FINANCIAL INTEGRATION IN ASIA ANDebook.lib.hku.hk/HKG/B35840092.pdf · FINANCIAL INTEGRATION IN ASIA AND THE ROLE OF HONG KONG Contents Page ... Mahmood Pradhan, International Monetary

F I N A N C I A L I N T E G R A T I O N I N A S I A A N D

T H E R O L E O F H O N G K O N G

Contents Page

Preface I

Overview of the Conference 3

Conference Programme 6

Opening Session

Opening Remarks 13Joseph C K Yam, Chief Executive,Hong Kong Monetary Authority

Welcoming Remarks 15Christopher Patten, Governor of Hong Kong

Session I: Key Aspects of Regional Economic andFinancial Integration (Part I)

Chairman's Introductory Remarks 23Joseph C K Yam, Chief Executive,Hong Kong Monetary Authority

Globalisation and Asia; The Challenges for 26Regional Co-operation and the Implications for Hong KongMichel Camdessus, Managing Director, International Monetary Fund

Regional Economic and Financial Integration: 37The Role of Hong Kong in Asia and the WorldKenneth Clarke, Chancellor of the Exchequer, United Kingdom

Economic Integration in Asia and Hong Kong's Status 46as an International Financial CentreDai Xianglong, Governor, People's Bank of China

Contents

BIB. REG. MO. RDATE B E C ' D l J I M

CLASS NO.AUTHOR NO.

Contents Page

Financial I n t e g r a t i o n : O p p o r t u n i t i e s and Risks 52

Anwar bin Ibrahim, Deputy Prime Minister and

Minister of Finance, Malaysia

Sess ion 2 : K e y A s p e c t s o f R e g i o n a l E c o n o m i c a n d

F i n a n c i a l I n t e g r a t i o n ( P a r t I I )

Cha i rman 's I n t r o d u c t o r y Remarks 59

Gabriel C Singson, Governor, Bangko Sentral ng Pilipinas, Philippines

Globa l T rade and Financial I n t e r d e p e n d e n c e - 60

T h e Key t o P r o s p e r i t y and T ranqu i l l i t y

£ Gerald Corrigan, Managing Director, Goldman, Sachs & Co

Policy D i r e c t i o n Towards a M o r e I n teg ra ted As ia : 71

A C e n t r a l Banker 's Perspect ive

Kyung Shik Lee, Governor, Bank of Korea

Luncheon Speech: 78

T h e Eleven C o m m a n d m e n t s

Donald Tsang, Financial Secretary, Hong Kong

Remarks o n Financial Secretary 's L u n c h e o n Speech 84

Michel Camdessus, Managing Director, International Monetary Fund

Sess ion 3 : T h e C h a l l e n g e s a n d O p p o r t u n i t i e s

f o r H o n g K o n g o f G r o w i n g R e g i o n a l I n t e g r a t i o n

( P a r t I: P o l i c y Issues f o r H o n g K o n g )

Cha i rman 's I n t r o d u c t o r y Remarks 89

Chen Yuan, Deputy Governor,

People's Bank of China

G r o w i n g Regional In teg ra t ion in As ia : 90

Some Pol icy Issues Regarding T h e Ro le o f H o n g K o n g

J Soedradjad Djiwandono, Governor, Bank Indonesia

Contents

Contents pQge

Hong Kong's Economic Transformation: 103

Policy Challenges and Future Potential

Hubert Neiss, Director, Asia and Pacific Department,

International Monetary Fund

The Importance of Regional Co-operation 107

Rafael Hui, Secretary for Financial Services, Hong Kong

Session 4: The Challenges and Opportunitiesfor Hong Kong of Growing Regional Integration

(Part II: The Challenges of Greater Regional Integration)

Chairman's Introductory Remarks 121Kunio Saito, Director, Regional Officefor Asia and the Pacific, International Monetary Fund

Factors Influencing East Asian Performance 122David Borthwick, Deputy Secretary,Department of the Treasury, Australia

Tokyo's "Big Bang" Plan and Its Implications 130for Asian Financial MarketsYukio Yoshimura, Deputy Director-General,International Finance Bureau, Ministry of Finance, Japan

Economic and Financial Integration - Singapore's Perspective 136Khor Hoe-Ee, Deputy Director and Advisor,Economics Department, Monetary Authority of Singapore

Policy Challenges from Increased Global and 144Regional IntegrationDavid Goldsbrough, Senior Advisor,Asia and Pacific Department, International Monetary Fund

Contents

Contents

Closing Session

Chairman's Introductory Remarks 151

Joseph C K Yam, Chief Executive,

Hong Kong Monetary Authority

Concluding Remarks 153

Michel Camdessus, Managing Director,


Closing Remarks 157Tung Chee-hwa, Chief Executive,Hong Kong Special Administrative Region

Background Papers

Asia: Recent Economic Trends and Prospects, 165and the Challenges of GlobalisationMahmood Pradhan, International Monetary Fund

Hong Kong: Structural Change, Integration, 197and Economic PoliciesAasim Husain, International Monetary Fund

Hong Kong's Monetary Arrangements Through 1997 218Hong Kong Monetary Authority staff

The Importance of Financial Infrastructure 237in Financial IntegrationHong Kong Monetary Authority staff

Biography of speakers 258

The term "country", as used in this book, does not in all cases refer to a territorial entity thatis a state as understood by international law and practice; the term also covers someterritorial entities that are not states, but for which statistical data are maintained andprovided internationally on a separate and independent basis.

Contents

P R E F A C E

Financial integration is no doubt one of the most important issues

in Asia. To sustain economic development in the Asian region,

there is a strong demand for funds for infrastructure and other

investments. Rapid economic growth and high saving rates have

generated substantial domestic funds to meet some of this

demand. There has also been a substantial inflow of direct and

port fol io investment funds f rom outside Asia, attracted by the

promising economic prospects of this region and made possible by

financial liberalisation of individual Asian economies.

It was against this background that the Hong Kong Monetary

Author i ty and the International Monetary Fund co-organised the

Conference on Financial Integration in Asia and the Role of Hong Kong

in Hong Kong on 7 March 1997. For the IMF, co-hosting the

Conference is an indication of the importance IMF attaches to

stability and growth in the region. As for Hong Kong, the

Conference brought together key ministers, governors and

policymakers from the region and the rest of the wor ld at an

important moment as Hong Kong enters a new chapter in its

history.

The Conference took stock of the increasing integration of trade

and financial markets across Asia, assessed what these trends

meant for policymakers, analysed the key factors that have been

behind the remarkable economic success in the Asian region and

considered the lessons to be drawn.

A consensus view emerged from the Conference that sound

macroeconomic policies, good quality of supervision, and co-

operation in the region are among the most important policy

responses to cope wi th growing integration in Asia. As for Hong

Preface

Kong, many speakers and participants shared the view that Hong

Kong's existing f ramework of prudent fiscal policy, non-

interventionist approach, and a transparent and rule-based policy

framework were important factors contributing to Hong Kong's

success.

