ASIAN AFFAIRS INTERVIEW WITH JOSEPH YAM

Chief Executive of the Hong Kong Monetary Authority (HKMA)

Serge Berthier. - A few months ago, Hong Kong was said to be recession-proof. In a couple of weeks, it will very likely be said officially that the Hong Kong economy has been in negative territory during the first and second quarter of the year, which is the technical definition of an economic recession. Is Hong Kong in a very serious situation?

Joseph Yam. - If we look at the experience of the past, Hong Kong has been through two recessions before this one. The two previous ones lasted for only two-three quarters. This one will last maybe a little longer. The first one was in the seventies, the second one was the 1983 crisis. It was a bit different because that one had a political angle to it. The future of Hong Kong was being discussed and we had an asset bubble at the same time that burst. There was a loss of confidence and the crash was rather dramatic. The stock market went from something like 1700 to a low of 150. The adjustment was rather sharp.

S.B.- Is the present crisis similar to the 1983 crisis in terms of adjustment?

J.Y.- The adjustment has been sharp too. Our real estate market has seen a decline of about 40% in a matter of six months, and the stock market which was at about 16000 points a year ago came down to about half that (1). But the circumstances are very different. It is clearly a consequence of the financial turmoil in Asia, whereas the previous one has nothing to do with Asia. It was interesting to note that the hand over took place on 1st July 1997, and the financial turmoil broke out on 2nd July in Thailand.

S.B.- Of course, it is merely a coincidence, but has the transfer of sovereignty to China in any way helped or weakened Hong Kong's immune system to fight the contagion effect?

J.Y.- In fact, because of the transition and the political uncertainties of one sort of another that were perceived in the 1980s, the banking system and the monetary system had prepared themselves quite well over a period of ten years, starting in the mid 80s. We thought that there might be volatility, and it was better to start building the system as soon as possible rather than to wait. And we did that with a number of significant reforms and the setup of the Hong Kong Monetary Authority in 1993.

S.B.- As Deputy Secretary for Monetary Affairs in 1985, you were involved from the very beginning in this process. Did you ever have in mind that the system would be tested by a financial crisis rather than a political crisis?

J.Y.- Clearly it was more political issues that we had in mind and the banks themselves working closely with us strengthened significantly their position, operating with a very high adequacy ratio. Even now, after the turmoil and the share adjustment we have witnessed, they still operate with a capital adequacy ratio of 17.5%, compared to the Basle requirement of 8%, and the liquidity ratio is at this point of time still in the region of 40%.

S.B.- How come such a high liquidity ratio when it is often said that Hong Kong as well as Asia suffers from a liquidity crunch?

J.Y.- There is a misconception. We know that there is a credit crunch. But it is not that the system is not liquid and that the banks are short of capital, it is simply because there is this kind of adjustment in property prices and share prices. The banks are of course rather reluctant to lend. It is not that they don't have the money. It is the credit risk they are concerned about. If the property market continues to fall and there is no end to it, if they cannot see a support level, then if you are a bank, you won't lend but just sit on your money or buy very safe assets. That is the background of the credit crunch in Hong Kong.

S.B.- If we compare the attitude of the Hong Kong banks, it seems obvious that they have been more cautious than their pears in other Asian countries. Would you attribute this prudence to the fact that, for the past fifteen years, they had to live with the transfer of sovereignty in the background?

J.Y.- Maybe. The point is that the banking system as a whole has been rather cautious prior to the hand over and so today the banks are in a rather comfortable position compared to the banking system in the United States and in the region (2). But of course, as the crisis continues to adjust downward sooner of later it is going to affect the quality of the assets of the banks because they have lent quite a significant proportion of their money to the property market, notwithstanding the fact that we have actually been drawing attention to the banks that they should not be overexposed.

S.B.- What are the guidelines?

J.Y.- We have this guideline of loan to valuation ratio of no more than 70% and another guideline advising banks that they should not be exposed to property to a total of around 40% of their loan book. These are sensible measures.

S.B. The Hong Kong property market is known as one of the most expensive in the world and even after the sharp adjustment you mentioned earlier, the prices remain higher than in 1996. What makes it so peculiar?

J.Y.- It is not a perfect market. Supply will take a long time to catch up with demand. It is a market that can be affected quite seriously by sentiment. And we sense that when there is overshooting one way or another in that market, the result is the government has to come up with certain measures to try to stabilize the market. I believe it is the right thing to do. As you know, the government is now freezing the sale of land for nine months, until March 1999. That may help to stabilize the market.

