision, it is like a central bank and might be pressured accordingly. Third was a calculation that, even if we did let the currency board act without interference, the higher interest rates that this would create would be too painful to sustain, particularly for banks heavily exposed to the property sector, and before long we would be compelled to break the link to the US dollar.

Those perceptions were and are profoundly wrong.

What drove the inter-bank lending interest rate very briefly to 300% during the attack on the Hong Kong dollar on what some in the market call the "Black Thursday" was not desperate intervention by a central bank, but the automatic market mechanism of the currency board as lenders had to scramble to obtain the dollars they needed to cover short positions. That mechanism is a simple but extremely powerful deterrent to speculation, or to those who support speculation. It has worked again this year, just as it has worked the few times we deployed it since it was established in 1983, just as it will go on working. I have made it public that I am reviewing all that we have done this year to defend our currency, but I have made it plain - and I emphasise this again now - that I am not going to move off the stable foundation of our currency board and the link at the current parity that it maintains with the US dollar. Making that clear; making sure that whatever we need to do to respond to the new developments in Asia's financial and economic position does not obscure understanding of that central fact, is the purpose of the review. In other words, we are sharpening our tools, making them more painful for the speculators and less so for ourselves, but we will not forsake our cause.

We have tried other monetary systems before. Between 1974 and 1983 the Hong Kong dollar floated. It was the most volatile and unsteady period in Hong Kong's economic growth since 1945. The Hang Seng index fell by 60% in one year, to rise 104% the next. Inflation rose from 2.7% in 1975 to 15.5% in 1980. The Hong Kong dollar halved in value against the US dollar. Since 1983 when we introduced the linked exchange rate, we have sailed steadily through a stock market crash in 1987, the turbulent events of 1989 in our Mainland, the Gulf War, the 1992 ERM turmoil, the 1995 Mexican peso crisis and now the Asian currency crash with our own currency keeping steady; steady economic growth averaging 5% per annum in real terms and a steady increase in interest among international businesses looking to make long term investments in the region.

For the exceptionally externally oriented economy of Hong Kong, which depends so much on international trade, exchange rate stability ranks highest in our economic considerations. Unlike that of most well developed and larger economies, Hong Kong's external trade (visible and invisible) amounts to 284% of our GDP. The corresponding figures are 24% in the UK and 59% in the US. We simply cannot afford to give up the steadiness, strength and stability which the linked exchange rate regime has brought to Hong Kong.

In part, that is a political statement. Hong Kong is once more a part of China, but the strength and independence of the Hong Kong dollar is the visible expression, in economic terms, of the "one country, two systems" concept; the assurance that Hong Kong does have a high degree of autonomy. The recent statements by our leaders of their confidence in Hong Kong's ability to manage the financial turmoil, and their refusal to intervene unless it should have been at our request, were exactly what was needed to demonstrate their faith in Hong Kong's system and management, and to give assurance to the world that these would remain unchanged.

But, events elsewhere in Asia have demonstrated that statements of political will are of no value where they are not matched with sound economics and financial discipline. I am confident to make a political statement about the Hong Kong dollar link because I know that it is economically sensible.

Maintaining the linked exchange rate does cause pain sometimes through higher interest rates. It is one of the reasons for the stock market decline and the major reason for the sluggishness in the property market. But think what these declines indicate. They show the real economy adjusting quickly and efficiently to market realities, adjusting in ways that will give long term improvements to our competitiveness. Since the 80's, Hong Kong has seen spectacular asset appreciation, which, particularly through effects on property prices and rents, have blunted our competitive edge. That is now being shaken out. Our banks, like their counterparts elsewhere are exposed to the property sector, but they also have much higher capital adequacy ratios than other banks in the region - or indeed in the UK - and the property market is substantially different from that in many other troubled parts of the region. We do not have huge stocks of unused office space, great blocks of unfilled flats. Vacancy rates are among the lowest in the region and developed economies. Meeting the demand for decent homes from a prospering and growing population, and meeting demand for high quality business facilities from increasingly sophisticated local and international companies will remain great challenges for our compact, physically constrained city. Softer property prices and rents are not so much a problem as a real opportunity to put home ownership within reach of more people who need it, and to reduce the costs of doing business in Hong Kong.

Contrast that sharp but sensible adjustment with what would happen if we accepted the plentiful but ill judged advice to improve our competitiveness by devaluing our currency. I ask myself, first, whether there would be any advantage at all for Hong Kong in devaluation, since the Asian economies whose currencies have fallen are not our major competitors or trading partners. Most of our trade in goods and services is with China, the USA, Japan and Europe, against whose currencies ours has remained stable - with the exception of the strengthening pound. Even if I were to find some immediate advantage, I would next have to ask myself how soon we would see that advantage eaten away by inflation as we had to pay higher costs for our imports. Since the costs of our annual imports even now substantially exceed our GDP - indeed the value of our total trade is equivalent to nearly three times our GDP - it doesn't take very long to work out that any advantage would be gone as quick as a flash. The markets know that. Any devaluation would have catastrophic consequences for our stock, financial and property markets. It would do lasting damage to our economic prospects.

