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SCMP Reporter

HONG KONG is not facing recession. The Hong Kong dollar peg is not about to go bang, nor will it in the medium term. The problem with apocalyptic economic models brewed up by the many gloomy counterparts of Jardine Fleming economist Daryl Ho is that they overestimate the importance of domestic private demand. They also fail to take into proper account the role of exports in the economy and what is fuelling inflation.

  'There has been growing pessimism over Hong Kong's economy,' said Mr Ho.

  Investors had been worrying about poor retail sales, layoffs in the financial sector, a climbing unemployment rate, disappointing results and a sluggish residential property market.

  'Meanwhile, journalists have penned sensationalist headlines, hinting that the domestic economy is headed for a recession.'   While Hong Kong was experiencing an economic slowdown, 'we believe economic growth will rebound rather than fall further in 1996', Mr Ho said.

  There are two reasons for this view: the peaking of the interest-rate cycle and a bottoming out in 1995 of a China economy that is set to improve in 1996.

  'On the one hand, the recovering Chinese economy will make Hong Kong's export growth stronger and add inflows of Chinese capital.

  'And on the other, the dampening effect on domestic consumption brought about by rising interest rates will taper off.'   Mr Ho believes exports are a key indicator of where things are going.

  There have been three phases of export trade: the first was powered by immigration from China, the second by mainland China's economic reform, and the third by the development of export-oriented businesses. In the third phase there has been a hollowing out of manufacturing in the domestic economy. A growing reliance on services has led to a decline in overall labour unit productivity. That partially explains why Hong Kong has under-performed fellow newly industrialised economies.

  'However, the hollowing out of domestic industry does not imply Hong Kong is no longer export driven. Hong Kong is more export driven than before,' said Mr Ho.

  Growth in services is closely linked to export growth, and more than 70 per cent of the service sector is linked directly or indirectly with trade-related business.

  'Hong Kong now is the most important hub, producing services such as finance, transport and communications to China-related trade flow,' said Mr Ho.

  The economy was more reliant now than ever before on China-related imports and exports. Such trade represented 321 per cent of the territory's 1994 gross domestic product, against 60 per cent in 1975.

  Many of Mr Ho's economic counterparts have placed their emphasis on domestic consumption. A decline of consumption in 1994 coupled with nine consecutive months of declines into 1995 has led many Hong Kong economists to conclude the territory is in for a big recession, one that is led by a downturn in consumption.

  Mr Ho argues it is wrong to place too much emphasis on consumption. Jardine Fleming believes Hong Kong's exports to the United States will remain stable while trade-related activity in China is set to pick up in 1996. Given the importance of exports to the local economy, a recession appears unlikely.

  So what about the peg and the eroding influence of inflation? Many economists believe the peg has a sell-by date on it, while inflation is making the territory uncompetitive. Mr Ho disagrees.

  There are three main anti-peg arguments.

  The first argument says the Hong Kong dollar is overvalued, its peg to the US dollar doomed by high inflation in Hong Kong and low inflation in America. The second says the peg will not be able to cope with the flight of capital expected before 1997. The third anti-peg argument is that the Hong Kong dollar will be absorbed by the yuan.

  When people talk about inflation and the peg they need to consider all aspects of the comparison. Hong Kong's nine per cent inflation figure is obviously greater than the two or three per cent price rises in the US.

  But in terms of purchasing power, the more important numbers to analyse are those for tradeable goods.

  'The higher consumer price inflation in Hong Kong is in fact due to the strong domestic demand for services as a result of rapid economic growth development in Hong Kong and southern China,' said Mr Ho.

  Export prices in Hong Kong had risen only 31.5 per cent from 1983 to 1994, much lower than the 125 per cent rise in the Consumer Price Index. 'This shows that the Hong Kong dollar is not over-valued at all,' said Mr Ho. It is probably undervalued, according to that vantage point.

  By taking the 1997 factor into account, there is the potential for major capital flight.

  The emigration chart shows a good number of people have already left the territory since the Tiananmen Square Massacre. In rather macabre fashion, Tiananmen Square shook out sellers in Hong Kong so that the flight of capital actually began in 1990. This spread out the overall impact of emigration by individuals with a high net worth.

  There could be one last upward spike left in the emigration figures, although as far as planned capital movement is concerned, the vast majority of the money has already gone.

  Absorption of the Hong Kong dollar into the yuan is unlikely for quite some time. Convertibility of yuan in tradeable items could begin in three to five years' time. But convertibility on the capital account, allowing a Shanghainese shopkeeper to buy a condo in Los Angeles, could be more than 10 years off.

  There would be a problem, however, if there was a loss of confidence in the territory.

  'We believe that, although the linked system is quite efficient and effective in deterring speculative selling of the Hong Kong dollar at the wholesale level, the Hong Kong Monetary Authority could do very little to save the peg in the case of a total loss of confidence in the Hong kong dollar among local residents,' said Mr Ho.

  It is okay if a white-socks forex dealer tries to hit the peg. But if the person on the street decides to liquidate all his cash and assets into foreign currency, the monetary authority will be powerless to stop it, warns Mr Ho.

  Given Mr Ho's views on the improving export picture and assuming there is no total loss of confidence next week, he is forecasting GDP growth in 1995 of 5.3 per cent, rising to 5.8 per cent in 1996.

  Inflation is expected to hold steady at nine per cent and rise slightly in 1996 to 9.1 per cent.



Growth will rebound in 1996