Five Years on: legacy and agony

SCMP June 3


The Japanese have had ten years of economic and stock market disappointment. So do not suppose that Hongkong's five years of post-handover stasis is either exceptional or that the cycle will surely turn up again soon.

To make a stab at forecasting the future it is necessary to try to assess how much of Hongkong's present condition is the result of outside forces, how much was inherited from the actions of the previous administration and how much has been caused by the policies, or lack thereof, of Tung Chee-hwa and his team.

The worst short term legacy of the ancien regime was the property bubble (and accompanying Red Chip share scam) which peaked just before the handover.The euphoria suited the interests of both Britain and China, and the greed instincts of the local property-owning population. It was indulged by the HK Monetary Authority, then as now headed by Joseph Yam which - despite warnings -- made no effort to limit the credit growth which fuelled the bubble. Property prices would have deflated anyway, regardless of the Asian crisis which merely advanced the collapse by a few months. As in Japan, it has left a trail of households with negative equity and perceived need to save more, acting as a continuing dampener on the economy as a whole.

At the same time property and other prices failed to deflate fast enough to keep Hongkong competitive in an Asia which was dramatically deflated by the currency and asset price collapses on 1997/98. The numerous efforts - moratorium on land sales, end of HOS sales, tax relief for mortgages etc -- made by the government to help the property sector in general and the developers' cartel in particular slowed the price decline.

This undoubtedly helped limit the number of corporate and household bankruptcies. Unlike elsewhere in Asia, relatively little debt was in foreign currency and the peg spared Hongkong the impact of sharp currency falls on unhedged borrowers of foreign exchange. Meanwhile the fall in interest rates since 1998 has enabled most over-indebted households to withstand negative equity despite the rise in unemployment.

Like Japan, Hongkong has avoided major Thai or Korean style crisis but equally this has meant prolonging the period of stasis. Prices have not fallen far enough to bring buyers flooding back, despite record low interest rates. For fiscal reasons, the government now needs to sell more land, and interest rates are now more likely to go up than down. Government policy on housing still seems a monstrous muddle trying simultaneously to satisfy the demands of the masses for better housing at affordable levels, and of the developers (who are more interested in fat margins than in volume) and existing owners who want to see prices rise.

Ideally the government should reduce its role in housing. But it can only do so if affordability improves further. A sharp decline in the dollar, the return of some inflation and hence a fall in real interest rates should relieve the situation over the next two years. Previous asset price booms in Hongkong have generally been preceded by a decline in the currency. But demographics is now unfavourable. Though the population is growing at 1% a year due to immigration, new household formation is declining due to a fall in the 25-35 year group and few newcomers from the mainland have the skills and capital to be able to afford to buy their own homes.

The property bubble legacy would have been a huge burden for any government. But short term measures and the influence of the crony capitalists on public policy has made a bad situation worse. Out of the mess may finally come a coherent housing policy and fiscal policy reforms. But so far government has shied away from hard decisions on taxes which would reverse the irresponsible erosion of the recurrent tax base indulged in by Donald Tsang.

Government deficits of 2-3% of GDP have been justifiable in the short term as counter-cyclical props to the economy. But they must soon be reined in regardless of the overall economy, and temporary deficits are no excuse for putting off tax reform. As it is, the operating budget looks now to be deep in the red for several years. Land sales revenue will pick up but even so the government is likely to have to continue large scale asset sales - such as the MTRC/KCR to balance its budget. That is not a process that can continue indefinitely - ask Argentina.

One asset sale with diminishing returns is the Tracker Fund. Remember how Donald Tsang boasted about the success of the stockmarket intervention in defeating speculators and delivering a huge profit to the government? The intervention may have had short term benefits - though it was not neccessary to save the peg. What is coming through now is the long term cost - the overhang of Tracker units which has helped depress the market, and the use of MPF savings to fund the government's deficit by buying its Tracker shares.

There is also no doubt that the intervention damaged Hongkong's free market reputation, and reduced stock market activity by drastically reducing the free float of Hang Seng index companies. Worrying too has been the reaction of officialdom to the challenges posed by the Asian crisis.

In Korea, even in Malaysia and Thailand entrenched interests have been overthrown, cartels opened up. But Hongkong remains beholden to the interests of a small groups of inordinately influential people who dominate large areas not just of the domestic economy but of those which provide its links to the outside world. Port expansion has effectively been vetoed by the existing players. Air traffic rights protect Cathay Pacific at the expense of the territory's hub role. The Jockey Club has had its betting monopoly re-inforced. The Stock Exchange remains a private monopoly maintaining commission rules which militate against Hongkong's ability to compete as an international centre, and abjectly failing to impose reasonable standards on listed companies.

The GEM has been a disgrace. These have not just been minor matters. Investments which should have gone into real businesses ended end enriching the initial, already very rich, pre-flotation investors in the likes of PCCW and at the expense of the public. Massive losses by individual and institutional investors have had a depressing effect on investor confidence. The same may have happened in the US - but at least the US has legal remedies.

None of this is altogether new in Hongkong. But it has been highlighted by recession and the bursting of bubbles. It also appears to have become worse as the links between the political leadership and the leading families have been strengthened and the separation between the bureaucracy and private institutions such as the Stock Exchange been eroded. The Cyberport fiasco may have generated enough derision not to be repeated, but the kind of thinking which produced it is still alive.

The damage caused by Hongkong's version of cronyism has been increased both by the strong dollar, and by the development of China. It is still often complacently assumed that Hongkong automatically benefits from China's growth. In fact China is showing diminishing need for Hongkong as intermediary as its own transport and service infrastructure improves.

That is not to condemn Hongkong to the margin of China. But it does emphasise the need to allow new services to spring up, if necessary at the expense of old business and professional cartels and liberalising entry of mainland professionals. It also means taking better advantage of Hongkong's international links, and introducing competition laws which encourage new business and cut costs all round. Hongkong's problems are not unique.

Singapore is suffering from Malaysian competition jut as Hongkong must now compete with the mainland. Freer trade and movement of capital around Asia, and indeed globally, and a general lowering of taxes have reduced the relative attractions of the city states. But Singapore's leaders at least have clear policies, wrong-headed though these may sometimes be. Hongkong leaders meanwhile bandy about silly slogans like "Asia's world city" but their vision seldom seems to go beyond emphasising the merits of the Pearl River delta, as though that, not Hongkong's own institutions and world trading links, were its biggest advantage.

Instead of emphasising the attraction of Hongkong as a competitive global financial centre, Joseph Yam, the world's highest paid central banker, has been out with his begging bowl, asking for special privileges. He has been trying to convince a rightly sceptical Beijing that mainlanders should be allowed to invest in Hongkong stocks before they can invest in New York, Frankfurt or Singapore.

Such attempts to claim One Country privileges makes a mockery of the Two Systems and undermines the unique status that has been the basis of Hongkong's prosperity. Such attitudes will undermine Hongkong's prospects long after the property bubble collapse has finally worked its way through the system.

The way Hongkong has been managed these past five years reminds me of a comment I made in a column before the handover. If Hongkong could not elect its chief executive it would be best off with a hard headed mainland provincial governor with an outsider's clear view of Hongkong's strengths, allies in the Politburo, not beholden to local businessmen and as determined to do a great job for his adopted "country" as former Dutch coach Guus Hiddink has done for Korea's football team. As it is, in his efforts to please everyone from Li Ka-shing to Beijing to home owners and the old leftists Mr Tung has lost sight of the three things that matter most: openness, competition, internationalism. ends

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