Eye of the Storm

Eye of the Storm

1. In the lead up to the Handover, we had often been asked the question as to what came after 1997 or what came after 1 July 1997. To demonstrate confidence in the future of Hong Kong under the twin principles of "one country two systems" and "Hong Kong people running Hong Kong", which are enshrined in the Joint Declaration and the Basic Law, we often replied robustly with punch lines - what came after 1997 must of course be 1998 or what came after 1 July 1997 must of course be 2 July 1997. This is an effective way of saying that things in Hong Kong would largely remain unchanged after the Handover.
2. Specifically on the monetary front, given that, with superb, quiet, close and effective Sino-British cooperation we had strengthened our monetary system and prepared ourselves as well as anyone could, one punch line that I had often used is that 1997 would turn out to be very dull. Well, I was wrong. The year, at least the second half of the year, has not been dull at all. The first of July 1997 was indeed followed by the second of July. But as the celebration of the Handover ended on 1 July, the worst financial turmoil in the history of Asia broke on 2 July.
3. Thankfully, I was wrong also for the wrong reason. The financial turmoil did not originate from Hong Kong because of the political transition. Hong Kong was the least and the last to be affected by the financial turmoil in Asia. If anything, many have since considered Hong Kong or the Hong Kong dollar as the pillar of stability in the region and a sterling example of financial prudence, the eye of the storm or an oasis of calm in a region of financial turbulence.
4. This audience is I am sure well aware of the efforts put in, ahead of the Handover, to make sure that the stability and prosperity of Hong Kong could be maintained after the Handover - the negotiations leading to the Joint Declaration, the promulgation of the Basic Law for Hong Kong, the work of the Sino-British Joint Liaison Group and the many discussions and meticulous preparations amongst the technical experts within that co operative framework.
5. Specifically on the monetary front, it was the joint effort of the technical experts on both sides, working together closely and quietly for a period of over ten years, reforming the monetary system, that have enabled Hong Kong to be in this relatively comfortable position as the storm swept through the region with such force, with particularly the Hong Kong dollar exchange rate remaining so stable as the currencies of our Asian neighbours tumbled one after another. This is a successful piece of history of Sino-British cooperation that may have been overlooked with the passage of time, and perhaps because of the lack of publicity at the time, which was deliberate, given that one would need to be extremely careful about discussions on issues which could be highly market sensitive. I had the privilege of being closely involved in these technical discussions in various capacities throughout, initiating and seeing through the implementation of a series of monetary reform measures, and building up a monetary armoury which has, and in the crucial year of 1997, in the days and months just after the Handover, proven to be most useful and effective. On this score, at least, I was right.

