Hong Kong: 1997 Asian Financial Crisis Group: Caleb Mangohig, Nina Asmoni, Karson Taylor, Daniel Pho

Abridged History of Hong Kong 1841-1898 Hong Kong territory ceded to Great Britain 99 year lease Started in 1898 Expired in 1997 Transfer of Authority from Great Britain to China occurred June 1997

History Leading up to Financial Crisis The 1980’s rising levels of emigration in anticipation of 1997’s handover 1987 financial crisis April 4th, 1990 Hong Kong Basic Law was accepted

“One country, two systems” Hong Kong government addresses internal and external affairs Financially independent People’s Republic of China is responsible for defense and foreign policy

Government Head of Government – Chief Executive Tung Chee-hwa (1997 - 2005) Executive Council – enacts policies Secretaries Financial Secretary: Donald Tsang Yam-kuen (1997-2001) Ministries

Hong Kong Monetary Authority (HKMA) HKMA acts as both Hong Kong’s Central Bank Issues Hong Kong Dollar Currency Board Reports to Financial Secretary HKMA Chief Executive: Joseph Yam (1993 – 2009)

The Beginning of the 1997 Asian Financial Crisis Hong Kong's small, open economy is vulnerable to events outside its control The Asian financial crisis began with devaluation of the Thai baht. October 23rd, 1997 Hong Kong’s Stock Index falls 10.4% Wiped $29.3 billion off the value of stock shares What caused the Asian Financial Crisis? Probable causes: 1. Attack on the monetary market 2. Liquidity Problem 3. Government Philippine peso, Malaysian ringgit, Indonesian rupiah, Singaporean dollar, New Taiwan dollar, and South Korean won fell in value too. All as much as -79% Hong Kong’s Stock Exchange is one of the world's major stock markets, second largest stock market in Asia after Japan

1. Attack on the Monetary Market The East Asian currency was collapsing Short-term commercial bank loans Dominant form of capital inflow in East Asia Caused: domestic booms and asset market inflation Balance of payment came under pressure due to market sentiment that caused investors to pull out Speculative attacks Illiquidity problem Inability to rollover short-term bank loans Banks demanding immediate repayment caused sector to freeze up

2. Liquidity Problem Balance sheet vulnerability Caused by the weaknesses of Asian Banks, Non-Banks & Corporations Banks depended on direct finance (i.e. short-term bank loans) for investment capital with high debt-to- equity ratios Weakness exposed to currency mismatch and maturity mismatch Mismatch causes currency depreciation Bank balance sheets were badly hit Caused a lack of cash and an inability for banks to repay investors Insolvency

3. Government Banking problem Pre-modern corporate sector: no transparency Unhealthy relationship between government and big businesses Problem on productivity and competitiveness Heavy dependence on exports Political backwardness and lack of democracy

Affects of the Crisis on Hong Kong’s Economy Gross Domestic Product Hong Kong’s real GDP fell in 1998 GDP Growth was volatile, Fall in 2001 - US “dotcom bubble” Fall in 2003 - SARS crisis By 2004, real GDP began to grow Hong Kong’s real GDP fell in 1998 1997: 5.3 1998: -5.1 Contracting 5.5% Hong Kong was suffering from six consecutive years of deflation Nominal GDP did not overtake its pre-crisis level until 2005 Real GDP began to grow on average at a rate of 7.7% Reason for strong recovery accredited to fast-growing Chinese economy

Exchange Rate Fluctuations Hong Kong’s currency is pegged at a fixed exchange rate with the US Dollar Rate is set at 7.75 HK$/US$ Maintains monetary stability However, there is room for fluctuations: 1996 7.7343 HK$/US$ 1997    7.7421 HK$/US$ 1998    7.7453 HK$/US$ 1999    7.7575 HK$/US$ 2000    7.7912 HK$/US$ 2001    7.7990 HK$/US$ Hong Kong’s currency did depreciate in value between 1997 and 1998 by 0.4%

Inflation and Deflation Hong Kong experienced high inflation in the early 1990s Then high deflation following the Asian Financial Crisis Hong Kong’s currency is pegged to the US dollar, so it was unable to employ an exchange rate policy that could allow devaluation of the currency. The economy then adjusted on its own, falling from inflation, into deflation Because neighboring countries Hong Kong is in competition with had dramatic devaluations of their currencies, they were providing cheaper products and labor. To remain competitive, Hong Kong businesses cut costs (lowering wages, increasing unemployment) to reduce prices – led to deflation

Labor Market Unemployment Rates: 1994 1.9% 1995 3.2% 1996 2.8% 1994 1.9% 1995 3.2% 1996   2.8% 1997   2.2% 1998   4.6% 1999 6.2% 2000 4.9% 2001 5.1% 2002 7.3% 2003 7.9% 2004 6.7% 2005 5.6% 2006 4.8% Changes in Labor Cost Rate: 1998 +8.5% 1999 -3.1% 2000 -1.0% 2001 +2.5% 1994 -2006, Hong Kong is unable to return to pre-crisis levels. This can be explained by the lengthly period of deflation following the financial crisis. Deflation causes job losses. High in 2003 because of SARS. Unit labor costs did not fall - actually increased 8.5% during 1998

Government Spending Budget fell into deficit in 1998 All the major categories of recurrent expenditures increased steadily i.e. personnel-related expenses, health, education, social welfare Hong Kong practices fiscal prudence and stability. Government budget was balanced/in surplus most years prior to the financial crisis Budget fell into deficit in 1998, except for a small surplus in 1999/2000 The deficit reached a historical high of 5% of GDP in 2001/02 Under the currency board arrangement, the government cannot rely on the central bank to finance spending Government Revenue 1998 – 2003: 16.75% of GDP Compared to 17.5% in the previous five years All the major categories of recurrent expenditures increased steadily i.e. personnel-related expenses, health, education, social welfare

Business Bankruptcies and Consumer Spending Businessmen benefit from inflation Businesses were profitable in the early 1990s Firms closed down in period of the deflation following the Asian financial crisis. Wage earners suffer in times of inflation. But deflation gives them greater purchasing power. The spike in bankruptcies prior to 1998 can possibly be explained by the hand over of Hong Kong to China. During the period of deflation after the financial crisis, the number of bankruptcies climbed, and hit a peak in 2003. Hong Kong could have reached this peak in 2003 because of the SARS outbreak.

How the Crisis Was Resolved To stabilize its currency while inflation soared Hong Kong pegged its currency to the US Dollar Hong Kong used its cash reserves This was short lived when the crisis got more severe Government incidentally raised interest rates to 28% and then as high as 280% The Hong Kong Monetary Authority used its ties with China for help on controlling its monetary policy Backed by large monetary powers helped Hong Kong get through the crisis

The Hong Kong government and HKMA now believe that being financially independent is the best way to sustain themselves. In order to resolve the crisis and keep it from it happening again, Hong Kong has made sure that the banking system is more liquid and has high cash reserves. They can also deal with shocks more easily because of their large cash reserves. Hong Kong has also made sure to keep a fixed exchange rate with the United States in order to have their deficits and debt not affect their exchange rate. This exchange rate is being fixed by the large amounts of foreign currency reserves that the Hong Kong government now holds. This is what they believe will keep them from having to deal with another large financial crisis in which they need to be bailed out of.

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