A budget deficit would lead to fresh attacks on the Hong Kong dollar and push up interest rates, Tung Chee-hwa warned yesterday. Under pressure from newly elected legislators, Mr Tung twice rejected calls to cut taxes and increase spending. Speaking before dining with members of the new Legco, Mr Tung warned that a budget deficit would give rise to doubts over the Government's ability to defend the pegged exchange rate. 'When we go out of our way to make a budget deficit, we have to consider the atmosphere in the outside markets,' he said. International speculators would interpret the deficit as a signal the Government could not defend the peg and launch another attack on the Hong Kong dollar, he said. 'As soon as they start attacking, interest rates will increase.' Speaking at a conference earlier in the day, Mr Tung emphasised the need for a prudent fiscal policy. 'Any deviation from our long-held philosophy of fiscal prudence may well give rise to speculative attacks again on the Hong Kong dollar, the result of which might well be another increase in our interest rates. This is not something we want,' he said. Mr Tung noted that the current Budget had provided massive tax cuts and expenditure increases. 'The provision of these stimuli . . . will give the necessary boost to our economy. We know the pain of the adjustment process but the Budget measures must be given time to work.' Secretary for Financial Services Rafael Hui Si-yan said: 'The use of reserves is not a problem in itself. The point we should never forget is not to give an impression to local and international investors that there is a drastic change of policy. A prudent fiscal policy should be upheld now and in future.' Independent Eric Li Ka-cheung said legislators-elect had not advocated abandoning fiscal prudence. 'We should not under-estimate our own strength nor the understanding of foreign investors about Hong Kong. Also, they are more familiar with budget deficits in their own countries. 'We just need to explain to them that a small deficit does not mean we have scrapped our policy,' said Mr Li. Tsang Yok-sing, Democratic Alliance for the Betterment of Hong Kong chairman, said: 'We are not saying we must go for a budget deficit. 'But that seems to be inevitable. We do not think a budget deficit in one single year is in breach of the Basic Law.'