The Currency Board System of Hong Kong

6. But there had been controversies as well, as the automatic defence mechanism of our currency board system inflicted the inevitable interest rate pain across all sectors of the economy and the community, hurting speculators shorting the currency as well as the innocent borrowers paying mortgages. These controversies arose for two main reasons. First, the manner in which the automatic adjustment mechanism of the currency board system operates is not something that is widely understood. Second, the monetary reform measures in the past ten years or so, carefully introduced to strengthen that automatic mechanism in order to cope with modern day financial arrangements in which financial transactions are predominantly conducted electronically and globally rather than physically through the use of bank notes, had been misinterpreted by some to be a shift away from the rule-based currency board system to a central banking system involving discretionary monetary management.
7. As you know, the currency board system requires the monetary base, which should be clearly defined, to be backed 100% by foreign currency assets. More importantly, it requires the operator of the currency board, in our case the Hong Kong Monetary Authority (HKMA), to allow the monetary base to be increased or decreased only when foreign currency reserves are sold to it or bought from it respectively at or around a fixed exchange rate. And throughout this process, the HKMA is to be the passive party to those foreign currency transactions. But for the currency board system to be effective in maintaining exchange rate stability, having regard to modern day financial arrangements, the monetary base must include a crucial element. This is what we refer to in Hong Kong as the clearing balance of the banking system. It is the totality of the balances in the clearing accounts maintained by all the banks with the HKMA for the purpose of the settlement of interbank transactions, and also transactions between the banks and the HKMA.
8. It was only through monetary reform in 1988 that the clearing balance of the banking system was made subject to the discipline of the currency board system; in additional to currency in circulation being subject to that discipline when the linked exchange rate system was introduced in 1983. The HKMA was aware of the possible misinterpretation of its intentions when introducing reforms that also put it in the position, albeit unintentionally, of being able to create money or conduct open market operations of the central banking type. This is quite understandable, given always the risk, so evident in other jurisdictions, of political interference on monetary management for a political objective, although this is highly unlikely in view of our legal and institutional framework, and the high degree of transparency in the HKMA's operations. And the nature of these esoteric issues is such that nobody cares when things are going normally, but everybody would instantly become an expert when there is, as in the case of the currency attack last October, unusual pain.
9. So, encouraged by the Administration that has been politically responsive to the plight of the community and called for a review of our currency defence, rather critical comments had been forthcoming. Many accused the HKMA for messing around, and offered schemes for maintaining stability in the exchange rate and interest rates at the same time, thereby relieving the pain so heartlessly heaved by the HKMA at the economy, at the borrowers, particularly those having to spend a substantial part of their household income in mortgage payments. The call for a review was of course politically timely. And I suppose after ten years of continuous reform behind the scenes, a more public debate on the technical issues would serve a useful political purpose, if only to confirm the effectiveness of the efforts in the past, as long as the downside risk of creating a damaging impression that something has gone wrong on the monetary front could be managed.
10. Thankfully, supportive words from the international financial community, in particular endorsements from authoritative sources on how we handled the currency attack last October, gave us the vindication on the robustness of our system. The International Monetary Fund (IMF), in its report on the Article IV Consultations on Hong Kong in 1997, conducted interestingly right after the currency attack, said specifically that "it is important to recognize that allowing interest rates to rise in response to exchange market pressure is an essential element of the currency board mechanism that lies in the heart of Hong Kong's monetary arrangements. Recent events demonstrate that the system is working exactly as intended..." Michel Camdessus, the Managing Director of the IMF, praised the Hong Kong dollar link as a pillar of stability, a sentiment very much shared, publicly and privately, by leading central bank governors and finance ministers. Wim Duisenburg of the European Monetary Institute was in Hong Kong at my invitation to deliver the HKMA Distinguished Lecture earlier this year and he advised the Administration to "stick to your guns". I appreciate these comments very much.

