Hong Kong down but not out as market plummets

Reeling from its worstever stock market meltdown yesterday and bewildered by the way it has been dragged down by Asia's financial and stock market crisis, Hong Kong is trying to weather the storm by sacrificing its economy to save its currency and ensure long-term financial stability.

It was as bleak a day as could be imagined. People saw their savings disappear. Bookings were cancelled in restaurants. A 43year-old British financial executive committed suicide, an act the Sing Pao daily said was related to the stock market collapse. After suffering its largest oneday stock market fall in history, analysts say the only action left to Hong Kong now is to raise interest rates further to defend the its dollar's link to the US dollar.

This is regarded as crucial to its future as a safe haven for capital and investment in the south-east Asia region. If the link goes, they say, it will be a disaster, as a devalued Hong Kong dollar would bring about a flight of capital and the collapse of the capital, equity and property markets.

But the prognosis is not all doom and gloom. Economists generally agreed that though the situation is bad, it may not be fatal, and that Hong Kong has a good chance of toughing it out. Its fundamentals are sound. It does not have the problems of corruption and cronyism which undermined the foundations of the economies of Thailand, Malaysia and Indonesia. Also the effects of the crisis on booming China are likely to be minimal, according to a western economist with a leading financial institution in Beijing. "Banks in China don't have direct exposure, though the Bank of China has a major subsidiary in Hong Kong," he told The Irish Times.

"Companies may put off their listings in Hong Kong but few enterprises see capital loss because of holdings in Hong Kong. It's not like everyone in China is holding Hong Kong stocks and property. In fact China lowered its interest rates in the last few days, which shows that it is not caught up in this crisis." China is at a different stage of development than countries like Thailand, where the regional turmoil began in late summer when the Thai baht was forced to break its peg to the US dollar, starting a currency slide throughout the region which has turned into competitive devaluations to make exports less expensive.

China's currency is not fully convertible, and therefore not as vulnerable to speculation. With one of the highest savings rates in the world and reserves of $125 billion (£85 million), China can also defend any attack on the yuan. Most of the foreign investment is in buildings or enterprises and not vulnerable to a sudden pull-out.

There are other silver linings. A severe dent in the Hong Kong property market bubble could ultimately work to the territory's advantage, though in the short term a fall in property values of 30 or 40 per cent would hit Hong Kong's equity market. Hong Kong's worst economic crisis since the crash of 1987 was brought about by the fear that it will be unable to hold out as the only Asian economy not to devalue its currency. The Hong Kong dollar has been pegged to the US dollar at a rate of HK$7.80 (70p) since 1983. This has ensured its survival as an oasis of financial stability through times when confidence in its future has been shaken, such as the 1989 crackdown in Tiananmen Square and the rows between Britain and China over its future as a Special Administrative Region of China. But if it keeps the peg intact the price will be high. Hong Kong is becoming too expensive for its environment. Economists are already cutting economic growth forecasts as the markets buckle under the interest rate burden.

Hong Kong's leaders are frantically trying to restore confidence in the Hong Kong dollar. Financial Secretary Mr Donald Tsang said: "I believe very strongly in defending our dollars. Our dollars reflect the fundamentals of Hong Kong, and the fundamentals are exceedingly robust."

In London, Hong Kong chief executive Mr Tung Chee-hwa said: "There is tremendous determination on the part of the Hong Kong government to maintain the exchange rate. We have every confidence this can be done."

Whatever happens, Hong Kong is in for a painful readjustment, less than four months after it came under Chinese sovereignty. The blue chip Hang Seng index ended yesterday 10.41 per cent lower at 10,426.30 and has now shed almost a quarter of its value in the last four trading sessions as interest rates soared. One-month interbank rates reached 47 per cent yesterday, while overnight money leapt to 250 per cent.

These higher interest rates will inevitably cause the stock and property markets to plunge, and depress the entire economy. Mr Lee yesterday cut his 1998 economic growth forecast to 4.75 per cent from 5.5 per cent. "If the negative approach to the Hong Kong market continues for a protracted period of a few weeks, we're looking for a pretty rough 1998," said Mr Ian Perkin, chief economist at the Hong Kong General Chamber of Commerce.

Some Hong Kong banks tried to remove the major risk to devaluation - the flight of domestic capital - by refusing to redeem time deposits before maturity, but were criticised for undermining the established market mechanism. "If people don't want to hold your currency, you raise rates until they do," said Mr Don Hanna, chief economist at Goldman Sachs. The Chinese government said yesterday Beijing would not intervene. "We believe the situation of Hong Kong's economy is very good and Hong Kong's economy is strong," a spokesman said. The Hong Kong Financial Secretary said he was not at all worried by the stock market plunge. "Just look at the corporate structure of Hong Kong, our companies are still making good profits," Mr Tsang said. "I don't think it is a matter for people to panic about."

But panic they did. Hong Kong market players have a reputation for following the herd. The stock market regularly plunged at alarmist reports of the health of China's former leader, Deng Xiaoping, who died in February. Yesterday they stampeded as Hong Kong stocks crashed below the 10,000 point barrier. But at the end of the day they pulled back a little and after touching 9,998 points the Hang Seng Index climbed back above the 10,000 point mark. "The Hong Kong market is in a free fall, actually it's a bungee jump," said Mr Patrick China, research director at China Everbright Research. "Who knows where the bottom is?"