Economic adjustment and financial reform on the Mainland will continue to have important implications for Hong Kong in 2005. So too will the depreciation of the US dollar now in progress.
I have developed the habit of sharing with readers in this column my views - however cryptic and hedged in by reservations - on the outlook and risks for the coming year at around this time every year. This may be considered a dangerous habit for central bankers because in monetary and financial matters it is not always easy to be right; and being wrong, even in an almost impossible task, risks undermining institutional credibility. But it is the duty of those with responsibility for monetary and financial stability at least to draw the attention of all concerned to the risks ahead. This is itself a risk management technique, which helps minimise the probability of those risks materialising. And I am encouraged by what the late Sir John Bremridge, the Financial Secretary who took the courageous step to link the Hong Kong dollar to the US dollar in 1983, once said to me. He said, "Joseph, do not aim to be always right; aim to be less wrong." Well, I am happy that my views about 2004 given around a year ago have been less wrong than they might have been.
Our economic outlook depends increasingly upon the prospects of the Mainland economy. This is to be expected with increasing economic integration. And so the success or otherwise of "macro adjustment and control" on the Mainland is of key importance to Hong Kong. Despite the rough edges of the instruments being used - administrative measures and interest rates - there should be little doubt about the ability of the authorities to exercise control. Although a concept rather alien to free markets, the "guiding of thoughts" or "unification of thoughts" towards objectives that are in the best long-term interests of the country, as seen by the State Council, continues to provide an effective reinforcement of policy, at least for the time being. I do not think anybody should be cynical about this. Gradualism in market reform presents the least risk to stability in the challenging process of reform and liberalisation in an economy as big as China's. So I am confident that there will be a soft landing, with growth in the economy, fixed investments, money and credit guided to more realistic and sustainable levels. This augurs well for Hong Kong in terms of the sustainability of the economic recovery.
But this is not to say that there are no risks emanating from the Mainland. The intended introduction of exchange rate flexibility on the Mainland is a very delicate issue, not so much for the Mainland as for trading and economic partners in the region, in particular for Hong Kong. The structure of the foreign exchange and money markets on the Mainland is such that, whatever change might occur in exchange rate policy, it should be peaceful, in the sense that there might not even be ripples, not to mention destabilising volatility, requiring little time to settle down. The situation, however, may be quite different for the free and open markets that are highly dependent on the Mainland economy. Whether or not this is an event for 2005 is anybody's guess and I am not making any predictions on timing here. But it promises to be the one great event of global financial significance on the time horizon. Thankfully, we do have a robust monetary system that has a proven track record. We will be able to cope with this, as we have coped with other events in the past. Those using the Hong Kong dollar as a proxy for taking positions on the renmimbi should take note, in particular of the need for further structural adjustment in Hong Kong arising from economic integration with the Mainland. Although deflation has dissipated, the adjustment process, in view of unemployment being stubbornly high, is probably not over yet.
The one other event that might match the significance of a change in exchange rate policy on the Mainland is perhaps disorderly volatility in the US dollar exchange rate. So far, the weakening of the US dollar has not been disorderly, and it is justifiable given the large current account deficit, at least in terms of the direction, although no one is in a position to take a reliable view on its magnitude. The foreign exchange market will determine what is required, but the short-term market dynamics can be difficult to predict and handle. The large accumulation of foreign reserves in recent years by many economies has added complexity to the market dynamics; very large market players have emerged that are capable of taking concentrated (but probably not co-ordinated) positions. And currency allocation of these large foreign reserves is a matter of national interest, having regard to the pre-occupations of individual holders, rather than something motivated entirely by considerations of risk, return and liquidity. Exchange rate policy considerations are, of course, relevant to how foreign reserves are managed. But the fact that long-term US interest rates, as indicated by US Treasury yields, have not increased sharply so far is perhaps an indication of a recognition by those concerned of their responsibility in contributing to global financial stability. I hope this continues to be the case.
Joseph Yam
30 December 2004
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