Controversies

11. But I also appreciate the many ideas for improvement put forward by others, particularly those by the academic community in Hong Kong. There were suggestions for the HKMA to sell insurance products, guarantees, structured notes, options and other derivatives, so to speak, to put our money where our mouth is, in holding the exchange rate fixed to the US dollar at HK$7.80 to US$1. Such a demonstration of confidence, it was argued, would bring down Hong Kong dollar interest rates to levels closer to those for the US dollar.
12. But I doubt very much whether this would be a demonstration of confidence on the exchange rate system or, as others have pointed out, a demonstration of weakness. It could be seen as a lack of resolve to defend the currency and bear the necessary interest rate pain. Keeping interest rates artificially down when there is capital outflow amounts to providing cheap funding to those who are shorting the currency. These derivative products, however they are structured, in effect amount to discretionary intervention in the forward foreign exchange market, involving possibly an uncontrollable commitment of foreign reserves that even those with very large reserves would find the situation difficult to hold. This was the mistake of one or two Asian economies now in financial difficulty.
13. The academics have further argued that the contingent liability arising from these currency derivatives can be contained by limiting it to a credible amount and possibly also by suitably pricing them. But the fact of the matter is that the limited supply of such derivatives would benefit only those with access to the product and that there will be irresistible political demands, on grounds of equity, for supplying it to all. This process is likely to end in misery rather than greater confidence in the currency link. The pricing of the derivative product is also a tricky issue. If one allows the free market to price the product, by auction or by tender, chances are that the price would reflect the market interest rate differential between the Hong Kong dollar and the US dollar, which would defeat the original purpose of the product in trying to dampen the interest rate pain. If alternatively the pricing of the product is administratively determined, involving possibly a subsidy, then the difficulty is again to target equitably a group of beneficiaries entitled to the comfort afforded by the product.
14. A related area of controversy is whether or not the currency board should also be the provider of liquidity at the end of the day to assist banks that occasionally find themselves short of funds for settling outstanding interbank transactions. The HKMA has built and is running a real time gross settlement payment system which is one of the most robust interbank clearing systems in the world. This is a very important piece of financial infrastructure contributing greatly to financial stability in Hong Kong. But in doing so it might have given the impression that the HKMA, as operator of the currency board, is also the lender of last resort, something that the purists would object to. However, putting aside whether the HKMA is or is not the lender of last resort, we have to accept the reality of modern day finance underpinned by sophisticated information technology and the undisputed responsibility for monetary authorities over the "plumbing" of the financial system. The realistic answer to this complex question lies in the HKMA ensuring that any such provision of liquidity should be infrequent, suitably priced and secured by assets backed by foreign reserves. Without going into the technicalities of the relevant arrangements in Hong Kong, I can assure you that this is indeed the case.
15. Another controversy concerns the level of exchange rate at which the HKMA establishes its passive presence in the foreign exchange market and allows the automatic adjustment mechanism of the currency board system to be triggered by passively taking in US dollars from or selling US dollars to the banks. Some have suggested that the HKMA should always be present at just the fixed exchange rate of HK$7.80 to US$1. This would mean, however, that each and every foreign exchange deal would be transacted with the HKMA, thereby killing off the foreign exchange market involving the Hong Kong dollar altogether. So, in line with Hong Kong's free market philosophy, we have chosen to leave the foreign exchange market alone under normal circumstances and the exchange rate to fluctuate in accordance with the forces of supply and demand. But this does mean that under circumstances considered abnormal by the HKMA, the automatic adjustment mechanism would be triggered by the HKMA establishing its passive presence, not necessarily at, but around, the fixed exchange rate level. There is thus a degree of what I would call "constructive ambiguity" that does not involve any meaningful departure from the discipline of the currency board system. And I see no reason why I should show all my cards to the speculators.