These factors would continue after I July 1997 when Hong Kong

becomes a Special Administrative Region of the People's Republic

of China. Under the principle of "one country, t w o systems",

Hong Kong - as the paradigm of free trade, free markets, and

prudent fiscal and monetary management - wil l continue t o play an

important role as an international financial centre, serving the

development needs of the region, in particular China. The

important factors that have contributed to Hong Kong's success in

the past have been clearly enshrined in the Basic Law prescribing

the systems t o be practised in Hong Kong after I July 1997.

The Conference, which was attended by more than 400 participants,

was a tremendous success. We are grateful to the speakers for

their valuable contribution. Encouraged by the positive feedback

to the Conference, we have decided to compile the speeches into

a handy volume to make available the wisdom and wealth of

information on a wider basis.

Joseph Yam Michel Camdessus

Chief Executive Managing Director

Hong Kong Monetary Author i ty International Monetary Fund

Preface

O V E R V I E W O F T H E C O N F E R E N C E

This overview sets out the aims of the Conference, outlines the

main conclusions f rom the papers that have been prepared, and

relates these to the issues the speakers will cover in each session.

As such, it is intended to provide participants wi th an indication of

how each of these elements wil l come together to achieve the

Conference's goals.

The Conference has two main aims. One is to reassess the

process of economic and financial integration that has been taking

place in Asia. The other is t o examine the role that Hong Kong

can play in the region, now and in the future. The policy lessons

for Hong Kong that, it is hoped, wi l l emerge f rom the Conference

should be consistent with the overall vision of regional development

elaborated, but they wil l be specific to Hong Kong's particular

economic, geographical, historical, and political circumstances.

T h e Process of Regional Economic and FinancialIntegrat ion

By seeking to understand more clearly the process of regional and

international integration, the Conference aims to develop

suggestions for the framework needed to sustain this process.

This framework is likely to consist both of policies and of an

institutional structure to achieve them. It wil l cover traditional

areas, such as trade, on which much progress has already been

made, as well as the challenges posed by the increasing globalisation

of financial markets.

The paper by Mahmood Pradhan, entitled "Asia: Recent Economic

Trends and Prospects, and the Challenges of Globalisation,"

provides some interesting background to this topic. Among the

paper's key findings are that the region's impressive growth

Overview of the Conference

performance looks set to continue, but important challenges lie

ahead in the areas of strengthening financial systems and financing

infrastructure developments. The speakers in the morning sessions

wil l outline the challenges they foresee, and the forms of regional

co-ordination and co-operation that wil l be necessary to overcome

these challenges in the future. These will include arrangements for

co-operation within the region and between the region and the

rest of the wor ld . They will suggest ways in which the region's

financial system can be strengthened to meet its growing

investment needs, and to cope wi th the systemic risks posed by

broader and more complex links between financial markets.

T h e Role of Hong Kong

The Conference will then consider the position of Hong Kong in

the process of regional and global integration. Much can be

learned by looking at the role that Hong Kong has played in the

past, and the way it has adapted t o a changing environment. This

suggests ways in which Hong Kong can continue to adapt as the

process of regional integration moves on, and as sovereignty

returns to China. The paper by Aasim Husain, entit led "Hong

Kong: Structural Change, Integration, and Economic Policies,"

highlights Hong Kong's increasing integration wi th China over the

past decade and a half, and the associated structural transformation

of Hong Kong to a mature, services-based economy. The

transparent, noninterventionist economic policy approach that the

authorities have pursued has promoted efficient allocation of

resources and macroeconomic stability. The paper concludes that

continued adherence to the rules-based policy f ramework wil l

help maintain strong economic performance.

Against this background, the paper entitled "Hong Kong's Monetary

Arrangements Through 1997," prepared by the Hong Kong


Monetary Authori ty (HKMA), sets out how the concept of "one

country, two systems" will be applied in the financial area. In

short, the basic economic and monetary policy framework

underpinning Hong Kong's economic success will remain unchanged

after 1997, and Hong Kong will continue to enjoy a high degree of

autonomy in the monetary, financial, and other areas.

As a leading investor and capital exporter in the region, Hong

Kong plays a crucial role in the financial integration process.

Another HKMA paper, entitled "The Importance of Financial

Infrastructure in Financial Integration," describes Hong Kong's

role in intermediating between saving and investment as well as its

policy response to challenges arising f rom financial integration.

Speakers in the afternoon wil l therefore be seeking to identify

how Hong Kong - wi th a broadly unchanged policy framework -

can best ensure its continued growth as a mature services-based

economy and its growing role as a leading financial centre in Asia,

thus contributing to further growth in the region.

Speakers in these sessions include several senior officials from the

region who will be able to respond to the suggestions for regional

co-operation made earlier in the day. Those f rom the other major

financial centres of Asia wil l be able to give their own thoughts on

Hong Kong's prospects and wil l counterpoint the policy

prescriptions developed for Hong Kong, drawing on their own

experiences.

The papers prepared for this Conference by the staff of the

International Monetary Fund should be considered t o be works in

progress. The views expressed in the papers are those of the

authors and not necessarily those of the International Monetary

Fund.


C O N F E R E N C E P R O G R A M M E

Thursday, 6 March 1997

6:00 pm-8:30 pm Reception hosted by Hong Kong Monetary

Author i tyVenue: Tiffin Lounge, Mezzanine Level,

Grand Hyatt Hotel

Friday, 7 March 1997

7:30 am-8:30 am Registration

8:30 am-10:15 am Opening Session

Chaired by: Mr Joseph C K Yam, CBE, JP,

Chief Executive, Hong Kong Monetary

Author i ty

Welcoming Remarks: Rt Hon Christopher

Patten, Governor of Hong Kong

Session I : Key Aspects of Regional

Economic and Financial In tegrat ion

Chaired by: Mr Joseph C K Yam, CBE, JP,

Chief Executive, Hong Kong Monetary

Author i ty

Speakers:

Mr Michel Camdessus, Managing Director,


Rt Hon Kenneth Clarke, Q C , MP,

Chancellor of the Exchequer, United

Kingdom

Conference Programme

10:15 am-10:45 am

10:45 am-12:00 noon

Governor Dai Xianglong, Governor,

People's Bank of China, People's Republic

of China

Hon Dato' Seri Anwar bin Ibrahim, Deputy

Prime Minister and Minister of Finance,

Malaysia

Questions from the Audience

Coffee Break

Session 2: Key Aspects of RegionalEconomic and Financial Integration(continued)

Choired by: Hon Gabriel C Singson,

Governor, Bangko Sentral ng Pilipinas,

Philippines

Speakers:

