When Heritage Foundation president Edwin Feulner turned up for breakfast on December 1 with Chief Secretary Anson Chan Fang On-sang, Financial Secretary Donald Tsang Yam-kuen and Deputy Secretary for Financial Services Rebecca Lai Ko Wing-yee, the discussions that followed were - to use the Government's word - 'robust'. Mr Feulner was trying to explain why the foundation would soon issue a report that carried the headline: 'Hong Kong No Longer Has World's Freest Economy.' The foundation argued that as a result of the Government's decision to intervene in the markets, the honour now belonged to Singapore. To say Hong Kong representatives were displeased would be an understatement. One source described the meeting as a 'bloody great row', and even a government spokesman confirmed 'voices were raised'. Rumours were that Mr Tsang stormed out but, as it turned out, 'he had to leave early to attend another engagement'. The issue at the heart of these 'robust' discussions has dominated government policy-makers since the handover - the maintenance of Hong Kong's position as Asia's leading business centre in an environment of unprecedented challenges. And why is the Government so sensitive? Because many in the international financial community believe it is not just failing to maintain the SAR's position, but undermining it, making the coveted title of Asia's premier financial hub available to eager rivals such as Singapore, Shanghai, Tokyo and Taipei. Consider the critics. Federal Reserve chairman Alan Greenspan mirrored the Heritage Foundation's conclusion, saying the Government had eroded Hong Kong's 'credibility' by intervening in the financial markets. No end of academic economists have also railed against the decision, the most prominent being Nobel Laureate Merton Miller who described it as a 'serious blunder'. The criticism did not end at the intervention. The Government has - rightly or wrongly - taken some blame internationally for wider economic woes such as the high cost of doing business, rising unemployment, the recession, deflation and the increasing budget deficit. All this conveniently ignores the fact most of these negatives have been caused by the regional economic crisis. But the criticism certainly has been a factor in making it easier for pretenders to Hong Kong's throne to emerge. SG Securities Research, the analysis arm of Societe Generale, said: 'Hong Kong has to counter an unprecedented intensity of competition. Not only is Singapore aggressively bidding for its financial sector business, Tokyo's big bang could also draw some business away. 'The financial sector is not the only one threatened: Chinese ports are winning more business from Hong Kong, and growing direct economic relations between China and Taiwan should also diminish Hong Kong's intermediary role. Even in air cargo, Singapore and other regional centres are slashing charges to woo business.' Moreover, SG said, the Government was not seen as handling things too well. 'The new SAR Government has to tackle multiple challenges with limited resources. It needs to manage domestic expectations over asset prices, deflation, economic growth, unemployment, etc. It must convince the market that it is not averse to the necessary adjustments to maintain long-term competitiveness. Confidence is key in keeping the rates low and the peg stable. This confidence is being eroded by the manner in which the challenges in 1998 were tackled.' David Dodwell, co-author of The Hong Kong Advantage, a study of competitiveness, said: 'You have a new Government operating in a highly uncertain context and learning a wholly new agenda. It is a very unstable period of political evolution.' The effects of what SG calls an erosion of confidence are already being felt. The Economist Intelligence Unit, since the second quarter of 1997, has forecast problems for Hong Kong's business climate over the next five years due to 'an expected deterioration in the operating environment associated with the handover and fallout from the regional economic crisis'. So severe is the anticipated decline that it predicts the SAR will drop from being the best place in the world to do business to 12th-best by 2003. What is the reason? According to experts, the recession and various other woes stemming from the regional economic downturn - while important - do not go to the heart of what is undermining competitiveness. The real damage has been done in an area far harder to pin down: the perception internationally that Hong Kong has been politicised. One prominent Western banker said: 'There is a feeling that Hong Kong has lost something. We all know that Singapore has a much more politicised environment than Hong Kong, but it has always been that way. There is a fear that this could be the beginning of an ongoing erosion and that things are going to get worse not better, whereas in Singapore at least you know things are going to stay the same.' Robert Broadfoot, head of a think-tank, the Political and Economic Risk Consultancy, says three events led to accusations that the economy was becoming politicised. 'The emergency programme announced by Tung Chee-hwa at the end of May to stabilise the property market was a mistake. Prior to that point the official strategy was clear: hold the Hong Kong dollar steady and permit the market to force a downward adjustment in prices that will help the Government maintain Hong Kong's competitiveness. 'The May package made it seem like the Government was trying to protect property developers. By siding with developers, the Government has shown that it might be vulnerable to pressure from vested interest groups in ways that could compromise the SAR's non-intervention, more international image.' Hot on the heels of the property package came Mr Broadfoot's second example - the new airport. 'The airport was opened prematurely, mainly for political reasons. Someone at high level decided it would be a good idea to time the opening with the first anniversary of Hong Kong's transition, Jiang Zemin's visit to the SAR and US President Bill Clinton's stopover. 