S.B.- It also means that the government has full control of the supply-side of the market. It is very difficult then to pretend that the market is a free-market.

J.Y.- We do believe in a free market, but as regards land, the fact is that the government is the monopoly supplier. So it was never a free market and the government is deeply involved in it.

S.B.- It also means that the property sector is for the government one of the main sources of income, and any crisis in that sector may affect badly its revenues.

J.Y.- I would not say one of its main sources of revenue. And I think that the government shouldn't be overdependent upon property (3).

S.B.- But that is where we are now.

J.Y.- Yes. But you've seen in the region how markets can overshoot one way or another. Look at the currency market. Look at Indonesia. What have they done to justify a devaluation from 2400 to over 16000? There is always overshooting in a market and there is a responsibility to try to stabilize. This doesn't affect the free market principles, and as regards the property market in Hong Kong, as you mentioned, there was never a free market. So I hope that the measures will be successful.

S.B.- There is a perception in Hong Kong that the government is not doing its job mainly because there are difficulties between the administration and the new Executive power. You have a technical responsibility which is out of the field of political issues. Nevertheless, do you perceive a change between, say June 1997 and July 1998?

J.Y.- Not a lot has changed. What has changed is that as a result of the financial turmoil, everybody is in pain. Hong Kong people have not been in pain for a long time, the last time was in the early eighties, and they can’t even remember. And when you are in pain, you are looking for a culprit.

S.B.- Of course, but I don't think that the financial turmoil is entirely responsible for that perception. The remarks are made by academics, wealthy individuals who are not in pain, as you said, but who feel that something doesn't work somewhere.

J.Y.- I admit that Hong Kong is now a little more politicized. We have always had a minority government. Embodied in the elected councils are all the opposition personalities. The government and the administration will have to lobby everybody in the legislature in order to gain support on certain issues; it is an impossible position, to put it mildly. There is now a sharper focus on that anomaly. As I don’t actually sit on the Executive Council, I don’t know whether the chemistry or the atmosphere is worse or better than previously (4). I have no idea at all.

S.B.-Why is there a sharper focus on the fact that the government is a minority government?

J.Y.- Hong Kong has been like that for a long time, but when you have a more and more politicized environment and democratic elections, then your problems come into sharper focus. Under this sort of environment, those people who do not actually have responsibility may speak irresponsibly. Those with responsibility do not actually have the community support, because they were not elected into office. So you have this anomaly, which I think will need to be addressed. People have mentioned a possible move to a ministerial system etc. Now is it feasible under the Basic Law? I haven’t researched into this, but I think those people who were elected should carry responsibility. I think that, before, there were quite a lot of people who were appointed to the legislature and into quite a lot of important positions. They did have a very close dialogue. Now, with the high degree of democracy and with the directly elected seats, people maintain their political positions. As a result, the situation gets more difficult. You know, I am not a political animal. I am just an expert in central banking, and I like very much to stay away from all sorts of political issues.

S.B.- Admittedly, monetary issues are purely technical once you stick to a principle, which is the peg system.

J.Y.- Monetary problems are not that difficult to resolve. Our present difficulty is that we are facing a community who is in pain, and there really isn’t much we can do to relieve that pain. If you do something to relieve it, that would mean that you are, for example, suppressing interest rates (5), and that move would be seen by the market as a demonstration of weakness. So we have little choice but to stick it out. Of course, it is all very well for me as Head of the Monetary Authority to tell everybody who is in pain to stick it out. In fact, I have to stick it out too because I have to pay a mortgage like a lot of other people. But I know what the alternative might be: really unthinkable.

S.B.- The government announced a set of measures a few weeks ago to try to turn around the economy (6). Do you see early signs that they are having some effects?

J.Y.- We see early signs. In the property market, there have been a few sales that have shown that prices have stabilized, and the stock market has responded positively. But I come back to the point that the crisis is not a domestic issue. We are facing a global phenomena. It is not even confined only to Asia, much less to Hong Kong.

S.B.- For you, the contagion effect is not over yet.