Mr E Gerald Corrigan, Managing Director,

Goldman, Sachs & Co

Governor Kyung Shik Lee, Governor,

Bank of Korea


12:00 noon-1:30 pm Lunch

Venue: Convention Hall, Level 2, Hong

Kong Convention and Exhibition Centre

Introduction of Speaker: Mr Joseph C K

Yam, CBE JP, Chief Executive, Hong Kong

Monetary Author i ty

Luncheon Speaker: Hon Donald Tsang,

Financial Secretary, Hong Kong


1:30 pm-3:00 pm Session 3: T h e Cha l lenges andOpportunit ies for H o n g Kong ofGrowing Regional In tegrat ion

I. Policy Issues for Hong Kong

Chaired by: Mr Chen Yuan, Deputy

Governor , People's Bank of China,

People's Republic of China

Speakers:

Prof D r J Soedradjad D j iwandono,

Governor, Bank Indonesia

Mr Hubert Neiss, Director, Asia and

Pacific Department, IMF

Mr Rafael Hui, JP, Secretary for Financial

Services, Hong Kong


3:00 pm-3:30 pm Coffee Break

3:30 pm-5:00 pm Session 4: T h e Cha l lenges and

Opportuni t ies for H o n g Kong of

Growing Regional In tegrat ion

I I . T h e Cha l lenges of G r e a t e r

Regional Integrat ion

Chaired by: Mr Kunio Saito, Director ,

Regional Office for Asia and the Pacific,

IMF

Speakers:

Mr David Borthwick, Deputy Secretary,

Department of the Treasury, Australia


Mr Yukio Yoshimura, Deputy Director-

General, International Finance Bureau,

Ministry of Finance, Japan

Mr Khor Hoe-Ee, Director, Economics

Department, Monetary Author i ty of

Singapore, Singapore

Mr David Goldsbrough, Senior Advisor,

Asia and Pacific Department, IMF


5:00 pm Closing Session

Chaired by: Mr Joseph C K Yam, Chief

Executive, Hong Kong Monetary Authority

Concluding Remarks:

Mr Michel Camdessus, Managing Director,

IMF

Closing Remarks:

Mr Tung Chee-hwa, Chief Executive, Hong

Kong Special Administrative Region


O p e n i n g S e s s i o n

O P E N I N G R E M A R K S

Joseph C K Yam

Chief Executive


Good morning, Governor, Mr Camdessus, honourable Ministers,

fellow central bankers, distinguished guests, ladies and gentlemen.

It is my great pleasure to welcome all of you to this Conference

on Financial Integration in Asia and the Role of Hong Kong. I

would like to thank Mr Camdessus and his colleagues in the

International Monetary Fund (IMF) for coming to Hong Kong to

co-host this event wi th us. The Hong Kong Monetary Author i ty is

very honoured to be associated in this event wi th the IMF whose

sound advice has helped to sustain macroeconomic stability in

Asia and the rest of the wor ld . Mr Camdessus, who has personally

done so much to promote international monetary understanding,

has brought many top financial leaders f rom Asia and beyond to

join us here today. Your presence does honour to Hong Kong and

shows the importance you all attach to financial integration and

co-operation in this region.

Like other Asian economies, we in Hong Kong have benefited

much f rom the Fund's good advice. Since 1990, the Fund has held

annual consultations with Hong Kong, under Art ic le IV of its

Articles of Agreement, t o examine Hong Kong's monetary and

economic policies. The IMF has consistently commended Hong

Kong in these consu l ta t i ons and fu l ly suppor t s ou r

nonintervent ionist , transparent and market-or iented policy

framework. Such generosity f rom the IMF is I understand quite

rare.

Opening Remarks

So much for the advertisement. Ladies and gentlemen, formally to

welcome you all to this Conference we have the Governor of

Hong Kong, the Rt Hon Christopher Patten. In the past five years

under his leadership, the Hong Kong economy grew at an enviable

average annual rate of more than 5% in real terms. Stock market

capitalisation nearly quadrupled. Turnover in our foreign exchange

market rose from around US$60 billion a day to almost US$100

billion a day. Our foreign reserves grew 2.2 times to US$63.8

billion, the seventh largest in the wor ld. I can go on, but I'd rather

leave the man responsible to tell you about our success story. Mr

Patten please.

Opening Remarks

W E L C O M I N G R E M A R K S

Christopher Patten

Governor of Hong Kong

Joseph, Mr Camdessus, ladies and gentlemen,

I am delighted to welcome you all to Hong Kong. I'm extremely

pleased that this Conference is taking place.

As you all know, in little over 100 days, the chapter of British

administration in Hong Kong will close; and a new chapter will

begin. So it's quite a good t ime to reflect on what this borrowed

place has achieved in ISO years of borrowed time.

From rock and scrub, the people of Hong Kong have turned this

territory into one of the wonders of the wor ld :

- the eighth largest trading economy on earth;

- the world's busiest container-port and the th i rd busiest

airport - we Ye building what wil l be the second busiest;

- the fifth largest banking centre in terms of external assets;

and

- the fifth largest foreign exchange trading centre.

Al l these things have come f rom 400 square miles and six million

people. In the last 35 years, between 1961, the first year we

calculated our GDP. Before then our market economies thought i t

was too interventionist t o collect the statistics t o calculate GDP.

But between 1961 and 1996,

Welcoming Remarks

- the GDP increased by 12 times, wi th an average annual

increase of over 8%;

per-capita GDP increased by 5 times, despite a near doubling

of the population. In relative terms, we have overtaken

Australia, Canada and should add the United Kingdom; and

- total exports have increased by 70 times.

How many modern economies have transformed themselves from

a fishing village into a major manufacturing economy, and then to a

service-based centre, wi th so few social tensions and while

sustaining almost full employment?

The recipe for Hong Kong's success is easy to see, if not always

quite so easy to put into practice. We fol low some simple

principles.

First, we believe that markets, not central planners, make the best

economic decisions.

Second, people, individuals and families, must be free t o run their

own lives. Free markets wo rk best wi th free people.

Third, government should focus on maintaining the environment

for individual and entrepreneurial liberty to f lourish: low and

predictable taxes; a sound, fair f ramework of regulation and law; a

free f low of capital and information; good education and social

infrastructure; the absence of corrupt ion.

In short, minimum interference but maximum support. That has

created the most entrepreneurial environment in Asia, if not the

wor ld. Adam Smith and Alexis de Tocqueville would have had no

difficulty in recognising that successful formula.

Welcoming Remarks

Our extremely able Financial Secretary, Donald Tsang, who has

helped to translate these principles into reality, will have more to

say on the precise shape of our policies in his luncheon address.

Let me just summarise a few basics.

First, we have a small government. We believe - and we put this

belief into practice - that government spending must follow, not

outpace economic growth. Public expenditure has been kept at

under 20% of GDP. We have a budget surplus year after year -

indeed its existence and its size sometimes regarded rather

curiously as a sort of embarrassment. I must say that in my

previous incarnation as a politician. It was the deficit that was the

problem. Our fiscal reserves, wi th no debt, stand at over US$19

bill ion, or 13% of GDP.

Second, we have a stable currency linked to the US dollar. This

link provides the monetary discipline for the government and the

private sector to maintain flexibility and competitiveness.

