Dollar peg seen blocking recovery

HONG KONG'S economy will not recover as long as the Government retains the linked exchange rate, a regional economist says.

Nigel Hatcher of Australia-based BIS Shrapnel, sees more tough times ahead for Hong Kong unless the local dollar's link to the US dollar is broken.

'If the exchange rate stays where it is, basically, the economy won't recover. It's similar to Japan,' he said.

'Japan, through much of the 1990s, has been affected by an overvalued exchange rate.' Six of 14 countries covered in BIS Shrapnel's latest regional outlook would see their economies contract this year, Mr Hatcher said. Hong Kong would be among the laggards, with its gross domestic product shrinking 2.9 per cent this year.

Though painful, that would be an improvement on last year's contraction, estimated at 5.6 per cent.

Mr Hatcher said many of the region's crisis-hit economies would bounce back after this year, with no negative growth rates in the following year, but that these rebounds would prove short-lived in nations which failed to undertake deep economic reforms.

In most countries, those decisions involved overhauling local business culture and raising prudential standards in the banking sector. But in Hong Kong, change concerned the peg, which Mr Hatcher called a 'self-destructive policy'.

Unless the linked exchange rate was discarded, the SAR would probably see its targeted 3.8 per cent growth rate for next year shrink dramatically in subsequent years. The overvalued Hong Kong dollar would inflate the cost of doing business here and the price of the SAR's exports.

Other economists have argued that these negative effects could be lessened by allowing property prices to fall further as well as by deflating wages. But Mr Hatcher said neither of these factors could begin to make up for the too-strong exchange rate.

'Just let it [the peg] go. Just bite the bullet now,' he said. 'The longer they wait, the more damage, the longer the economy will stagnate.' With or without the peg, Mr Hatcher sees Hong Kong's economic growth gradually slackening. But the slower pace would be mitigated to some extent by the SAR's increasing integration with the fast-growing Pearl River Delta region.

The long-term outlook depended on the mainland's ability to manoeuvre through a minefield of economic, social and political problems, he said.

It was especially important for the mainland to regain the trust of foreign investors and domestic depositors. Though its chances of success in that endeavour were impossible to predict, Mr Hatcher said events surrounding the bankruptcy of provincial and municipal government fund-raising units had made him more pessimistic.

'As time goes by, I think the weight of probability is shifting in the other direction and that there will be a major setback to growth in China at some point over the next few years.' He pointed to the hardening of Beijing's attitude towards state-owned enterprises, as demonstrated by its decision to force Guangdong International Trust & Investment Corp (Gitic) into bankruptcy.

Gitic, China's second-largest Itic, collapsed in October, leaving more than 36.1 billion yuan (about HK$33.61 billion) in liabilities, compared to assets of 21.4 billion yuan. Without a government bailout, foreign creditors had little hope of retrieving their money.

If foreign capital dries up, or if there was a run on domestic banks (Mr Hatcher estimated that 22 per cent of the sector's loans were non-performing), the mainland would be forced to undertake a more rapid rationalisation of its economy and banking sector. That would lead to a dramatic drop in economic growth, perhaps even negative growth.

'[The mainland] economy is dominated by large state-owned enterprises which are far more indebted and less competitive than the Korean chaebol ever were, and the banking system is in worse shape than any in Asia,' he said.

'However, the economy is protected by limitations on capital flows, an exchange rate that is not fully convertible and massive foreign-currency reserves.' Assuming China avoided a big economic setback in the next two years, Mr Hatcher forecast that Asian economies would bottom out this year and show solid signs of recovery by next year.

Countries that had not participated in the investment boom of the 1980s and 1990s - and so avoided its excesses - would emerge as winners, he said.

The Philippines, for example, was emerging strongly from a long period of supervision by the International Monetary Fund just as other countries were having to begin such monitoring.

India and Vietnam had avoided the excesses of the 'Asian Miracle' and thus maintained high growth levels. Mr Hatcher described the two nations as competitive at prevailing exchange rates, with cost advantages and low levels of development underpinning growth in the near term.

Taiwan was the only Tiger economy still on track, he said. Of those that had come off the rails, South Korea and Thailand were most vigorous about reforms: writing off bad debts within the banking sector, consolidating and capitalising on weak currencies to boost exports.

Malaysia would begin to rebound next year, but he said its economy would remain weak for a prolonged period because the Malaysian Government had failed to recognise the extent of its problems and restructuring efforts had been inadequate.

Indonesia would be sidetracked by political changes, he said. Singapore's economy would shrink this year but rebound next year. Japan was at its lowest, but was finally addressing troubles in its banking, corporate and financial sectors.

As a result, the fundamentals were in place for it to embark on a sustained upturn.

Sara French