Interest Rates

16. Hong Kong's currency board system has no doubt insulated the Hong Kong dollar from the process of competitive devaluation of Asian currencies. But we obviously have to pay a price and this is in the form of higher interest rates. When the speculative currency attack spread to Hong Kong in October last year, sparked off by Taiwan allowing its currency to depreciate, our interest rate for overnight money were bid up by those shorting the Hong Kong dollar to almost 300%. This, however, lasted for only around an hour. As the shorters realized that the only way whereby Hong Kong dollar liquidity could be provided to the interbank market, as dictated by the discipline of our currency board system, was for them to square their short Hong Kong dollar positions by selling US dollars back to the HKMA, the speculative pressure receded as quickly as it came.
17. But the market has since factored in an Asian premium in Hong Kong dollar interest rates over those for the US dollar, reflecting the perception of risk that the Hong Kong dollar may be swept along in the financial storm of Asia. This is notwithstanding the robustness of the currency board system which requires 100% backing for the monetary base by foreign reserves and the very substantial reserves that we have, which currently amount to about 800% rather than just 100% cover for the monetary base. The interest rate premium also reflects the higher credit risk of borrowers in an economy that is less buoyant and the funding risk for the lender in case short term interest rates are bid up to very high levels again as a result of another attack on our currency. But that premium has since been on a declining trend, with spasmodic blips of decreasing amplitude as sentiment was affected by ripples from Indonesia or Korea or rumours about a possible devaluation of the renminbi (RMB), the currency of the Mainland of China. Currently, the interest rate premium for the Hong Kong dollar over the US dollar ranges from 170 basis points for three-month interbank money to 230 basis points for a ten-year Hong Kong dollar issue over the corresponding US Treasuries. But for short term interbank money, for example overnight money, there is in fact a discount of around 140 basis points because of continued capital inflow.
18. You may be surprised to hear of the capital inflow. Indeed, we have been accumulating foreign reserves that grew from US$82.9 billion in the middle of last year to US$92.8 billion at the end of the year. Perhaps there has been a flight to quality, with Hong Kong being very much regarded as the typhoon shelter of the region. And the higher longer-term interest rates of a currency that is holding stable against the US dollar are clearly an added attraction. Furthermore, notwithstanding the rather sharp downward adjustment of asset prices seen recently, which is the inevitable outcome of some irrational exuberance in the past and so arguably beneficial for the longer term, the stock and property markets seemed to have quickly found its new equilibrium levels and stabilized. Whilst the sharpness of the falls is unpleasant to all, it is also a reflection of the efficiency of the markets concerned. In any case, taken over a longer period, the falls in the Hong Kong markets were less than that of most other markets in the region. There has also been limited damage to the financial system, particularly the banks, which have been exceedingly well managed, working closely within the prudential supervisory framework of the HKMA, and again well prepared for possible financial disturbance over the sensitive period of political transition.

