Outlook for 2009

inSight

31 Dec 2008

Outlook for 2009

A challenging year ahead.

All indications are that the year ahead of us is going to be tough. It is not a matter of whether we will have a recession but of how deep the recession will be. With the financial systems of the developed markets dysfunctional to varying degrees, the global economy will suffer. And as a highly externally oriented economy, Hong Kong will not be spared. Fortunately, our financial system is still intact and structurally robust, although there has been a need for some government support, notably the blanket guarantee for customer deposits and the other measures that the HKMA has taken to stabilise the operating environment of the banks. But compared with what the authorities in the developed economies in Europe and America have had to do to rescue their banking systems from a total collapse, involving nationalising a significant part of their financial systems, I would say that Hong Kong has not done badly.

The current concern over the functioning of the financial system of Hong Kong is whether it is performing the important function of financial intermediation well enough to sustain economic activity. Stresses in the global financial system are making financial intermediaries in Hong Kong more risk averse than before. This is understandable, given the fairly sharp downturn in the economy and asset prices, both of which are affecting the ability of borrowers to service debt. But, as I have pointed out before, there is some risk of credit tightness and economic downturn reinforcing each other. This is something that no one wishes to see. To prevent it from occurring, the banks need to take a longer-term view of their lending activities and be alert to the possibility of the short-term tightening of credit by them collectively undermining their long-term positions. I am sure the banks are able to manage this risk. Meanwhile, I am glad to see the resolve of the Government in assuming some credit risk through expanding the SME loan guarantee scheme.

The HKMA will continue to provide as accommodative a monetary environment as possible to support general economic activity. But obviously monetary easing will have a diminishing return as interest rates approach zero and as systemic liquidity, measured by the size of the Aggregate Balance, hits record highs. This is akin to pushing a string, as long as heightened credit concern remains. There is a need for fiscal stimulus to support the economy and we welcome the measures taken by the Government.

Readers will have noticed the recent substantial inflow into the Hong Kong dollar. While this gives us the opportunity to engage in quantitative easing, there is always the risk of a reversal of the inflow. We are acutely aware of this possibility, given its implications for domestic monetary conditions, although we do not see any plausible reason why it might happen in the near future. The inflow, to the extent that we can ascertain, reflects principally the unwinding of carry trades. But there are other possible reasons, including the repatriation of funds from overseas to finance domestic activities, given the diminished availability of domestic credit. There has also been talk of an inflow of funds to position for a possible rebound in the asset markets, based on the view that Hong Kong will benefit from sustained economic expansion on the Mainland. There is also the possibility of an inflow of funds to take advantage of the blanket deposit guarantee, although I doubt this, since foreign-currency deposits are also guaranteed. But we shall be able to see the picture more clearly as the deposit figures from the banks begin to come in. None of these reasons, however, is conducive to a sudden reversal of funds.

We will try to keep the monetary and financial environment this year as favourable as it can be under the circumstances, and I hope that this will contribute to lessening the severity of the economic downturn and the pain that the community may suffer as a result of the sharp downturn in the global economy. However things work out, I wish all of you a happy and healthy new year.

Joseph Yam
31 December 2008

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