J.Y.- The financial turmoil is not confined to Asia. South Africa, Latin America, Russia and many other countries are affected. It is even possible that it may spread one day to New York. It's very difficult to be precise as to why there is such contagion. Of course you can think of the trade effect, but it is not much. But the investor effect provides you with a better explanation. Because of the lack of liquidity here, and the region still going down, perhaps requiring liquidity, then you may go to the US market and withdraw a rather substantial amount of reserves as private sector savings from this developed market and then you have contagion. So investor sentiment is important. And then, you have markets that are at historical levels and the US Central Bank worrying about inflation, etc.…

S.B.- Paul Krugman said that when a market is overvalued, which is the case of Wall Street, then anything - any loud noise- could have surprising consequences, a bit like slamming the door in the kitchen and having the soufflé collapse in the oven!

J.Y.- Well, something may trigger it. I don't know. I remember last year, in October, when our stock market went down, we had an attack on the Hong Kong dollar. We dealt with that in a couple of days, but then our interest rate overnight went up to about 280% and as a result our market went down. It spread to New York. So the contagion effect is there.

S.B.- Then what we have to deal with is not is just an Asian problem. What do we need to do to deal with it?

J.Y.- If you ask me to focus on the source of the problems and the possible solution to the problems, I would look at Japan, at the stability of the yen. The yen has been very volatile in the past. At the beginning of 1990, you were talking of 80 yen to the dollar, now you are talking of about 140, and of course in the middle of 1985, you were talking of about 200 something to the dollar. The volatility has been so sharp that it affects quite a lot of people. And of course the Japanese economy is in a rather depressed state. How do we get out of this turmoil? I think it is more the Japanese who have to get out of the turmoil, and that will help everyone.

S.B.- Do you think that will happen soon?

J.Y.- There are two aspects to it: the structural problem of the banking sector and the depressed state of the economy. You need to sort out the structure and issues, the banking problems, which means you need to bite the bullet. If at this sort of low level of interest rates, you still can't nurse the banks out of trouble, then perhaps you should hike the interest rates. At least that would stabilize the exchange rate.

S.B.- But it may make it even more difficult to nurse the banking sector.

J.Y.- Yes, and it might actually affect the stock market and other assets markets to a certain extent. That is the problem. That is why I am not too sure about higher interest rates. There are significant ploys calling for high interest rates in Japan (7). I am not too sure it is the right answer at this point of time. Certainly if you look at it purely from the point of view of stabilizing the exchange value of the yen, I think it would be helpful, but some other problems need to be sorted out, and high interest rates would make it more difficult. What is needed is political will and a credible fiscal package.

S.B.- Do you think that intervention on the foreign market is a way to show foreign traders that the game is nearly over?

J.Y.- So far, intervention in the foreign market by the US and Japan has helped to stabilize the yen somewhat. But then the intervention needs to be supported by some credible adjustment policies. The whole market is waiting for those sorts of policies to come out.

S.B.- But as you pointed out, markets tend to overshoot and they are fickle. Traders expect things to change overnight, when in such matters, any decision needs time to really achieve its objective.

J.Y.- I accept that obviously these are not things that you can turn around overnight, but at least there needs to be a clear demonstration that there is a will and that the right package is being worked out. I think the market sentiment may change, but if market sentiments stay like they are now, that turmoil, that recession may drag on.

S.B.- How badly will the Hong Kong economy be affected if the recession drags on in Asia?

J.Y.- Hong Kong is a very externally oriented economy. It depends on trading (8). Inputs and services with the rest of the world will be affected.

S.B.- Is the Hong Kong trade affected by the currency melt-down that took place in Asia?

J.Y.- I am a little optimistic in the sense that although the Hong Kong economy is very externally oriented, it is also a very much service oriented economy. I think a service oriented economy is less sensitive to exchange rate fluctuation, so the rather significant devaluation of Asian currencies may not actually affect Hong Kong that much.

S.B.- Yet, the economy is slowing significantly.

J.Y.- Yes, in the short term, our economy is slowing. In the first quarter of this year, we record a negative growth of minus two percent, but we should not confuse two issues. If you look at the economies in the region, their currencies have devalued very sharply. It was supposed to enhance their competitive positions. But just look at the inflation! In Indonesia, we are talking about an inflation rate of eighty percent, and a contraction of the economy of fifteen percent, and we are also talking about a near breakdown of the financial system. They don’t really have a choice now they have got to this position, but I’m not too sure that allowing their currency to be devalued at the beginning was actually the right choice. I think quite a lot of people are expressing doubts about that.