The discipline that the linked exchange rate mechanism imposes on Hong Kong is good for Government and good for our business. Upon Government it imposes prudent fiscal policies. We have no debt. By keeping any increases in Government expenditure within the trend rate of growth of the economy, we have been able consistently to improve services while cutting taxes and increasing our financial reserves : reserves that ensure, even in the face of the more difficult economic conditions of today, that we can sustain programmes of investment in infrastructure and education needed to keep Hong Kong competitive in future. On companies, the discipline has the effect of forcing them to seek real improvements through innovation and productivity to remain competitive. Again, Hong Kong has shown consistent improvements in productivity and in the variety and responsiveness of its services over the past decade, improvements that have kept us ahead of our regional competitors.

The present adjustment process is painful, but I have no doubt that it will lead to Hong Kong emerging from the present difficulties in Asia sooner than any others, and in a stronger position to serve the next stages of economic development there.

On top of that, we have the enduring strength of our unique position in relation to our motherland, China. China isn't some pot of gold at the end of the rainbow, there for the picking if you could only get there. It is a tough market that one needs to approach sensibly and steadily to earn returns. You know from your newspapers the formidable difficulties that China faces in terms of reform of its State Owned Enterprises, from growing inequalities of wealth, or from environmental pressures. I don't under-rate those difficulties : nor should any investor. Yet it is a market of unparalleled opportunities. Hong Kong's relationship with Mainland China is one of our biggest competitive advantages.

I have two reasons for that confidence. First of all, if you ask what China needs to do to develop its economy, the answer comes back that a three pronged approach is needed; spreading market forces through enterprise and pricing reform; servicing markets through legal, social, physical and institutional infrastructure; and integrating its economy with world markets. That programme is exactly what China has committed itself to at the 15th Party Congress earlier this year. Their plans have moved away from the old emphasis on physical and numerical targets, to strategies and policies designed to sustain steady growth through improvement in efficiency.

Don't doubt the difficulties, but don't underestimate the strengths of China's economy either. Inflation is low, domestic savings rates are exceptionally high, the domestic market is huge; and, China's record of consistent reform over the past nineteen years is unparalleled. The target that China has set itself of 8% growth over the current five years is not ambitious. According to the latest World Bank analysis, Mainland China's savings rate can afford to decline from the present level of over 40% to 35%, and annual productivity gains could drop to only about 1.5%, her annual GDP growth would still exceed the 8% target. And I note that the IMF and World Bank have consistently under-estimated China's growth potential in year's past.

Within that steady process of reform and growth, the potential for Hong Kong entrepreneurs and investors is substantial. Equally, there is a growing demand for services, which, pre-eminently is what Hong Kong has to offer. Our accountants, lawyers, financiers, designers, production engineers and marketeers are finding ever wider fields for their endeavours.

The second reason for seeing opportunity for Hong Kong in China's market grows from that experience with China's economic reform. Yes, that reform makes it easier for foreign companies to go directly into China. Yes it means that we face growing competition within China. But competition is good for us. It helps us to refine what we do best, and to innovate. Nowhere else has the depth of experience that we have in doing business with China : not just local companies but nearly 9,000 overseas companies having offices in Hong Kong, 1,000 of those being British. We have a growing pool of expertise, finance and ideas, that is uniquely flexible, ready to put together in new packages to profit from market opportunity.

Even in the middle of all the uncertainties about Asia, and these testing times on financial markets, in Hong Kong we are pressing on with measures to make ourselves a better place for doing business. Over the next five years we have a massive programme of investment in education, focusing on improving the quality of basic education, language training and information technology skills. We are the first place in the world to offer an interactive TV licence. We are vigorously extending the use of new technology to improve services in the public sector. We are strengthening the framework for the private sector to exploit the potential of the information age. Next year our new airport will open. That will release the manpower resources we will need to embark on massive railway development programmes to improve internal transport and serve the flow of goods and passengers between Hong Kong and the mainland. We will continue to take every opportunity to reduce the costs that Government imposes on business in Hong Kong - costs which are already among the lowest in the world.

And we are not neglecting the qualities that give us the most fundamental competitive advantages : the soundness of our legal system; our campaign against corruption; the openness of our Government policies, decision making and purchasing processes; the free flow of information; a free press; a free market; freedom of choice. In short, Hong Kong will remain a civil society, wedded to free markets and the rule of law. That is a structure in which many of the components have a "Made in Britain" label on them. It is a structure that we in Hong Kong have made our own, that we treasure, and will continue to build on. It is a structure that can stand supple and strong under any conditions. It provides the foundation for Hong Kong to stand as a lasting bridge between Britain and China.