The challenges facing HK' s next finance chief
SCMP July 25 2003

It is natural that at this moment in its history, Hong Kong should be focused on politics. Contrary to the opinions of one-party-state apparatchiks and businessmen who "abhor politics" so long as their friends are in charge, politics is a generally healthy business of apportioning power among interest groups and ambitious individuals.
That said, it may be time for people in Hong Kong to lift their gaze from their navel and see what is happening in the world around them that may be relevant in the not-too-distant future. That is especially the case for whoever will be the new financial secretary.

Will Chief Executive Tung Chee-hwa choose a harmless placeman like the temporary incumbent Stephen Ip Shu-kwan, in the expectation that he will do nothing either in terms of policy or personal behaviour to make himself and the government unpopular? Or can he find an individual with sufficient vision, communications skills and public trust to make the hard decisions from which Antony Leung Kam-chung shied away?

Sars may be behind us, the Chinese economy is almost back at full throttle and the world economic picture is looking a little brighter. But Hong Kong is still facing a structural fiscal deficit of at least 3 per cent of gross domestic product. Mr Leung's budget proposals for dealing with it relied largely on rose-tinted expectations of asset sales and medium-term gross domestic product growth.

Hong Kong still needs a plan for more radical spending cuts and revenue increases. Whatever they are, they will not be an easy sell. But selling it will be a lot easier if the public can be convinced of the sense of fairness, as well as wisdom, of the financial secretary, that he or she is someone who is demonstrably not connected with major interest groups. Hong Kong could do with, and would likely accept, a dose of honest talk and some tough measures if Mr Tung's appointees and the upper bureaucrats were themselves prepared to do their penance.

The international situation looks to have more bumps for Hong Kong. Not all need be harmful. On the plus side, it is increasingly likely that China will revalue significantly, whether with a formal change or more likely a rapid adjustment via a trade-weighted basket. China hates to be pushed - but it has been prevaricating on its exchange-rate mechanism for too long.

An initial revaluation upwards of, say, 15 per cent would make economic sense, would win political kudos around the world and would show China to be the pacesetter in Asia. Others, such as Taiwan, Malaysia and South Korea, would follow with their own adjustments to exchange regimes, which would bring about further changes to the yuan's value against the dollar on a trade-weighted basis. Over a year, one could expect to see a rise of 20 to 25 per cent. Under this scenario, it would make sense for the Hong Kong dollar to remain pegged to the US dollar for the time being, improving competitiveness vis a vis the mainland and Asian rivals.

Longer term, Hong Kong also needs to move to a new exchange rate system which would accommodate the new realities in China and the increasing future role of non-dollar currencies. But that can wait until the next round of global currency adjustments - which began with the Euro and Australian and Canadian dollars, but has stalled thanks to Asian intransigence - is complete.

Escaping the dollar trap will be vital sooner or later. The major reason why the fall in property prices has not caused more pain, or led to the sort of mortgage defaults and bank collapses seen elsewhere in Asia in 1997-99, has been the collapse in interest rates. Negative equity is, as yet, mostly a theoretical problem. With property looking to remain plentiful and demographics remaining unfavourable, it is imperative that Hong Kong interest rates remain low. There are already signs that US rates have bottomed out.

There is probably little danger of a significant rise in short-term rates, to which almost all Hong Kong mortgages are linked. US Federal Reserve chairman Alan Greenspan is clearly determined to pump money into the economy, regardless of the consequences for the US dollar. But Hong Kong's new finance chief will need to start thinking soon about the future of the peg and, in co-operation with the Monetary Authority, explore how best - and when - to abandon the peg.

A different and bigger worry could be if the US resorts to new forms of protectionism to solve its trade problems. The New York Times may have hinted at things to come in an article last week, linking the failure of the US economy - to respond to huge doses of fiscal and monetary stimulus - with globalisation. Consumers are still spending, but increasing amounts are going on imported items. It is no longer just toys and garments, or even electronic goods, which come from overseas. Now, services such as computer programming and call centres are being outsourced. The world may have seen globalisation as an American-driven phenomenon, but it is beginning to bite the US. More people in America are beginning to ask whether there should be controls on outward investment, at least in more advanced industries. Proposals for restrictions on the importation of services are also beginning to surface.

Major currency changes, if they come soon enough, may start to turn the US trade situation around before the pressure for widespread protection gathers political momentum. But the deficit is so large in proportion to total trade that currency changes may be insufficient. Meanwhile, there is an election in just 15 months. Although the Republican administration is generally in favour of freer trade, the George W. Bush administration is not one to let international trade rules get in the way of politically advantageous unilateralist action to "protect America".

In short, the next financial secretary should commit to fiscal reform, attack cronyism and monopolies and distance the administration from business and family special interests. He or she must honestly outline the challenges that Hong Kong faces, which cannot be cured by better standards of governance - badly needed though those are.

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