Economic Outlook

19. That is why the Hong Kong economy is not expected to be severely affected by the turmoil. The official forecast, which has a higher batting average than most other forecasts, on the growth rate of the gross domestic product (GDP) in 1998 has just been put at 3.5% in real terms - a very respectable growth rate under the circumstances, although somewhat below the 5.2% recorded for 1997. As a result, inflation will continue to ease to about 5%. The fiscal budget will still be in surplus, albeit a smaller one than those in previous years, after major tax cuts. The unemployment rate currently at around 2.5% may edge up, perhaps significantly, or should I say the over-employment situation may ease; but, however one sees it, I hope unemployment would not become a serious concern. No significant adverse movement is expected on the balance of payments position, notwithstanding the substantial devaluation in the Asian currencies. This should not be surprising given that Hong Kong is now very much a service oriented economy, which should be less sensitive to exchange rate changes than a manufacturing economy. The notion that exchange rate changes are inversely correlated to the balance of payments position is, as economics textbooks would tell us, not necessarily true.

Exchange Rate Policy

20. Thus the economic outlook for Hong Kong is a lot better than many of our Asian neighbours. And in the context of Asian financial turmoil this must bring into question whether there was any point to the competitive devaluation that they had gone through. Indeed, many have underestimated the extent of hedging that could be generated when currencies which had been operating on fixed exchange rates are floated, particularly when there is perceived to be structural problems in the economies concerned. The situation had been exacerbated by financial liberalization that had not been accompanied by the building of a robust monetary management mechanism, a modern framework of prudential supervision and a sophisticated financial infrastructure for moving money and financial instruments safely and efficiently. The result is a financial system that is highly vulnerable to the volatility of capital flows. And so we saw the free fall of currencies and assets which has been so devastating for some of our Asian neighbours. Mistakes might have been made in economic management in individual countries, but none so serious as to justify the slashing of the international value of the assets of a country by as much as 80% within half a year and leaving it further in huge foreign debt and cripplingly high domestic interest rates.
21. Indeed, there has been much talk recently about currency stabilization arrangements in the region, while the strong medicine prescribed by the IMF is being taken. There have been interesting ideas proposed, some more realistic than others, and we in Hong Kong are observing these with keen interest. Where appropriate, we are prepared to share our experience quietly with others, spelling out the pros and cons, the pre-conditions, and the practical issues, for example, for operating the currency board system that has been the hallmark of stability for Hong Kong.
22. On this particular issue, one thing is clear, at least to us: the financial technology of today is highly different from the days when the settlement of financial transactions in the economies operating with currency boards was done predominantly in currency notes. When large financial transactions are settled almost exclusively through electronic means, the mechanism for maintaining exchange rate stability in a currency board system operates through the interbank payment system. The control, albeit a rule-based and passive one, of the currency board on the clearing balance of the banking system, the crucial element of the monetary base I have identified earlier, is essential. What ensures exchange rate stability in a modern day currency board system is no longer the mechanism of currency notes arbitrage which featured prominently in the literature of currency board systems of the old days.
23. Furthermore, a currency board is not a panacea for financial ills. A currency board imposes very strict disciplines on the financial system and the rest of the economy, not to mention on those controlling the purse strings of the economies concerned. You need a banking system that is in a position to understand, identify and manage interest rate risks. You need an administration that is prepared to give up discretionary monetary controls. You need fiscal discipline. You need solvent private sector corporations that are well capitalized, lowly leveraged and willing to take the interest rate pain.
24. The bitter experience of others in the region is perhaps a sharp reminder to Hong Kong that the exchange rate link must be kept. This is obviously for our own good, but I imagine also for the good of the region and possibly beyond, for if the Hong Kong dollar's fixed link with the US dollar were to be broken, the likelihood of yet another shock wave of gigantic dimensions sweeping across financial markets worldwide cannot be dismissed.
25. Thus the interest rate premium seen now in Hong Kong is relatively speaking a small price to pay. And in fact it can be even smaller if the level of confidence in the currency link itself, in the Administration's unwavering determination to maintain it, in the high level of reserves backing the currency, in the robustness of the monetary management mechanism under the currency board arrangement, in the prudential standards of banking and other financial regulation in Hong Kong, in the sophisticated financial infrastructure which has been painstakingly built up over the years, in the fiscal discipline that Hong Kong is so firm in adhering to, etc., etc., could be further enhanced.
26. Support and understanding on the part of the international financial community, not only on the technicalities of our robust system, but also on the wider implications on world financial order, will of course be helpful; and so I look forward to your assisting us in promoting more widely the true picture which has often been distorted by the frustratingly forthcoming views of the uninformed who may have a pecuniary interest in volatility. Prudent businessmen, particularly those engaged in international trade, in both visibles and invisibles, hate volatility, especially exchange rate volatility. It is therefore also in your interest to promote stability.
27. As mentioned earlier, we are already getting a lot of support on this from the multilateral financial institutions such as the IMF and the Bank for International Settlements (BIS), and also from the central banking fraternity. The authorities in the Mainland of China, in particular, have been excellent in their support for Hong Kong, through their faithful compliance with the Joint Declaration and the Basic Law. They have left us alone in conducting our own affairs. There are no telegrams to read and respond "deskby". There is no need for seeking approvals in accordance with the Royal Instructions and the Ordinances featuring the Secretary of State, for these powers have either been localized or are absent in the Basic Law. There are no requests for detailed briefings or for explanations on why we do this and why we do that; not that, I hasten to add, there were such requests under British Administration. But instead, as before the Handover, there are sincere and helpful expressions of confidence in our ability to handle our own affairs, kind and forthcoming offers for help in defending our currency in case we need it - and this is somewhat different from before the Handover - to the extent of giving access to their substantial foreign reserves. Their clear statement that the RMB will not be devalued is also partly made out of concern of the possible psychological implications on the Hong Kong dollar, although there indeed is no need for any devaluation.

