Structural adjustment

inSight

20 Nov 2003

Structural adjustment

Structural adjustment in Hong Kong's economy, though painful, is inevitable. The role of the HKMA in this process is to maintain a stable monetary and banking environment so that structural adjustment can take place smoothly.

The continuing reform and liberalisation of the Mainland of China will eventually lead to an intensified economic integration of the Mainland with the rest of the world. With the Mainland being potentially a very significant economy, this integration will affect the rest of the world in terms of, for example, its product mix, and its trade and financial relationship with the Mainland. Given its geographical proximity and extensive links to the Mainland, Hong Kong has been feeling the effects of this integration much more than any other economy in the world. In fact, the Hong Kong economy is itself increasingly integrated with the economy of the Mainland, involving profound structural adjustment.

As we have all noticed, this structural adjustment has turned out to be rather painful, probably to the majority of the community. The initial big discrepancies between price levels in the two economies, the asymmetric mobility of people, capital and products, and the size differential between the two economies have contributed partly to the downward price adjustment in Hong Kong. Because the risks of taking this adjustment through the exchange rate are too great to contemplate, particularly against the background of political transition swiftly followed by the Asian financial crisis, the Government "opted" for downward adjustment in domestic prices instead. Thus we have been experiencing deflation in Hong Kong for almost five years and, associated with and as the transmission mechanism for deflation, economic growth has been slow and unemployment has been high. When structural adjustment is complete, Hong Kong should be able to benefit more fully from the rapid pace of economic expansion on the Mainland.

Structural adjustment in the economy, in whatever form, involves dislocation, to varying degrees, for different sectors of the economy and different sections of the community, with possible implications for political, social, economic and financial stability. In our case, the fall in property prices has affected the well-being of homeowners and has created a strong sense of dissatisfaction in the community. The fall in financial asset prices, as also in the case of property prices, dampened general consumer confidence and economic growth. At times, it also exhibited the tendency of overshooting, under the influence of volatile international capital, and threatened financial stability. The fall in consumer prices and incomes has led to significant deterioration in the public finances, with possible implications for confidence in the currency and monetary stability. The dislocation of structural adjustment can be so great as to be beyond the (unknown) tolerance limits of those affected, in which case there could be responses and reactions that are destabilising, highly damaging and difficult to handle. The task of government is to manage the risks of these occurring and provide as stable an environment as possible, so that the inevitable structural adjustment could be completed speedily and effectively.

The intensity of the structural adjustment, which has been exacerbated by adverse cyclical factors, has meant that this task has been a particularly difficult one. And the aspirations and expectations of the community have grown through years of economic prosperity. We in the HKMA are responsible for part of this difficult task, specifically in the maintenance of monetary and banking stability. We have, I think, been able to deliver, against very unfavourable conditions. After five years of intense structural adjustment, overlaid by the worst financial turmoil in recent Asian history, the burst of the property and IT bubbles, and SARS, the monetary and banking systems are still robust by any standards. Confidence in the Link remains strong. The one-year forward points for the Hong Kong dollar are now trading at a discount rather than at a premium. The yield spread between 10-year Hong Kong dollar Exchange Fund paper and US Treasury bonds of the same maturity is almost zero. The ratio of non-performing loans (NPL) of banks is currently 3.83%. The delinquency rate of the mortgage loan book is 1.05% , notwithstanding the presence of a large number of negative equity mortgages.

It is difficult to tell when this painful structural adjustment will come to an end. What seems clearer though is that the intensity of the adjustment is now being lessened by the move towards greater mobility of people and capital from the Mainland. There are also grounds for believing that the worst of the pain is now over and the adjustment process is entering its last phase.

 

Joseph Yam

20 November 2003

 

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