Outlook for 2006

inSight

29 Dec 2005

Outlook for 2006

2006 looks like being a complex and challenging year on the monetary and financial fronts but Hong Kong's monetary system should be able to cope with any swings. Competition in the banking sector will continue, raising some social issues but benefiting depositors and borrowers alike.

Let me first wish readers of this column a very happy new year. It is customary at the beginning of a new year to look ahead, identify the risks and opportunities that we are likely to face, position ourselves as best as we can to meet them, hope for the best and prepare for the worst. As an individual, I would very much like to be more carefree and not to be worried about anything. Indeed, this is not a bad recipe for happiness. But throughout 35 years of public office, the majority of it in a regulatory capacity in an area that has been changing rapidly, this particular recipe has been a luxury that I could ill afford. I hope, nevertheless, that readers can enjoy that peaceful state of mind for at least some of the coming year, which looks to be a rather complex and challenging one on the monetary and financial fronts.

If peace of mind for you comes with exchange rate stability, you will certainly have it, at between HK$7.75 and HK$7.85 to one US dollar. But if you are interested in knowing where the market exchange rate will be within that 1000-pip range, I am afraid I cannot tell you with any degree of certainty. The strengthening trend of the renminbi and the apparent sentiment that somehow the Hong Kong dollar will strengthen along with it may keep the Hong Kong dollar at the strong side of the range, particularly if the "Inevitable" downward adjustment of the US dollar, expected as a result of the large external imbalance of the US, materialises. Higher interest rates, a slower economy and the associated dampening effects on asset prices may provide some counter-balance, although this may be limited if US dollar interest rates stabilise or even peak during the year. Market sentiment will oscillate quite sharply as usual, possibly producing financial market volatility. In our case this will take the form of volatility in money market conditions rather than in the exchange rate. During the coming year it is therefore quite possible that we could face both periods of easy monetary conditions and inflationary pressures, and periods of tight monetary conditions and a slowing economy. Hopefully, these swings will not be too severe. The clarity of the monetary policy objective and the transparency with which we operate the monetary system should help.

Keen competition in the banking system will probably persist, particularly if loan demand slows along with a slower economy. The banks should therefore be mindful of the risks arising from more intense competition. Our risk-based supervision, which the banks are coming to understand and support, should hopefully increase vigilance against the risks that come with greater competition. The confident pace at which the banking system is moving in implementing Basel II suggests that this should be the case. I expect that there will be further innovation in the delivery of banking services and consolidation. As revenue comes under pressure, banks will no doubt have to review their cost-benefit analyses and this may lead to further reduction in branch networks. As a result, consumer issues and the delicate question of whether commercially run banks have a social responsibility to provide banking services where they are needed may attract greater attention from the community and Government. As supervisors we have a clear role, defined in the Banking Ordinance, to provide a measure of protection to depositors and to promote the general stability and effectiveness of the banking system. But we will certainly also provide any assistance required of us in the deliberation of these delicate social issues, noting of course that greater competition, brought about through the phased liberalisation of interest rates, has brought tremendous benefits to both depositors and borrowers.

Regarding the capital markets, for which we have only some indirect responsibility and about which I therefore hesitate to comment, let alone make predictions, I do hope that activity there can be sustained. Readers are aware of my earlier alert about the possible changes in the Mainland's policy views concerning the continuing need to attract foreign savings through, for example, overseas IPOs by Mainland enterprises, when the Mainland's own savings rate is so high and increasing. The longer-term sustainability of such activities in the capital markets and therefore the status of Hong Kong as an international financial centre is a subject that we should all pay greater attention to. I hope to hear and participate in meaningful discussions on the matter in the coming year.

 

Joseph Yam

29 December 2005

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