Thi rd, we have an efficient and robust infrastructure. We have

worked in partnership wi th the business community to provide a

modern physical infrastructure: continually upgrading our

telecommunications, airport, container and shipping facilities,

highways, bridges and tunnels. No other economy in Asia has so

much private involvement in public infrastructure. We cheerfully

use private capital for public benefit.

Fourth, we have an open and responsive social infrastructure: an

independent judiciary enforcing the rule of law which reigns

supreme; free f low of information; a level playing field for all; and

one of the lowest crime and corruption rates among modern

societies. We have built a strong education system to preserve the

values that are cherished in Hong Kong.

Welcoming Remarks

Our success has meant that we have been able to provide ever-

improving public services wi thout imposing a heavier burden on

the taxpayer. We have maintained our low tax rates and relieved

the burden on the taxpayer wherever and whenever we safely

can. Our top rate of salaries tax is an onerous 15% - paid by a

staggering 2% of the working population. 60% pay no salaries tax

at all. N o t only have we cut taxes. Over the last five years we

have also increased our spending on public services in real terms:

- on education by 32%;

- on the environment by 60%;

- on health services by 48%;

- on housing by 34%; and

- on social welfare by 88%.

We published the draft estimates of expenditure for the coming

financial year yesterday. The continued high level of investment

proposed in those vital areas which I have just mentioned is clear

evidence of how our well-tr ied principle of prudent public

financial management enables us to continue to give benefit to the

community without the Government's take from GDP increasing.

All these things have made Hong Kong what it is today - a thriving

city at the heart of a thriving region wi th China's continuing

economic revolution bringing benefits to everyone. Hong Kong is

a model of what free markets can do for Asia, and indeed, for the

wor ld .

It is not an accident of history that has made Hong Kong what it is

today, nor is it an accident of economics. Like other prospering

cities, Hong Kong has faced a political as well as an economic

agenda. Economic activity does not take place in vacuum. As

people have settled down here, as they have obtained the security

of homes, the benefits of education and the opportunit ies of a free

Welcoming Remarks

market, they have also come together as a community, developed

a civic consciousness, and developed as well the institutions and

values of civil society. The Government has responded positively

to that process, and to the changes in aspirations which have

accompanied it, by welcoming ever wider public participation in

the process of government. Democracy - as promised and

pledged in the Joint Declaration and in the Basic Law - has taken

root and started to flourish here. This has strongly underpinned

Hong Kong's economic prosperity and social stability. GDP has

gone up; crime levels have come down.

In this small, extraordinarily densely populated place, the demands

of economic change place huge pressures on the community.

Those pressures - on the urban environment, on assumptions

about work , on housing, on transport, to name but a few - those

pressures demand sophisticated. and responsive institutions of

public administration to channel them productively into communal

progress, rather than letting them build up to the detriment of

political and economic stability. Hong Kong has responded

creatively to the pressures that it has faced, preparing itself for all

the challenges which, like all the developing economies of Asia, it

wil l face in the coming century. That is not a process that should -

or could - be stopped. As Lawrence Summers, the Deputy US

Treasury Secretary, aptly put i t in Hong Kong earlier this week,

" there is no firewall between economic freedom and freedom in

its many other dimensions."

The sustainability over recent years of Hong Kong's success is not

a matter of chance or fate. It is a demonstration of the power that

economic and political freedoms have when they are allowed to

flourish together. It is not a formula exclusive to Hong Kong.

There are universal principles that make markets the most

efficient system known to mankind, the system that offers the

most hope to mankind, and there are universal values within

Welcoming Remarks

which markets perform at their best. We might usefully remember

that Adam Smith, whose name I'm happy once again to associate

with Hong Kong's success story. Adam Smith would have regarded

himself f irst and foremost as a moral philosopher.

Once again, can I say how much I welcome this Conference, ably

organised jointly by the IMF and the Hong Kong Monetary

Authority. It gives us the opportunity at a pivotal moment in our

history in Hong Kong, to consider some issues that are not only

crucial to our own future well-being, but are crucial as well to the

potential advance of the global economy and to the protection

and enhancement of human decency and dignity.

I wish your discussions every success today and I'd like to thank

you all for joining us here today. And I'm sure both at this

Conference and when you go away when you leave Hong Kong

that you'll be wishing Hong Kong well in the momentous months

that lie ahead. I'm certainly one of those who expects Hong Kong

to rise to those future challenges wi th great success. Thank you

very much.

Welcoming Remarks

I:Key Aspects of RegionalEconomic and Financial

Integration

(Part I)

C H A I R M A N ' S I N T R O D U C T O R Y R E M A R K S

Joseph C K Yam

Chief Executive


Ladies and gentlemen,

We shall now begin Session I of this Conference where we shall

focus on the key aspects of regional economic and financial

integration. This will also be the subject of Session 2 to be chaired

by Governor Singson of the Central Bank of the Philippines. There

have been four background papers prepared for this Conference.

They present a useful overview of the issues on financial

integration in Asia and the role of Hong Kong. I am sure many of

these issues will be more specifically addressed by the distinguished

speakers of this Conference.

May I, however, take advantage of being Chairman of this Session

to say a few words on just one aspect of financial integration in

Asia that has recently been occupying our minds extensively here

in Hong Kong, having regard to our role as an international

financial centre. This concerns financial intermediation in Asia, or

the process by which savings are being channelled into investments

- a process which is so essential to promoting and sustaining

economic growth and development in this region. As the financial

community in Hong Kong would know, I have been somewhat

critical about the effectiveness of financial intermediation in this

region.

Asia has very substantial savings. Rapid economic growth in recent

years, coupled with high savings rates in the region of 30%, have

produced an enormous pool of private sector savings, which have

Chairman's Introductory Remarks

also been increasingly institutionalised in the form of collectively

managed provident funds. Savings in the public sector have also

been substantial. Five out of the seven largest foreign reserves

holders of this wor ld are in the Asian region, control l ing about

40% of the world's foreign reserves.

Asia also has huge investment needs particularly for building the

social and economic infrastructure in order to sustain the pace of

economic growth and development it has been enjoying. Private

sector investment needs are also enormous.

Yet the process of financial intermediation in which the very

substantial savings of this region are mobilised to satisfy the

demand for investment funds is, putting it mildly, a peculiar one.

Foreign reserves are predominantly invested in financial assets of

developed economies rather than in the region. Financial

liberalisation and the institutionalisation of savings in Asia have led

to significant outflows of private sector savings seeking a greater

variety of less risky investment alternatives, although this outf low

has been more than offset by the large inflow of foreign direct and

portfol io investment funds that have been attracted by the

promising economic prospects of this region.

This process has brought many policy challenges to economies in

this region, one of which is the need to deal wi th volatile capital

flows and their impact on monetary stability, in particular

exchange rate stability. Some have unkindly described this scenario

as Asia providing the funding for the hedge funds in New York to

play havoc with Asian currencies and financial markets. I do not

share this view. Financial liberalisation and globalisation of financial

markets have brought economic prosperity to many, particularly

Asia. We need to adopt a positive attitude on these challenges.