S.B.- The Hong Kong dollar has not devalued because Hong Kong has a currency board system that pegs the currency to the dollar. Even though, it was, as you mentioned earlier, under speculative attack. Do you think that Indonesia should have tried to set up a currency board to avoid the kind of situation the country is in today?

J.Y.- No, I wouldn’t say that because a currency board system requires quite a lot of discipline on all fronts. Very simply, a discipline of not creating money unless you have foreign currency reserves backing this creation of money, a fiscal discipline, a discipline of allowing financial institutions and companies to go bust, etc. Those are the sort of disciplines that are not easily observed.

S.B.- What you say basically is that Indonesia did not have the discipline that is required, but what was the alternative?

J.Y.- A currency board system is a very strong form of fixed exchanges. Perhaps Indonesia should have defended its exchange rate with more willpower.

S.B.- The Thai government tried to defend the baht, but it didn’t work. Can you really make it work just by willpower?

J.Y.- The Thais tried to defend their exchange rate, but the thing is that when you want a stable exchange rate, you must accept high interest rates. The Thais have actually intervened in the forward market, meaning that they didn’t really want interest rates to go up…

S.B.- In other words, they were not really going for it...

J.Y.- Exactly. And so how much reserve that you have may well disappear overnight, whereas for ourselves, operating the currency board system, we accept that with a stable exchange rate system, you have to allow interest rates to move up. That’s why we saw 280% on the 23rd October last year. Of course, our fixed exchange system, in the form of a currency process, is a lot different from the pegged exchange systems that are practiced in some other economies. You must be prepared to bear the pain, and if you are not bearing the pain, if you are afraid, then it won’t work.

S.B.- There is a political angle to it. Some Asian politicians, as well as some economists, are saying now that the mistake was to liberalize too quickly. Politicians were told: “we will assist you, help you out but you have to do it because the trend is globalization” but what happened actually was different.

J.Y.- I think one would be going a little too far to imply that financial liberalization is a bad thing. I am strongly of the view that it is a good thing. It has been good for the region and for the world as a whole. But financial liberalization brings with it certain risks, and you must be able to manage those risks before you go ahead. You need sequencing. You need to strengthen your financial system, to build a financial infrastructure, to make sure you can actually cope with the volatility of capital flow.

S.B.- Would you agree then that the sequencing was not right?

J.Y.- No. But I think the majority of people in the financial world have been surprised by how volatile capital flows can be in a liberalized environment. The flows can be volatile, the flows are of a great variety, there is a proliferation of derivatives, the flows are moving around at high velocity.

S.B.- So, in a way, those facts were overlooked.

J.Y.- It is not overlooking. It is something that we have never seen before.

S.B.- Well, except the fact that it is now a worldwide phenomena, I think that we have seen it before, in 1929, in New York.

J.Y.- It is a different problem. In 1929 it was not international capital flow (9). What we are seeing now is international capital flows encouraged by international liberalization and the globalization of the financial market. It is not something that has been seen before.

S.B.- Nevertheless the principle behind the velocity is the same. The banks and other financial institutions are doing what they did in 1929, except it is on a larger scale, with new tools, such as computerized trading. The purpose was to make money out of money.

J.Y.- Yes, they did, but they have made mistakes as well.

S.B.- There are sporadic rumours that the peg between the Hong Kong dollar and the US dollar is a thing of the past. Sooner or later it will have to go. Of course, I don't expect the chairman of the Hong Kong Monetary Authority to deviate from the well-known argument that the peg is here to stay. However, could you tell me what is the philosophy behind the defense of the peg, knowing that there is a price to pay for the peg to stay?

J.Y.- If you allow a depreciation of your currency, you have further down adjustment in the property prices, in the stock market and in the stock prices, high inflation rate, and in the end you need even higher interest rates to stabilize the situation. Nobody wants that.

S.B.- Is Hong Kong comfortable with that sort of policy?

J.Y.- As I said, because of the political transition, we were quite worried that there would be volatility, so we built up a very strong financial system. Therefore Hong Kong is now in a rather more comfortable position compared with the others.

S.B.- But what about the people's feelings?

J.Y.- Of course, within Hong Kong, nobody feels this is a comfortable position. Nobody likes the recession, nobody likes the pain of high interest rates. But what is the alternative?