'What was intended to be a symbol of Hong Kong's bright new future under China has become an example of poor planning, worse implementation and finger-pointing. Hong Kong's image as an efficient entrepot has been seriously tarnished.' The third indication of politicisation was, according to Mr Broadfoot, intervention in the stock and futures markets. 'This has thrown into doubt the Government's commitment to maintaining a laissez-faire system. These doubts, in turn, are causing some critics to speculate that Hong Kong's role as a regional trading and financial centre could be in jeopardy.' All of this leaves the Government with a problem. In seeking to affirm Hong Kong's position as Asia's leading business hub, it must enhance competitiveness. There is also the need to reassure investors that the SAR has not become politicised. Mr Tung tried last week at an economic conference in Davos, Switzerland. He conceded 'there are some businesses in Hong Kong who are concerned with the investment climate' but insisted 'the voices you hear are really a demonstration of our strength rather than our weakness'. What else has the Government done? In a written reply to questions, Mr Tsang pointed out that it has, crucially, maintained currency stability. It has kept the banking system intact in a time of crisis. In addition, it has moved aggressively to change the regulatory framework for the securities and futures markets to further protect their viability. The Government has also commissioned a study to enhance financial infrastructure and attempted to attract new financial products such as international debt to the market. Reacting to competitive challenges from rival business centres, the Government has set up the Services Promotion Programme to 'ensure Hong Kong remains the premier services centre in Asia'. It has also established the Helping Business Programme to 'review ways the Government can help the business sector by cutting red tape'. 'To meet international competition, the Hong Kong Government is acutely aware of the need to sharpen our competitive edge and will continue to respond creatively to the economic adjustment process,' Mr Tsang said. But for many critics, the Government must do two fundamental things to restore the competitive edge: sell the $120 billion stock portfolio as soon as possible and undertake to bring property and other asset prices to market levels. Mr Dodwell said: 'The Government will over time be seen to have made a mistake intervening in the markets. Hong Kong can take pain on the chin and move on. It did it in the 1970s and the 1980s and, when it recovered, you knew it was recovering from a firm foundation - a real bottom. This time the Government did not allow it to hit bottom. 'The Government now appears to be unified in planning to withdraw from the markets and reassert its historic distance from them. What's missing is serious attention being paid to the property market. The cost of property in Hong Kong needs to fall significantly to take the stranglehold off the retail, restaurant and business sector and make it possible for people to own their own home.' Andrew Freris, managing director of the Bank of America and former head of economics and finance at City University, said: 'Where I would criticise the Government is that they did not come out at the very beginning of the crisis and say the peg is going to stay and it is going to take a hell of a lot of pain.' The pain, said Mr Freris, would have been to allow asset prices - primarily property - to deflate to market levels. 'The choice of gun to shoot the tiger was wrong,' he said. Mr Broadfoot agreed, saying the Government could effectively kill two birds with one stone by allowing property prices to make Hong Kong a cheaper place to do business, while demonstrating it was not influenced by a few powerful businessmen. 'Important cartels continue to exist. The most notable is the property sector which is dominated by a handful of players. It is one thing for Hong Kong to have some of the highest property prices and rents in the world during boom times. As Asia wallows in recession, however, Western banks and multinationals are taking a much close look at profitability in Asia. Firms that cannot justify the commitment of capital are being ordered to reorganise (which often means scale back) their operations. 'What is good for Hong Kong's property sector might not be good for other businesses in Hong Kong, particularly not these days, and it is these businesses - more than property - that have established Hong Kong's credentials as an international business centre.' If this is what some in the international community want to see, it now appears they might get it - at least in part. Sources confirm the Government is now committed to offloading its stock portfolio. It has taken advice from major international banks on methods of doing so and a gradual unwinding of its positions seems imminent. But on the property sector it appears less willing to act; it is expected to resume modest land sales in April, enough to keep prices near current levels but not enough to bring them down further. The Government says property prices have fallen about 50 per cent from their 1997 peak to what it terms competitive levels. Nevertheless, the latest EIU survey on business costs says Singapore has dropped from being 11th most expensive to 13th, while Hong Kong remained third. Indeed, the Government's own Regional Representation Survey found more multinational firms closing their local offices, citing high costs. This has not gone unnoticed. Edgar Cheng, head of the Government's powerful think-tank, the Central Policy Unit, is expected to propose action to tackle property's disproportionate influence on the economy. The Government's need to act may gain urgency if Beijing comes up with ideas of its own. Two weeks ago, it despatched an 'observer' to Shenzhen to assess how Hong Kong's competitiveness and economic viability were being affected by the crisis and the Government's response to it. 'China has been one power centre in Hong Kong that has not really flexed its muscles publicly to shape government policy,' said Mr Broadfoot. 'However, if Beijing perceives that other local power centres [property developers] are exerting too much influence and threatening China's plans for Hong Kong, it would be not at all surprising if Beijing were to use its own influence more to protect its interests.'