PECC PEO/Structural Specialist Meeting Macroeconomic Management in Hong Kong since 1990 Osaka, 25-26 September 2004

Preamble Booming economy  prone to over-leveraging  vulnerable to external shock or abrupt turn in economic trend Individuals : excessive borrowing Corporates : excessive investment  high gearing ratio

Preamble Excessive debt  if accompanied with weak banking sector  risk of “debt crisis” Rising interest rate  debt servicing cost Currency risk Maturity mismatch

Preamble Solvency issue Bankruptcy Systemic breakdown of financial intermediation Spillover e.g. Asian financial crisis

Preamble Solvency issue Bankruptcy Systemic breakdown of financial intermediation Spillover e.g. Asian financial crisis

Preamble Painful adjustment Currency devaluation Asset price plunge NPLs Output contraction (rising unemployment)

Currency devaluation

Asset price plunges

Soaring non-performing loans

Output contraction

Rising unemployment

Hong Kong Experience Resilience to adversities Flexibility to maintain competitiveness Strong financial infrastructure

Hong Kong’s resilience Setbacks in 1998 and 2001 Rebound promptly  led by strong external trade

Hong Kong’s resilience Direct investment (DI) inflow remained substantial  averaging at HK$192 billion or 15% of GDP a year  Hong Kong as one of the major DI recipient in the region

Hong Kong’s resilience Hong Kong  attractive hub to foreign enterprises

Hong Kong’s resilience Household’s unsecured loans (credit card advances + other personal loans)  a small part of total bank loans for domestic use (around 7% in recent years)

Hong Kong’s resilience

Hong Kong’s resilience Hong Kong’s gross external debt : mostly associated with normal operations of the banking sector and with inward direct investment Private sector’s share not significant (7-9% over 2000 - 2003); mostly of longer-term nature Backed by substantial external assets  strong net positions across sectors

Hong Kong’s resilience Current account consistently in surplus  high savings for the economy as a whole Substantial outward investment  accumulation of external assets  Hong Kong as a net creditor

Hong Kong’s resilience Prudent and conservative fiscal policy : always “strive to maintain a balanced budget” Simple tax system & low tax rates: tax burdens (direct + indirect) around 9-10% of GDP in recent years Small government

Hong Kong’s resilience Fiscal deficit currently averaged at 3.3% of GDP Fiscal reserves remained sizeable at the end of FY2003 : 23% of GDP Debt-free until lately Asset securitisation and bond offering : Toll Revenue Bond (HK$6 billion) in May 2004, HK$20 billion notes and bonds to institutional and retail investors in July 2004

Strong Banking Sector Hong Kong’s banks  asset quality remained high even during the crisis Non-performing loans ratio : peak at 7.6% in 99 Q4  2.28% in 04 Q2 Classified loans ratio : peak at 10.61% in 99 Q3  2.99% in 04 Q2 Capital adequacy ratio : stayed high even at adverse times (over 18%)  significantly larger than the minimum standard (8%) set by BIS

Strong Banking Sector Bank remained profitable and liquid even in the wake of the crisis Return on assets : dipped in 1998, yet rebounded to a high level since 2000 Bad debt charge : leaped in 1998 & 1999, yet eased back promptly and stabilised since 2000 Liquidity : bank credit increasingly supported by deposit base

Strong Banking Sector Increasingly a net creditor Hong Kong’s banks  sound external position  substantial net external claims (110% of GDP in 2003) Increasingly a net creditor

Lessons to learn - Flexibility Prompt adjustments in consumer prices, wages, export prices, property prices and rentals Competitiveness restored within a short period of time Maintain stable exchange rate (linked rate system), rely on internal adjustment

Lessons to learn - Flexibility

Lessons to learn - Flexibility

Lessons to learn - Flexibility

Lessons to learn - Flexibility

Lessons to learn - Flexibility

Lessons to learn - sound supervision HKMA loan classification system Classified loans  substandard, doubtful, loss also focus on borrower’s business prospects, cash flow and payment capability more effective management of credit risk Prudent lending approach of bank  playing an important role in enhancing corporate governance

Lessons to learn - sound supervision Limit bank’s exposure to property market : 70% guideline on loan to value ratio (Nov 1991) 40% ceiling for property exposure of Authorised Institutions (early 1994 to Jul 1998) 60% guideline on LTV ratio for luxury property (Jan 1997 - Oct 2001)

Lessons to learn - sound supervision Establishment of a Commercial Credit Reference Agency for small and medium-sized enterprises (SMEs) facilitate credit assessment an important addition to Hong Kong’s banking infrastructure

Lessons to learn - strong financial infrastructure Enhancement to currency board system (Sep 1998)  7 technical measures Volatility of local interest rates markedly reduced since then

Lessons to learn - strong financial infrastructure Real Time Gross Settlement System (RTGS) Launched in Dec 1996 Provides HK with a modern, efficient and robust inter-bank payment system Reduces settlement risk

Lessons to learn - strong financial infrastructure US dollar Clearing System Launched in 2000 Provide a range of opportunities for further development our stock and debt markets in the longer term Eliminate settlement risks that arises when a transaction is spread across different time zones

Thank You