S.B.- In the end, we are in the middle of a very serious financial crisis that no one had foreseen. Millions of people are affected, in Korea, in Indonesia, and even in Hong Kong where the unemployment rate is at a record high. It is hard to believe that it is the government of Thailand, or Indonesia or Malaysia, to name a few, that are responsible for such a debacle. I also doubt that it is the Japanese economy that created the current pandemonium, although it certainly contributed. What is your judgment?

J.Y.- I think there is scope for sharing responsibility in the whole financial system of the world. Now quite a lot of people in G7, G8, G15 group... all sorts of G groupings, are talking about strengthening the international financial architecture. This must be the right thing, but you need to promote international standards etc, and it takes time. For the immediate problem, I think there is a need to share responsibility in stabilizing markets.

S.B.- The Euro was not supposed to arrive at the tail end of a financial crisis, and there are lots of queries of whether it is good or will it make the situation even more difficult. What is your opinion?

J.Y.- I think at this point of time where there is turmoil, the emergence of the Euro actually comes at the right time, because then you will have an alternative currency whereby you can channel your official or private sector savings. Now of course it is too early days yet, the market is not built overnight, the rather more cautious people managing substantial reserves will adopt a wait and see attitude, but I have no doubt whatsoever that the Euro will be successful in time.

S.B.- Will it help stabilize currency markets?

J.Y.- In the short term, I am not too sure, because if you look at the currency world as a whole, you have the US dollar, you have the Euro coming and maybe establishing itself as a very strong currency. How about the rest? The third currency that you can think about is the yen. Yen, as an economy, is not that small, but compared with the dollar and the euro, it is, relatively speaking, a small player. Being a small player in the globalized currency market, you can get tossed around easily. From that point of view, I am not too sure there will be greater global stability.

S.B.- Does it make sense to have in the medium term only two basic currencies when we have three economic centers, the American one, the European one, and the Asian one, not to mention the Chinese one?

J.Y.- I don’t think at this point of time there is any leadership in Asia to address such issue. We have a situation which is very different from Europe. In Asia, you have a rather fragmented financial structure, because the region is geographically fragmented. It is not like Europe where you have very close interaction. There is a difference of culture as well, where mutual surveillance was actually unheard of until recently. So there may need to be a different solution. I have no idea at this point of time.

S.B.- But clearly the Asian financial sector is not matching the region’s economic weight.

J.Y.- This is really the problem of Asia. Look at the reserves, the official savings, Japan has over 200 billion dollars, Mainland China has 140 billion, Hong Kong 96 billion, Taiwan over 80 billion, and then you have Germany, and then Singapore. Five of these reserves are in Asia. Private sector savings are very substantial. We are talking about a thirty to forty percent savings rate! Where does the money go? The whole point is, because the financial development in this region is backward, the efficiency of financial intermediation is so low that the money is actually invested in the US and the European markets. It is also due to the perception of risk. Now, as a manager for a 96 billion dollars worth reserve, I can say that I would be quite prepared to invest in Asia if the risk profile is comparable to those of the developed markets, but it is not, and that is the problem, and as a result, the money is invested in Europe and America, and at the same time, Asian countries are all trying very hard to attract foreign direct and portfolio investment from New York, London etc.

S.B.- One day, surely perception will change. Some sort of common interest should bring maybe something like the "snake" that was the starting point of a common monetary initiative in Europe.

J.Y.- I can’t see in a foreseeable future an initiative taken by any economy in this region to create something similar to the EMU. It is politically very, very difficult, but it doesn’t necessarily mean that the economies in the region should not get together and take a look at their financial structures, trying to improve the efficiency of the financial intermediation in this region. Then you are talking about the nitty-gritty of upgrading the banking supervision, of building robust financial infrastructures, get real time payment systems in place, minimize contagion, minimize settlement risk, etc.

S.B.- Since the crisis broke out, various ideas were floated to try to have less reliance on the dollar for bilateral trades. Do you see anything new in all those ideas that have a chance to reduce the volatility of the exchange rates in the future and that will develop the financial system in Asia?