One Country, Two Currencies

28. Perhaps it will be useful if I go into the subject of whether or not there is a need for the RMB to be devalued in greater detail. There have been an abundance of praises on China's responsible attitude in maintaining stability in the RMB. These came from the IMF, the World Bank, G-7 and others. But there are as many predictions that the RMB will soon be devalued, notwithstanding assurances to the contrary by Chinese President Jiang Zimin, Premier Li Peng, Vice-Premier Zhu Rongji and others Members of the State Council, and Governor Dai Xianglong and other officials of the People's Bank of China. In this connection, the skeptics rather cynically reminded us that, in the monetary history of the world, devaluations of currencies were frequently preceded by strong denials and that these matters are determined by market forces and not by the words of government officials. Furthermore, they predicted that the Hong Kong dollar's link to the US dollar would not be able to hold if the RMB is devalued.
29. For myself, I am not going to hold my breath waiting for that to happen. Neither am I taking the assurances of the Chinese leaders on their face value. I would look at the facts at hand and I would like to share them with you, if I may. First, there are still exchange controls in the Mainland of China in the capital account. Technically this makes it easier for the exchange rate to be kept at a particular level, especially when the People's Bank of China has at its disposal US$140 billion of foreign reserves, the second largest in the world after Japan. It would be very difficult for anybody to take a short position in the RMB and so the RMB is not exposed to any risk of speculative attacks.
30. Second, China has strong economic fundamentals supporting the exchange rate for RMB. Economic growth in 1998, forecasted to be 8% in real terms, is only a shade below the growth rate of 8.8% achieved in 1997. Furthermore, inflation is expected to be below 3%. In 1997, the Mainland of China ran a trade surplus of over US$40 billion, equivalent to 4.5% of GDP. Although foreign direct investments have slowed down somewhat in 1997 to US$45 billion, this was still very high by international standards. Its foreign debt is only about 14% of GDP and consisting of mostly long term loans from official sources such as the World Bank and the Asian Development Bank, and its debt service ratio is at well below 10% of exports. The fiscal deficit in 1997 was small at below 1% of GDP and the monetization of such deficits is now prohibited. Interestingly, these figures are comfortably within the Maastricht criteria.
31. Third, there are political and policy considerations against a devaluation of the RMB. A devaluation of the RMB would risk intensifying bilateral trade friction, particularly with the United States. The trade surplus of the Mainland of China with the United States has risen to almost US$50 billion in 1997, very close to Japan's trade surplus with the United States at US$55.7 billion. On the multilateral front, a devaluation of the RMB may be seen as a move to gain undue competitive advantage to increase its trade share and may undermine China's efforts to re-enter the World Trade Organization. It is apparently getting very close to that goal. It would be in the interest of the Mainland of China to maintain a stable value for its currency and demonstrate its readiness to be a responsible citizen of the international financial and trading communities. Indeed, if the Mainland of China were to devalue the RMB, it could spark off another round of devaluation in the region. This could be highly destabilizing for financial markets in the region and beyond, and in the end would adversely impact upon China itself. China realizes this and has therefore given extensive assurances to the IMF and others that it will not devalue the RMB.
32. There is also a domestic policy consideration. The Mainland of China has just achieved a soft landing, after 3 years of tough battle, and brought inflation down to below 3% from double-digit inflation. To devalue the RMB now could roll back this achievement and re-ignite inflationary expectations again. In addition, the import prices of capital goods and semi-finished products, which China uses for outward processing, would go up, thereby offsetting much of the gain from devaluation. It would also undermine confidence in, and therefore the flow of, foreign direct investment into the Mainland.
33. Fourth, there are other less risky and more effective ways of maintaining competitiveness. Continuing reform of the state-owned sector, confirmed by the decision of the Party Congress in September 1997, unleashing the powerful forces of the market, will achieve more efficient allocation of resources and enhance productivity of the economy. There is also continued trade reform, liberalizing import barriers and cutting import tariff rates on more than 4,800 product categories by over 26% effective from 1 October 1997. The reform of export tax rebates will also benefit exporters. Continuing efforts to strengthen financial markets and the financial infrastructure will enable more effective financial intermediation and promote economic growth and development.
34. Fifth, in any case, the competitiveness of the Mainland of China is based on broader structural factors including underlying factor costs, market leadership and the trade policies of major importers. Even after the marked depreciation of Asian currencies, labour costs in the Mainland of China is still lower than most of Asian economies, perhaps with the exception of Indonesia. And there is in China a continued access to a huge labour pool made up of redundant state sector workers and surplus labour in rural areas. The effect of devaluation on the manufacturing costs in the Asian economies, on the other hand, are likely to be offset by higher inflation, higher costs of imports and higher interest rates. China has also established market leadership in a variety of products in world markets. It is difficult to see this dominant position being significantly eroded, particularly with the existence of international trade barriers that limit the extent of the possible shift of export orders from China to other Asian economies.
35. All in all, the case for a devaluation of the RMB is simply not there. In this connection, I can quite understand that the stability or otherwise of the RMB would appear to some observers to have implications for the Hong Kong dollar's link with the US dollar, particularly given the economic closeness between Hong Kong and the Mainland of China. But this does not necessarily mean that the Hong Kong dollar will need to move in sync with the RMB, in the highly unlikely event that the RMB is devalued. The Hong Kong dollar is linked to the US dollar and not to the RMB. The economic relationship has always been very close between Hong Kong and the Mainland of China. There has always been separate currencies for Hong Kong and the Mainland, and "one country, two currencies" is further enshrined in the Basic Law governing Hong Kong for 50 years after the resumption of sovereignty. The many differences between Hong Kong and the Mainland of China argue for monetary segregation and not monetary union. In 1994 measures were taken in the Mainland to unify the official and market exchange rates for the RMB, involving a de facto devaluation of the RMB of 33% on a nominal basis and 7% on a weighted basis. But this did not affect the Hong Kong dollar at all. As a matter of fact, in the fourteen and a half years since the Hong Kong dollar's link was established in October 1983, the RMB has depreciated by a total of 76% against the US dollar. So why should a devaluation of the RMB, which in any case has been ruled out by the Chinese leaders, affect the stability of the Hong Kong dollar's link to the US dollar now or in the foreseeable future? For the sake of argument, even if a devaluation of the RMB leads to greater competitiveness for the Mainland, this would be positive for Hong Kong as the service centre for China.