We need to meet them by pursuing sensible policies.


More specifically, we need to promote more effective financial

intermediation within the region through, amongst other things,

the development of liquid financial markets with a greater variety

of financial instruments, the building of robust financial

infrastructures, and the upgrading and harmonisation of supervisory

and regulatory standards. These are essential for commanding the

confidence of domestic and foreign investors, particularly the

institutional investors, who are becoming more and more risk

averse.

In this spirit, we in the Hong Kong Monetary Author i ty has been

promoting within the central banking fraternity of this region the

creation of an Asian Monetary Network whereby financial

infrastructures such as money payment systems and securities

clearing systems could be linked up in a manner that enables

payment, clearing and settlement risks of international financial

transactions to be minimised and possibly eliminated. The linking

up of real t ime large value payment systems is now a distinct

possibility. We have also created a network for co-operation

amongst central banks in this region in the provision of mutual

liquidity assistance in the maintenance of currency stability.

I look forward to listening to our distinguished speakers' advice

on these issues, amongst other things.

The f irst speaker of this Session is, of course, Mr Camdessus, the

Managing Director of the IMF. Mr Camdessus really needs no

introduct ion f rom me. He has served as Chairman of the

Monetary Committee of the European Economic Community, has

been Governor of the Bank of France, and this year begins his

th i rd five-year term as Managing Director of the IMF. His

experience and knowledge of international monetary affairs have

proved invaluable over the years and we are very grateful for his

presence today. Mr Camdessus please.


G L O B A L I S A T I O N A N D A S I A :

T H E C H A L L E N G E S F O R R E G I O N A L C O - O P E R A T I O N A N D

T H E I M P L I C A T I O N S F O R H O N G K O N G

Michel Camdessus

Managing Director


Thank you, Ministers, Governors, ladies and gentlemen. I would

especially like to thank Governor Patten for his welcome and Mr

Yam and the Hong Kong Monetary Author i ty for their generosity

in co-sponsoring this Conference wi th the IMF.

Implications of Trade and Financial In tegrat ion

The theme of my remarks this morning is globalisation. Hong

Kong is an Ideal location to discuss this topic, since many of the

East Asian economies, and Hong Kong in particular, represent the

very essence of globalisation - open, dynamic economies that

continue to amaze the wor ld w i th their rapid economic growth

and development. It is this success — the so-called "Asian miracle"

- that so many countries the wor ld over are trying to emulate

today. 1 would add that today's discussion takes place less than

12CX days before the resumption of Chinese sovereignty - a

historic event that highlights the benefits of combining further

wor ld economic integration and local adjustment wi th in a sound

policy framework.

It is plain to see that globalisation has changed Asia's role in the

wor ld . Less obvious, perhaps, are the changes that globalisation is

bringing about within Asia. What does the increasing integration

of wor ld trade and financial markets mean for Asia? W h a t are the

key challenges for Asian policy makers arising f rom globalisation?

B l Globalisation and Asia: The Challenges for Regional Co-operation andthe Implications for Hong Kong

And what can Asia, as a region, do to enhance its bright prospects

in the global economy? These are the questions I would like to

discuss with you today. I will then turn to the role of Hong Kong

and explain why I have great confidence in the bright future of this

city and its people.

Asia: Increasing Role in Global Economy

Clearly, globalisation has had a major impact on Asia's role in the

wor ld economy. As recently as a decade ago, the developing

countries of Asia accounted for only one-sixth of wor ld output.

But wi th many countries in the region having fol lowed sound

domestic economic policies, mobilised large amounts of domestic

savings, and attracted substantial private capital inflows, Asia,

excluding Australia, Japan, and New Zealand, now accounts for

about one quarter of wor ld GDP on purchasing power parity-

adjusted terms. On this trend, the region could account for one-

third of wor ld output by the year 2005.

Similarly, over the last decade the developing countries of Asia

have seen their share of wor ld exports nearly doubled to about

one-fifth of the total. These countries are also taking a growing

share of industrial country exports, a factor that helped cushion

the impact of successive recessions in industrial countries during

1990-93. These developments have been very positive, not only

for Asia, but for the global economy as a whole.

Regional Transformation and Integration

But what of the changes that globalisation is bringing about withinAsia? To begin with, there is an ongoing transformation in thecomposition of production and trade as the comparative advantageof many Asian economies continues to change. In particular,economies with relatively high wage costs are shifting toward

Globalisation and A$ia:The Challenges for Regional Co-operation andthe Implications for Hong Kong

higher value-added products, including services. The shift oflabour-intensive manufacturing out of Hong Kong into mainlandChina and the associated boost to Hong Kong's economy fromthe growth of trade and financial services is perhaps the mostdramatic example of this process.

Similar trends are also evident in the financial area. The continuedgrowth in net private capital inflows to the region - to overUS$100 billion in 1995, or well over half of total private capitalflows to developing countries - has been accompanied by a changein the composition of these flows. Between 1990 and 1995,foreign direct investment in the region increased more thanfourfold. Portfolio investment flows have also risen dramaticallyand, in the process, have helped deepen domestic capital marketsin Asia. In fact, in some countries the relative size of the equitymarkets now matches that in many industrial countries. Forexample, in Hong Kong, Malaysia and Singapore, stock marketcapitalisation as a share of GDP, exceeds that of France, Germanyand Italy.

At the same time, financial flows within the region have becomemore significant. True, the developing countries of Asia still relyheavily on London and New York to intermediate foreign savingsto the region. But Japan is, and is likely to remain, the world'slargest exporter of capital, and. the far-reaching reforms recentlyannounced by the Japanese government are likely to enhanceTokyo's role as an international financial market. Moreover, HongKong and Singapore - with their well capitalised banks, efficientclearing and settlement systems, and expanding range of financialproducts - have also emerged as major financial centres.Increasingly, these centers are intermediating savings within Asia,as well as channelling savings to Asia from other parts of theworld. In particular, Hong Kong is the main conduit forinvestment in China and arranges a significant proportion of Asia's

Globalisation and Asia: The Challenges for Regional Co-operation andthe Implications for Hong Kong

syndicated borrowing. Singapore, for its part, has evolved into themain banking centre for Southeast Asia.

