The pragmatist who abandoned principle in defence of the peg

PUBLISHED : Thursday, 16 June, 2005, 12:00am
UPDATED : Thursday, 16 June, 2005, 12:00am

The defining moment of Donald Tsang Yam-kuen's political ascent came in August 1998 in the depths of the Asian crisis, when the then financial secretary showed his readiness to sacrifice principles for pragmatism in the defence of the currency peg.

In a move that was fiercely criticised at the time, Mr Tsang threw Hong Kong's long-cherished free market values to the winds and spent billions of dollars of public money buying up shares on the Hong Kong stock exchange to scare off speculators selling the market short.

For a while it seemed touch and go, but Mr Tsang held firm and the gambit was a resounding success. Not only were the speculators sent packing, but ultimately the government earned a handsome profit and gave the local asset-management industry a shot in the arm to boot.

Hedge funds had already taken one speculative tilt at Hong Kong the previous year, following the city's return to Chinese sovereignty, but in the summer of 1998 they returned in force. By then Thailand, South Korea and Malaysia had been forced to devalue their currencies, the Indonesian economy had collapsed, and expectations of a yuan devaluation were rising fast. To speculators, the Hong Kong dollar's days looked numbered, and the city's exchange-rate peg meant the currency was a sitting target.

Pressure mounted through July and the early weeks of August 1998 as hedge funds and bank proprietary traders sold Hong Kong dollars short, forcing local interest rates higher. They also sold the Hang Seng index short through the futures market, as a wager that higher rates would hammer local businesses.

Intermittent intervention in the foreign-exchange market by the Hong Kong Monetary Authority did nothing to deter the short-sellers, and by mid-August the situation was desperate. Three-month interest rates were at 13 per cent and the Hang Seng had plummeted to 6,660 points, down 23 per cent in a month to its lowest level in five years.

Pundits around the world asserted that the government must immediately abandon the peg and float the currency to save Hong Kong's economy from total meltdown.

But Mr Tsang had other ideas. On Friday August 14, 1998, he ordered the HKMA to counter-attack. In an unprecedented move, the monetary authority simultaneously intervened in the foreign exchange and futures markets and bought billions of dollars worth of Hang Seng stocks to drive the index up 8.5 per cent in a single session.

'We have total resolve,' declared Mr Tsang at the time, pledging 'to drive those speculators out of the market'.

Economists around the world slammed the move, accusing the Hong Kong government of selectively supporting the stocks of companies run by its tycoon cronies, and some institutional investors sold out of long-standing holdings on the grounds that the city was no longer a free market.

The battle lasted two weeks, with the overnight interest rate at one point topping 20 per cent. But by the time the futures contracts expired at the end of the month, the government had bought an estimated $190 billion worth of stock to drive the Hang Seng up by 18 per cent, forcing the speculators to close out their short positions at a loss and retire defeated.

Within weeks, the government had refined the currency board mechanism to strengthen the peg against attack, and interest rates retreated to more normal levels. Little over a year later, with the Hang Seng at twice its August 1998 low, the government was able to begin selling down its shares with the launch of the Hong Kong Tracker Fund, which first popularised mutual fund investment in the city.

In retrospect, the decision to use public money to manipulate the stock market higher was a triumph for Mr Tsang. And his readiness to step forward and shoulder public responsibility for the gamble, while then chief executive Tung Chee Hwa took a back seat, was instrumental in setting him on his own path to the top office.