J.Y.- I remember very well that after the Mexico crisis, at the beginning of 1995, we called a meeting here in Hong Kong. We talked about the provision of liquidity to each other through what we call bilateral repurchase agreements, and this has soon carried on to talk about upgrading supervisory standards in the region, strengthening the banking system, building a financial infrastructure. We proposed the idea of an Asia clearing system, we proposed linking the debt clearing system and payment systems, etc. These are nitty-gritty things, but in the end, those are the very things that will enhance confidence in financial implication in this region. In terms of currencies, I have no idea. I think each individual economy is so keen to say they have got to safeguard its own currency, it would make it extremely difficult for the type of broad political decisions that have been taken in Europe to be taken in Asia. I can’t see it at this point of time. The other point is that there are a number of institutions, including the IMF, the World Bank, the ADB, which tend to regionalism this thing too much. We should look at our financial problem from a global perspective. It is a globalized environment, you must live with global standards. To some extent, this region has to share certain problems, and perhaps we should get together and try to do something.

S.B.- The ASEAN seems to have put together a sort of brains trust, a mechanism for control of currency flows that will be housed for the first two years by the Asian Development Bank. Could it be an embryo to a common approach?

J.Y.- Unfortunately, I am not involved in this. As you know, we are not part of ASEAN.

S.B.- Looking at the region in terms of financial arrangements, the name of China is seldom mentioned, except to say that China should not devalue the yuan. Can China be overlooked?

J.Y.- No. It is a huge economy, it has got very significant influence in the world stage. Even though it is, comparatively speaking, less developed in the financial sense. But it doesn’t necessarily mean that it cannot play a rather more significant role. The economy is getting big, it is growing rapidly... Forecasts show that China will become the largest economy in the world, so there is obviously a very important role that China can play, and Hong Kong, being a very important financial centre in China, can also play a significant role. But for the time being, I don’t think there is a very sharp focus on what to do exactly. Perhaps things will develop with time. There is now a lot of preoccupations on how to get out of this turmoil, and some preoccupations as what exactly we need to do in the longer term to strengthen our financial system. But I don’t think there is any attention being given to the macro monetary aspects of monetary co-operation, or even co-ordination, or even, union. I don’t think anybody has actually thought about this aspect. In a way, it is not surprising. After all it took fifty years for Europe to set up the Euro.

S.B.- If monetary co-operation in Asia is doubtful in the future, what about a co-operation between China and Hong Kong? In fact, to the annoyance of some politicians, it seems that in the minds of the people the Hong Kong dollar is already linked one way or another to the yuan, since it is said that if the yuan devalued the peg will not survive. What are your views on that risk and that linkage?

J.Y.- It is all a matter of perception. If you look at perception and then look at reality, rationally, through analysis, they do not necessarily come to the same conclusions. Unfortunately, in financial markets, perceptions can become reality. We try our best to tell people that the yuan is not going to be devalued, and that what is good for China is eventually good for Hong Kong. And if you take that long-term view, whatever they do in their best interest must benefit Hong Kong in the end. But specifically on the yuan, they are not going to devalue it. Full stop. Now all other questions are hypothetical, and as you well know, bureaucrats do not work on hypothetical questions.

S.B.- What are the arguments against a devaluation?

J.Y.- Part of the arguments is that people forget that the yuan is not fully convertible. Furthermore China has a positive balance of payments and a huge reserve. The government doesn’t want to create any further trade frictions with the United States, the World Trade Organization is fresh in its mind. Then devaluation is not the only means to maintain competitiveness. Look at the rest of the region! Are they benefiting from the devaluations? So why do it? You need a reason, and a very strong one. There is no reason to justify such action. Full stop.

Summer 1998

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Notes;

1 - At its peak, the Hang Seng index was 16 673 on 8 August 1997. The bulk of the decline was registered between early October 1997 and November 1997. During that period the volatility was extreme. Intraday fluctuation of 500 points or above was common. Its worst one day slump was a record 1438 points (13.7%). It is in June 1998 oscillating around 8500 points. The stockmarket price-earning ratio (PER) was never very high. At its best in 1997, it was 12.8. It is now well below 10 (New-York is at a all-time high of about 30). The dividend yield which was on par with mature markets in 1997 at about 2.5% has increased to above 6% for most of the blue chips. Such a high level may indicate that the market is oversold.

2 - The local bank's capital adequacy ratio fell marginally from 17.8% in 1996 to 17.5% in 1997. Provisions for bad and doubtful debts to total loans ratio was 2.01% in 1997. The level of overdue loans improved despite the crisis to 1.81% from 2.4% in 1996.

