Inflation is not all bad news for Hong Kong

PUBLISHED : Sunday, 06 April, 2008, 12:00am
UPDATED : Sunday, 06 April, 2008, 12:00am

Joseph Yam Chi-kwong came out to defend the city's currency peg to the US dollar again yesterday - the second time he has done so in a week. The Monetary Authority chief has come under mounting pressure because the 24-year-old peg is, rightly or wrongly, seen as contributing to the city's spiralling inflation, which has exceeded 5.1 per cent since February. Several leading investment houses have issued reports speculating on the possibility that the peg will be abandoned to rein in inflation.

Besides the usual unreliability of these reports, it is not clear that the current inflation is as harmful as it is often perceived to be. Nor is it clear that the peg is mostly to blame for it. The US Federal Reserve has slashed interest rates in response to the credit crunch that has affected that country's financial system. Because of the peg, Hong Kong has little choice but to follow suit. But studies conducted by Mr Yam's office show a 10 per cent depreciation of the greenback against other currencies would cause Hong Kong prices to rise 0.82 per cent in the short run and 1.61 per cent in the medium term.

These figures are undoubtedly high, but Mr Yam argues that rising salaries and labour costs are the more important contributors to inflation. Wages have indeed shot up since the economy emerged from long years of deflation in 2004. Then there is the fast-rising price of food. The price of rice - which led to runs on the staple at supermarkets and other shops last week - is but the latest example. It comes on the heels of big increases in the price of pork from the mainland. The price of grains, such as wheat and corn, and of oilseeds such as soya beans, have doubled or tripled since 2005. Unlike rice, they are not staples in Hong Kong, but they are key ingredients in higher-end food products.

Mr Yam is a staunch defender of the peg. He has often argued it is essential to maintaining exchange-rate stability. He has now added an additional argument - that the US dollar-Hong Kong dollar exchange rate is not contributing significantly to price rises or price instability. It takes some courage to adopt this position. The rich western countries - along with their neo-liberal economists, from institutions such as the International Monetary Fund - often equate price stability with economic stability. Since inflation, by definition, causes price instability, it must be bad for the overall economy, it is thought. Yet this is not necessarily so for Hong Kong.

The trade-weighted decline in the Hong Kong dollar's value has made the city more competitive and attractive as a goods and services hub. This has, without doubt, contributed to the fall in unemployment to a 10-year low. Our economy is growing at a respectable rate, even though a global downturn is anticipated because of the effects of the US economic slowdown. Property owners paying floating-rate mortgages are borrowing virtually free because of negative real interest rates. The poor suffer the most from inflation because they spend a disproportionate amount on food, but the government's bumper budget giveaways include billions of dollars in extra welfare which will go some way towards lightening their burden. Meanwhile, waiving property rates for the entire year will help dampen inflation. We should not be complacent about inflation, but nor should we be unduly alarmed.