Hong Kong people must be united to face the financial storm which has yet to arrive. Financial Secretary John Tsang Chun-wah October 9, 2008 For most of you who have lost a fortune over the past five days as the Hang Seng Index dived more than 4,000 points to 14,796.87, Mr Tsang's 'yet to arrive' comment is hard to comprehend or to swallow. It could be a political move. Yet, he could be right, given the downward spiral we are seeing globally, the vulnerable peg system we have, and the little effort we have made to address the latter. Let's talk politics first. Back in August, a senior government official was still arguing with me that any public suggestion of a worsening economy and unemployment would be self-fulfilling. The spin has obviously changed in the past week. The cynics will suggest that it is necessary to manage public expectations on the eve of Chief Executive Donald Tsang Yam-kuen's Policy Speech. In the good times, politicians and unionists were calling for more public spending to address the widening wealth gap. Now bad times are here, it is not difficult to imagine how deafening their call will be. The economists will suggest that it is necessary to manage public expectations so that people will not panic when the situation further deteriorates. After all, it is difficult to think of any Asian economy that is more exposed to the global financial crisis, global economic slowdown, unstable US currency regime and the mainland's economic slowdown than Hong Kong. Despite the dive in share prices and the credit-crunch-driven collapse of companies, domestic sentiment is far from bruised. In the past week, calls from friends and relatives concerned only one thing: 'Is it time to bottom-fish?' People are still holding lots of cash, and job-loss concerns have not sunk in. But the reality awaiting us can be far uglier than an economic slowdown. First, take the banking sector. Two weeks after Lehman Brothers' collapse, financial institutions in Japan and South Korea began to fall. While banks in Hong Kong are financially strong and have limited exposure to collateralised debt products, their counterparties' risk remains unsure. Another bank run can never be ruled out. The government's spin doctors are already spreading the word that it is prepared to provide full coverage for private deposits. Second, our peg regime will shake as our fiscal position deteriorates and the US dollar strengthens (which has been the case recently). Here is the threat: Hong Kong has one of the most narrowly based and pro-cyclical fiscal revenue systems. Not only does property and financial market-related revenue account for more than 70 per cent of public income, there is also investment income that is closely related to market performance. As the property and stock markets go south, so does the government's fiscal position - particularly after the aggressive increases in welfare spending and civil servant salaries handed out as political goodies. A deficit is widely expected in the coming financial year. Speculators could well have an excuse to attack the Hong Kong dollar peg again, warned Vincent Chan, Credit Suisse's head of China research. Those of you who have lived long enough will remember the horror in 1998 when the peg came under attack. As we pray for the best, the natural question is: Why are we reliving this? Haven't we learnt from the earlier suffering? The private sector did learn from the lesson and has maintained relatively low leverage. The public sector has not. In the past decade, little has been done to change the pro-cyclical nature of our budget, except for the half-hearted consultation paper on value-added tax. Little has been done to change the overreliance of the Hong Kong economy on the property and securities markets despite repeated promises by the administration. Like the garment retailer U-Right, which relied on an ample supply of cheap liquidity and on growth in the mainland economy without addressing problems in its business model, Hong Kong has flourished without undergoing any structural reform. But as bank credit dries up, U-Right has fallen into the liquidator's hands. Now that the window for reform has long closed, we can only hope for two things. First, speculators are too busy dealing with their domestic mess and there will not be many with sufficient strength left to attack our peg after the sweeping financial meltdown. Second, the mainland can fight the global recession and maintain a strong economy, providing Hong Kong with a strong backup. Let's keep our fingers crossed.