3 - As much as one-quarter of the Gross Domestic Product and between 30% and 40% of government revenues are derived from the property sector. In the 1997 budget, the income from land sources went to HK$59.8 billion (US$7.7.billion) compared to a budgeted estimate of HK$36.5 billion. The increase came because the government sold more land before the hand over to take advantage of a buoyant property market. To that amount derived from land premiums, one must add the substantial source of income provided by the stamp duty on land transactions (about HK$2 billion). Direct tax-rates receipts were budgeted at HK$85.5 billion. By comparison, tax receipts make up 79% of the Singapore government revenues and land transactions and stamp duty account for only 12.3%.

4 - Under the provisions of the Basic Law which was adopted on April 4 1990, Hong Kong is since July 1 1997 a Special Administrative Region of China. Its government has been derived from the old colonial system called an executive-led system. In other words, there is a Chief Executive who has the same power as the Governor of the past. The difference is that he is not nominated by the colonial power (the British government) or the Central Government, but is selected by an electoral college of 800 people. The Chief Executive, currently Tung Chee-hwa, previously a shipping executive with no political or governmental experience, exercises all the powers.

It is specifically said (article 48 - paragraph 4) that "the Chief Executive decides on government policies and issues executive orders" (if and when necessary).

The Executive Council is an organ for assisting the Chief Executive in policy-making. The members of such Council are appointed. Their appointment or removal is decided by the Chief Executive (article 55). No number is specified in the Basic Law. The Chief Executive can therefore appoint as many councillors as he may choose

It is said that the Chief Executive shall consult the Executive Council, and that if he doesn't accept a majority opinion of the Council he shall put the specific reasons on record (article 56). It is not said that he must consult either the Civil Service or the Legislative Council.

Tung Chee-hwa has appointed to the Executive Council the following personalities: Anson Chan, 58, civil servant, Donald Tsang, 54, civil servant, Nellie Fong, accountant 47, Rosanna Wong, 46, public servant, Elsie Leung, 58, lawyer, Yang Ti-liang, 68, retired Chief Justice, Leung Chung-ying, 43, surveyor, Tam Yiu-chung, 51, teacher, Chung Shui-ming, 47, bank executive, Leung Kam-chun, 45, bank executive, Raymond Ch'ien,46, businessman (industry), Henry Tan, 45, businessman (textile), Charles Lee, 61, solicitor and Chung Sze-yuen, 81, retired banker.

The Legislative Council has 60 members. Its power is limited to enact laws but a complicated procedure makes it very difficult for the legislative members to initiate laws and fix their own agendas, leaving in effect all the power to the Chief Executive.

5.- The Hong Kong Monetary Authority (HKMA), being not a Central Bank, does not fix a prime rate. It is the banks that are at liberty to fix the prime rate. However, the HKMA is the lender of last resort and the clearing house for the banks. Therefore it is in a position to affect the decision of the banks through the clearing system and the rates it charges. The prime rate of Hong Kong, because of the peg to the American dollar is primarily tied up to the rates decided by the US Federal Reserve. Currently, the prime rate is 10%. The differential of 1.5% with the US prime rate is necessary as it makes it more expensive to speculate against the HK dollar. The differential is a way to gauge the confidence factor. In the past, the differential has been as low as 0.5%.

6 - The government has frozen all land sales until March 1999.

7 - The yen prime is currently 0.46%. Low interest rates mean that the remuneration of yen-denominated accounts is very low.

8 - Of Hong Kong's total exports, in 1997 63% are supplied by the mainland, compared with 49% in 1994. 28% of goods exported by local companies are made outside Hong Kong. The offshore trade by Hong Kong companies is now equivalent to 85% of the reexport. It totaled HK$1.05 trillion (US$135.5 billion) in 1997. These figures give an idea of the openness of the Hong Kong trade, which is as much generated within Hong Kong as it is generated outside Hong Kong without ever touching the shores of the region.

9 - In 1929, derivatives didn't exist, but what was new was the proliferation of brokers' loans for securities purchased on margin. Early in the twenties the volume of brokers' loans - often referred to as call loans - varied from a billion to a billion and a half dollars. By 1926, they had increased to three and a half billion. By 1927, they reached three billion and a half. By 1928, they jumped to four billion on 1st of June, five billion by 1st November and by the end of the year they were along six billion. (Source - The Great Crash 1929. J.K. Galbraith 1955).

Summer 1998

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