Challenges Lie Ahead

What do these trends - Asia's increasing integration into theglobal economy, on the one hand, and its increasing regionalintegration, on the other - suggest for the future? Although anumber of countries in the region face some important policychallenges, their record to date suggests that they will make thenecessary policy adjustments which have been the secret of theirsuccess, enabling them to continue to perform well. In thisconnection, I would note that the recent slowdown in economicactivity in East Asia represents primarily a cyclical correction thatis not expected to be deep or prolonged. Indeed, in a number ofcases, the slowdown has been a welcome response to policytightening aimed at reducing inflationary pressures. However, theslowdown has been accentuated by a weakening of the externalenvironment and, hence, in export demand. This has left somecountries in the region with high current account deficits,suggesting a need for further policy correction. But beyond theseshort-term developments, increasing trade and financial sectorintegration - in the global economy and in the region - will notonly offer enormous potential benefits, but will also pose newchallenges for Asian countries. Why? First, because as theseeconomies develop, their comparative advantages will continue tochange. Moreover, these changes are likely to occur more rapidlyin a globalised economy. Thus, efficiency and flexibility will becomeall the more important for continued economic success. Second,as the trade and financial links within Asia intensify, developmentsin one economy will have a larger impact on the others.Accordingly, individual economies will have an increasing interestin the economic stability and prosperity of the others. Of course,this is also true at the global level, particularly as Asia's share inthe global economy increases.

Globalisation and Asia:The Challenges for Regional Co-operation and Jjflthe Implications {or Hong Kong • * •

In my view, these considerations point to challenges in three

related areas: trade, financial flows, and regional co-operation. Let

me say a few words about each.

Need To Maintain Trade Dynamism

First, on trade. Here in Hong Kong, there is no need t o preach

the merits of open trade regimes. Although a number of countries

in the region still have some ways to go on trade liberalisation,

much of Asia's dynamism can be traced to the openness of its

economies, and to the competitiveness and transfer of technology

that this openness has encouraged. Countries that have yet to

open their economies significantly should do so, so that they too

can reap these benefits. By the same token, countries that have

already benefited from trade liberalisation must ensure that the

openness that has served them so well in the past is extended to

the new trade frontiers, notably services. A t the same t ime, it will

be important to increase transparency and the free f low of

information on which the service and financial sectors — and,

indeed, the modern economy — depend. And as production shifts

to higher value-added products, countries will need to develop

effective "exi t " policies for noncompetitive industries.

These structural changes will inevitably require other adjustments,

as well. To sustain growth, a number of countries wil l need to

improve " the i r infrastructure, especially in t ranspor ta t ion ,

telecommunications, and power supply. The challenge wil l be to

do all of this without unduly straining public finances o r external

positions. In this regard, private sector participation can be very

helpful, although some countries wil l need to increase the

transparency of their regulatory regimes and clarify pricing

policies in order to attract substantial private interest in such

investment. In any event, the public sector is likely to continue to

have a role to play in the development of infrastructure. This, in


turn, points to the need to strengthen public finances by reducing

outlays in other, less productive areas, such as military expenditure.

Meanwhile, it wil l be important to ensure that regional trade

initiatives are compatible wi th further global trade liberalisation. In

this regard, I am optimistic that Asia's emphasis on a co-operative

approach to trade matters will complement and enhance the

global framework being developed through the Wor ld Trade

Organisation.

Keeping Pace wi th Financial Innovation

Second, the challenges in the financial area. A t the domestic policy

level, there is no substitute for stable macroeconomic policies -

policies that give confidence to financial markets and attract

private savings. Likewise, transparent and predictable regulatory

policies, and a reliable legal framework are essential ingredients in

creating a favourable investment climate. Certainly, Hong Kong's

record shows the value of such policies.

But the quickening pace of financial innovation and integration

raises other challenges, as well. To begin wi th, the presence of

large capital inflows reduces the room for policy manoeuvre and

limits the scope for policy mistakes. Moreover, financial sector

reforms and increased access to international markets expose

domestic financial systems to new risks. In many countries, in Asia

and elsewhere, prudential regulation and supervision have not

kept pace wi th the new complexities of the banking business. If

left unaddressed, this gap could pose dangers for domestic and

external stability. Indeed, all countries must be vigilant about the

strength of their banking systems, so that the monetary authorities

can tighten policy when needed, wi thout fear of aggravating

banking sector problems.

Globalisation and Asia:The Challenges for Regional Co-operation andthe Implications for Hong Kong

Beyond this, Asia needs a stronger, more dynamic financialinfrastructure that can handle the increasingly complexintermediation requirements of the region. As Mr Yam hasobserved on several occasions, Asia still relies significantly onEuropean and North American financial markets to intermediateits huge savings pool. I have no doubt that Asia's major financialmarkets - Tokyo, Hong Kong and Singapore - will continue togrow. This, and the development of other financial centres, suchas Shanghai, Bangkok, Kuala Lumpur, and Seoul, will eventuallycreate a network of modern financial centres in Asia that will helpmeet the region's immense financial intermediation needs.

Importance of Regional Policy Co-ordination

Third, the challenges for regional policy co-ordination. Withcountries becoming more closely integrated, each country has anincreasing stake in the sound policies of the others. Accordingly,countries of the region can play a constructive role in encouragingeach other to maintain sound policies. The swap arrangementsamong a number of Asian central banks are a good example ofconstructive co-operation to maintain regional stability. Certainly,it would be worthwhile exploring how such initiatives can befurther developed. Moreover, the effectiveness of bank supervisionwill be enhanced by greater co-operation between nationalsupervisors in the region, as part of the development of a moreglobal approach to such issues. In this regard, I also welcome themembership of several newly emerging market economies in Asiain the Bank for international Settlements, as well as their fullsupport for the strengthening of the surveillance role of the IMF,strongly endorsed by the Interim Committee.

Clearly, there is a broader need to reduce risks in the globaleconomy and strengthen financial safety nets. Of course, whenevera country faces a difficult situation, whether the problem is of a


short-term nature or a more fundamental disequilibrium, the IMFis ready to help with policy advice - and with financial assistance,if warranted. Toward this end, our strengthened surveillance leadsus to give greater attention to capital account developments, thesoundness of domestic banking systems, the quality and timelinessof data countries released to the public, and other issues ofparticular relevance to emerging market economies, includingthose in Asia.

We are also taking steps to ensure that the IMF has the necessaryresources to fulfill its mandate. In this regard, I welcome theparticipation of several Asian economies in the New Arrangementsto Borrow, which will double the amount of resources available tothe IMF to deal with exceptional situations that may threaten theinternational monetary system. These resources could become akey supplement to the Fund's own resources in a time of systemiccrisis. But they cannot support the Fund's normal operations -nor should they. The IMF is a co-operative institution based onquotas, and its strength and credibility depend on maintaining itsquota strength. To this end, the membership will soon be decidingon a quota increase, which I believe will need to be substantial.

Hong Kong's Continued Role in Asian Prosperity andIntegration

I have outlined what 1 believe are the globalisation means for theemerging market economies of Asia. You will have noted thatglobalisation makes imperative not only the maintenance, but alsothe continued expansion, of a network of well-equipped, first classregional financial centres. This is why the IMF sees as essential thecontribution Hong Kong will have to continue to provide in thefuture to the prosperity of Asia. Let me conclude with some morespecific remarks on Hong Kong.

