Economic prospects for Hong Kong

inSight

27 Feb 2003

Economic prospects for Hong Kong

The external environment presents many risks and dangers, but there are grounds for optimism in assessing Hong Kong's future economic performance.

Just when the growth rate of our exports is picking up robustly, responding to the deflation-induced depreciation of the real effective exchange rate, dark clouds once again loom over the horizon. Geo-political tension has been intensifying lately, pointing to prospects of war and therefore disruptions to the world economy. Although there is hope that the war will be brief, if it cannot be avoided, the possibility of retribution through a resurgence of terrorist activities is disconcerting, and, in addition to the loss of life and property, it would most likely undermine consumer and investor confidence in the large economies.

Being so externally oriented, Hong Kong would inevitably be adversely affected by such a development. But it is to be hoped that, with a weaker US dollar, and so a weaker nominal exchange rate for the Hong Kong dollar against foreign currencies other than the US dollar, we might be affected less than our competitors. The large current account deficit in the US has for a long time pointed to the possibility of significant exchange rate adjustment, and we seem to be seeing this now. But it is difficult to tell whether movements in the last few months are the beginning or the end, and it is impossible to predict the extent of the adjustment. Many other factors are at work. In the past, war has largely been associated with strength in the US dollar. A weak US dollar is also rather vehemently opposed by a Japan that is well equipped to moderate adverse market movements, through words and action. On the other hand, the euro has become rather more attractive lately despite the unimpressive economic performance of euroland: there is sustained market interest and momentum favouring the euro, encouraged by higher interest rates for the currency. We can only hope, therefore, that movements in the exchange rates of the G-3 currencies will continue to underpin the recovery we have seen in our exports. If anything, this would alleviate the need for further deflation to produce the depreciation in the real effective exchange rate necessary for regaining our competitiveness.

Thankfully, the economy of the Mainland looks like continuing to grow strongly. Hong Kong will benefit from this, hopefully to an increasing extent as structural adjustment progresses further. It is difficult to see why Hong Kong's economy, in the fullness of time, should not grow at more or less the same pace as the Mainland's. The fact that our growth rate is currently only a fraction of the growth rate of the Mainland is a reflection of the deflationary structural adjustment that we have had no alternative but to go through. But one thing is sure. There will be an end to this adjustment process. For an economy with the external sector that is as large as two to three times of GDP, the possibility of a self-reinforcing deflationary spiral developing is very low. The favourable effects on exports, income and employment of the deflation-induced, accumulative fall in the real effective exchange rate will more than compensate for the depressing effects on consumption and investment of deflation-induced high real interest rates. And the end of the adjustment process must be near, given the renowned flexibility of the Hong Kong economy, although there really is no scientific way of telling how near. There is no doubt that the process has been painful and disruptive to a large part of our community, and has involved some casualties. But at this advanced stage of structural adjustment we should all persevere and work together to expedite and not to frustrate the process. We in the HKMA will try our best and continue to ensure that the dislocation arising from this profound change will not create systemic problems in the monetary and banking areas.

Our monetary system, characterised by the currency board-type fixed exchange rate, remains one of the most robust in the world, allowing Hong Kong to enjoy the very low interest rate levels of the US dollar and the comfort of a stable external value for our currency. I am aware of the continuing, helpful comments from those wishing to explore a less painful alternative to structural adjustment, involving the use of the exchange rate. But we all have to be realistically alert to the risks of destabilising volatility and the doubtful benefits that might be involved. On the banking side, the twin problems of bankruptcy and negative equity need close attention, but they are unlikely to attain systemic dimensions, if all concerned address these problems fairly and rationally. We should all be proud of Hong Kong's banking system. It is doubtful whether anywhere else in the world has a banking system that could survive unscathed after a fall of over 60% in residential property prices and emerge with high capital adequacy, ample liquidity and even more competitive.

 

Joseph Yam

27 February 2003

 

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