Looking Ahead

36. The encouraging developments in China will continue to create opportunities for Hong Kong that are no less significant than the impact of China's open-door policy on us in the early 80s. The continuation of the Mainland's reform programme for state-owned enterprises will demand financial and corporate management services on a massive scale. The modernization of its economy will require effective channels of financial intermediation, domestically as well as across international boundaries. There is therefore a great need for efficient and safe banking, debt and equity markets. As the international financial centre in China, with a sophisticated financial infrastructure and a high degree of integrity in our financial markets, encouraged by regulatory system that meet international standards, Hong Kong is well positioned to benefit from all this.
37. The banking sector in Hong Kong is home for the great majority of the largest international banks, all with a keen eye on the business prospects in the Mainland and the rest of the Asian region. The debt market in Hong Kong has been developing rapidly in the past nine years with conscious effort on the part of the authorities, and now we have one of the most liquid debt markets in Asia. Although its size is still quite small, for we have been the victim of our success in not running fiscal deficits, the market has very good potential. With the institutionalization of savings in Hong Kong through the introduction of Mandatory Provident Fund schemes and the securitization of such illiquid bank assets as home mortgages through the creation of the Hong Kong Mortgage Corporation, the debt market is poised for another quantum leap. It has certainly got one of the most advanced market infrastructure, characterized by a fully computerized clearing system with a seamless interface with the interbank real time payment system. The Hong Kong stock market has a long history and considerable liquidity, and has already proved to be a very successful springboard for Chinese enterprises to tap international capital. Hong Kong is thus in a very good position to provide the financial and other expertise to help China as it goes through the current phase of evolutionary transition towards a modern economy.
38. The recent financial turmoil in Asia highlighted the importance of Hong Kong's further development as an international financial centre and the role that we can play in the region. Asian financial crisis stemmed from inadequate risk management and poor financial intermediation. The benefits of financial liberalization created an euphoria that regrettably encouraged neglect of the need to promote prudent management of financial risks and to build a robust financial system in order to cope with the associated volatility in financial flows. This is where Hong Kong has a lot to offer. After the Mexican crisis which spread to emerging markets in the Asian region, we played a key part in promoting greater awareness of the issues that needed to be addressed - building robust monetary management mechanisms, upgrading banking supervisory standards that are internationally accepted and constructing sophisticated financial infrastructures. Too late, one may say, but better be late than never. Although there is currently much fire fighting to do in some of the economies in the region, we must continue to look at these longer-term issues. Already on the table for consideration by central banks in the region are our suggestions for the creation of a network of clearing systems for debt securities for the region, or Asiaclear. We have also suggested the creation of a network of real time gross settlement (RTGS) payment systems, for whoever is ready in the move towards RTGS, to facilitate the efficient and riskfree settlement of cross currency transactions.
39. Speaking in the City of London, which is Europe's, if not the world's leading financial centre, it would be immodest of me to trumpet too much of Hong Kong's virtues. London is the world's leading centre for cross-border financial intermediation, foreign exchange business, international bond market, trading of foreign equities, derivatives business and insurance business. The most Hong Kong can claim is anywhere between fourth to seventh ranking in these areas, not bad for a city of 6.8 million people built on top of a barren rock. There is, however, one area where Hong Kong does claim to have an edge, not perhaps because we are big, but because we are small. Hong Kong is the leading example in the world of the Virtual Economy, with 84% of GDP derived from services, compared with 72% in the US and 70.8% in the UK. With 200,000 kilometres of fibre optics linking 1,500 commercial buildings, we already have one of the finest telecommunications infrastructure in Asia, if not the world, thanks to British capital and technology. Just like London, we have already mapped out our future as a leading financial service provider, through the use of technology and robust, efficient infrastructure.
40. Unlike other financial centres, we do not see Hong Kong as a competitor, but as a partner in free trade and free flow of capital. London has superior services in many areas and is at the cutting edge in financial products and innovation. Hong Kong is the window to Asia, and is the service centre for the giants of Asia that are just awakening, although some have just caught serious flu. We are the channel and bridgehead through which many British and European services are provided in Asia. We are also keen to develop Asian services through London in partnership, not in competition. We should remember that the HKMA was created with the blessing and help of the Bank of England, together with the People's Bank of China. The bond between London and Hong Kong is therefore a historical one that will strengthen with the passage of time.
41. Thank you.