Globalisation and Asia:The Challenges for Regional Co-operation andthe Implications for Hong Kong

Hong Kong is a prime example of an economy that has managed

rapid structural transformation in an increasingly integrated world

economy in a most successful way. And indeed, its history,

geographic location, openness to trade and importance as a

financial centre all point to its critical interest in continued global

integration - an interest that is shared in China, in the region, and

in the rest of the wor ld. Let me mention briefly the ingredients of

its success and explain why I have confidence - not only in Hong

Kong's future - but also in its increasing contr ibution t o global

integration and prosperity.

First, its long record of sound policies. Hong Kong's prudent

monetary policy built around the exchange rate link to the dollar

and supported by a tight, rule based fiscal policy has created an

environment of macroeconomic stability and investor confidence,

The Joint Declaration and the Basic Law, which together enshrine

the principle of "one country, two systems" provide confidence

that this policy framework will continue. And the arrangements

for the Hong Kong Monetary Author i ty and the People's Bank of

China to operate as two mutually independent, but co-operating,

monetary authorities have been wisely and clearly established.

As you know, the IMF generally visits each of its member

countries at least once a year to review its economic policies,

performance and prospects. In the IMFs annual review of Hong

Kong's situation and prospects, completed only two weeks ago,

the IMF Executive Board strongly endorsed this policy f ramework;

I am also pleased to confirm that these consultations wil l continue

on a regular basis after the transfer of sovereignty.

Second, its flexible product and labour markets. The lack of

flexibility, especially in labour markets, is the "Achilles heel" of

many advanced economies. This has not been the case in Hong

Kong. Indeed, the entrepreneurial and management skills of the

people of Hong Kong are second to none.

B H Globalisation and Asia: The Challenges for Regional Co-operation andthe Implications for Hong Kong

Third, the openness of its economy. Wi th a free port and no

capital controls, Hong Kong is one of the most open economies in

the wor ld . China is also moving toward greater openness: the

renminbi now trades on a market basis in China, and exchange

controls on current transactions have been eliminated. But I do

not believe that China wil l want to stop there; of course,

prudence is in order in view of the complexity of the issues still to

be resolved, but the Chinese authorities know quite well that the

sooner China moves to fuller trade liberalisation and creates the

conditions allowing for the progressive liberalisation of all capital

transactions, the more it, too, wil l benefit further from globalisation.

One can easily see how promising these converging trends in

China and Hong Kong are.

Fourth, the steps being taken to ensure that Hong Kong continues

to develop as a wor ld financial centre. Hong Kong's prudential

supervision is already of the highest standard; banks are highly

capitalised; and official foreign exchange reserves are large by any

standard. Thus, Hong Kong is well placed to deal wi th any

pressures that may arise.

Fifth, Hong Kong's sound legal and administrative framework, the

neutrality of its civil service, the impartiality of its judicial system

and its freedom of information. All have been critical to Hong

Kong's economic success to date and will remain so in the future.

Here, I salute the wisdom of the Chinese, British, and Hong Kong

authorities for incorporating these principles into the Joint

Declaration and the Basic Law.

And sixth, the continued economic development of the mainland.

This vast market provides excellent trade and investment

opportunit ies for Hong Kong, just as Hong Kong's own dynamism

wil l provide further impetus for China's growth and development.

Globalisation and AsiaiThe Challenges for Regional Co-operation andthe Implications for Hong Kong

Let me conclude by noting that transitions always present some

degree of uncertainty; that is their nature. But the remarkable

wisdom of the Chinese, Hong Kong and British authorities in

devising the "one country, two systems" approach will help ensure

that the transition runs smoothly and the uncertainty is short-

lived. IMF and Wor ld Bank members will have the opportunity to

see the uone country, two systems" approach in action in

September, when they come to Hong Kong for the 1997 Annual

Meetings.

You can be sure of our continuous interest, which wil l materialise

itself in the future as in the past in the framework of our yearly

consultations. I would be delighted if my remarks were to make

you share my confidence that Hong Kong - in the framework of

the new, faithfully implemented, arrangements - will continue to

play in the future a leading role in promoting Asian prosperity and

integration in the rest of the wor ld .


R E G I O N A L E C O N O M I C A N D F I N A N C I A L I N T E G R A T I O N :

T H E R O L E O F H O N G K O N G I N A S I A A N D T H E W O R L D

Kenneth Clarke

Chancellor of the Exchequer

United Kingdom

I am delighted to be able to participate in this HKMA/IMF

Conference on Financial Integration in Asia and the Role of Hong

Kong.

Asia: A n Outstanding Performance

Asia accounts for around a quarter of wor ld output, and is home

to the majority of the world's most dynamic emerging economies.

By any standards, Asia has produced a striking economic

performance. For many years now, the emerging Asian economies

as a group have grown more than three times as fast as the Group

of Seven leading industrial nations. We would expect Asia to

continue to grow faster than the industrial countries of Europe

and Nor th America. This inevitably means that Asia will increase

its share of wor ld output. In fact, if recent rates of growth were

sustained for another ten years, then Asia as a whole (including

Japan) would account for a larger share of wor ld output than

Europe and Nor th America combined.

The economic centre of gravity of the world is shifting. There is

no reason for the older industrial countries t o feel their

prosperity is threatened by this. Rapid growth in Asia presents an

economic opportunity for us all. It is good economic news for

Asia, but i t is also good news for Europe and America. It provides

our businesses wi th new opportunities for trade and investment

and so contributes to rising prosperity and more jobs for us all.

Regional Economic and Financial Integration:The Rok of Hong Kong; in Asia and the World

Role of International Open Markets

Asia has become one of the key trading regions of the wor ld. It

already produces more than a quarter of wor ld exports. Asian

exports have been growing rapidly. Over the past twenty years,

emerging Asia's share of wor ld exports has tr ipled. These rapid

rates of export growth have underpinned the strong growth in

Asian output, and reflect the progression to more open global

markets.

Through the transfer of technology, management skills and know-

how, the increasing openness to trade and investment flows

around the wor ld has been a key factor helping Asian countries

realise their economic potential much more rapidly than anywhere

else. Asia has achieved in just one generation what i t t ook first

Europe, then North America, three or four generations to

achieve. The world's first "emerging market" - Britain - took 58

years from the start of our industrial revolution to double real

incomes per head. It has taken modern China less than a decade

to make the same improvement.

And the Asian economies have played an important part in

securing these open markets wi th their good work in a range of

forums - in the international financial institutions, in the World

Trade Organisation (WTO), and in Asia-Pacific Economic Co-

operation (APEC). I look forward to their future contr ibut ion in

the new Asia Europe Forum - ASEM - which wil l have its first

meeting of Finance Ministers this September, and its second

meeting of Heads of Government in London next year.

In modern global markets, flows of direct investment are an

important way of deepening economic and financial links between

nations, supplementing more traditional trade links.

Regional Economic and Financial Integration:The Role of Hong Kong in Asia and the World

Asia is already host to around 15% of the world's stock of

international direct investment, and this share is growing fast —

Asia now receives almost a quarter of all direct investment flows.

And the countries in Asia are increasingly direct investors abroad,

as well as hosts for inward investment.

Open global markets have meant an increase in all investment

flows - not just direct investment. Fund managers in the West

have become increasingly aware of the potential and opportunities

in Asia. These inflows of investment have increased the need for

Asian financial centres to provide the financial skills and services

needed to channel this investment and to act as intermediaries.

Asia is fortunate in having not one, but three major international

financial centres - Hong Kong, Tokyo and Singapore.

H o n g Kong

Hong Kong occupies a key place in the Asian economy, and in

many ways is typical of the Asian success story

The transformation of the Hong Kong economy over the last forty

years is world-renowned. It can be seen wherever one looks in

Hong Kong. It has been achieved with almost no natural

resources, apart f rom a superb natural harbour and a prime

location at the heart of Asia, Hong Kong is now an international

financial centre, having transformed itself initially into a competitive

manufacturing economy and more recently into a services centre

for China, the region and the wor ld.

Some basic facts and statistics illustrate just what has been

achieved. Hong Kong is now the fifth largest international banking

centre in the wor ld , the fifth largest foreign exchange market and

the eighth largest trading economy. Gross domestic product is

about one fifth the size of China's, while per capita income is now


higher than in many western countries. Between 1985 and 1994,on average each year GDP grew by over 6%, exports of servicesgrew by over 8%, investment grew by 7%, while unemploymentremained as low as 2% of the workforce. These numbers are whatFinance Ministers' and Financial Secretaries' dreams are made of.

What Has Made Hong Kong Successful, and the Future

Hong Kong's progress provides many lessons for other developingcountries. What explains this success? It is the result of a numberof factors, above all the hard work and ingenuity of the peoplewho live and do business here. Their flexibility and sheer will tosucceed have enabled them to meet head-on the challenges thathave come their way.

But we British, during our stewardship, have also contributed tothis success. We have created the legal and economic frameworkwhich has given the people of Hong Kong the opportunity tomake the most of their formidable talents. Hong Kong'sdevelopment has been crucially dependent on a combination ofcircumstances that emerged under British rule:

- trust in the rule of law, administered by a professional civilservice, in which key positions are filled on the basis of meritrather than connections or vested interests;

- a policy of minimum intervention by the state, so thateconomic development can take place according to the rulesof the marketplace and not the bureaucrats;

- firm control of public spending and an easily understoodsystem of taxation in which personal and business taxes areamongst the lowest in the world;

Regional Economic and Financial Integration;The Role of Hong Kong in Asia and the World

- a strong commitment to public education with compulsoryuniversal education for all between the ages six and fifteen,and a strong emphasis on investment in training and skills tocreate a flexible and adaptable labour force;

- skilful management of the macroeconomy, evident in both thesuccess of the linked exchange rate and the regular budgetsurpluses which have built up into massive fiscal reserves;

- a commitment to open, flexible markets and free trade whichmake Hong Kong the most outward-looking city in Asia;

- a first-class business environment, including the latest inbanking technology and one of the most advancedtelecommunications systems in the world.

These have been the key features necessary to ensure HongKong's future success as one of the world's key internationalfinancial centres. I am confident that things will continue to gosmoothly in the economy in the run up to the handover to theChinese on I July this year. Hong Kong's continued success will bebuilt upon the continuation of sensible economic and financialpolicies - supported by the clear and transparent system of lawand administration that have ensured success under British rule,and which lie at the heart of the Joint Declaration.

I believe the commitment to "one country, two systems" andChina's strong assurances of Hong Kong's economic and financialautonomy provides a sound basis for achieving this and securingHong Kong's future economic stability. It provides the frameworkfor continuing policies that will secure the confidence of thepeople who have turned Hong Kong into Asia's number onefinancial centre. With this security, Hong Kong will continue tolead the way in the world's most rapidly growing region.


As a substantial investor here, and as a major trading partner,

Britain wil l continue to contribute substantially t o Hong Kong's

economic success. And, as a signatory of the Joint Declaration, we

will continue to take a close interest in ensuring that Hong Kong's

economic achievements and the rights and freedoms which

underpin them are fully preserved.

For the immediate future, I was glad to see that the recent IMF

mission here concluded that there had been a significant reduction

over the past year in uncertainties, and more widely held

confidence concerning Hong Kong's prospects. Indeed, following

the slowdown that began in 1995, the economy now seems about

to get into higher gear again, w i th activity back on the up, the

property market looking buoyant and the Hang Seng bullish.

Hong Kong's Role in the W o r l d Economy

But in Hong Kong as elsewhere, wi th economic success comes

responsibility - for preserving the stability of the wo r l d financial

system. Countries outside the GIO have an increasing stake in a

well-functioning international monetary system, particularly for

those like Hong Kong, whose own prosperity is founded upon

open markets.

The New Arrangements t o Bor row (NAB) are a good example of

new and old players joining together to share in this responsibility.

I am pleased to say that of the 14 non-GIO participants in the

NAB, five - the Hong Kong Monetary Authority, Singapore,

Thailand, Korea and Malaysia - are f rom Asia.

The UK fully supported the Hong Kong Monetary Authori ty 's

participation in the NAB - not only as the IMF member

responsible for Hong Kong's interests in the IMF, but also on the

basis of Hong Kong's own economic strength. And it was also

Regional Economic and Financial Integration;The Role of Hong Kong in Asia and the World

officially supported by China, who wil l continue to represent

Hong Kong's interests in the IMF from I July 1997. I congratulate

our chairman - Joseph Yam - on the HKMA being the first

participant to adhere to the NAB.

Once ratified , the NAB wil l be the IMF's first port of call should it

face a shortage of funds to lend to members in an international

financial emergency. It will double the resources currently

available to the IMF under such circumstances. But I believe

participation in the NAB is about more than just providing a line

of credit in case of emergency. It also creates a new forum for

discussing developments affecting the wor ld financial system. I

hope this group wil l grow over time, to embrace more of the

world 's emerging markets.

Another example of the importance of sharing responsibility is in

w o r k currently being undertaken on banking supervision and

financial regulation. Banking crises have already caused or

accentuated disruptions in many countries. More generally, weak

financial sectors constrain monetary policy, impede the expansion

of output and employment, and can hold back much needed

liberalisation elsewhere.

That is why the GIO have convened a working group, made up of

both old and new players such as Hong Kong, to look at ways in

which we can help strengthen bank supervision and financial

regulation. The international institutions — such as International

Organisation of Securities Commissions and the Bank for

International Settlements (which Hong Kong joined last year)

should also be able to help in achieving these goals.

We want to promote better international co-operation and

information-sharing between financial supervisors. In a wor ld of

rapidly developing financial markets and financial innovation, the


old dividing lines between products and between markets are

breaking down. That makes regulation and supervision of

internationally-active firms a much more difficult and sophisticated

task. Supervisors need to have adequate information to assess

risks, and t o require institutions to manage them appropriately.

We have also improved IMF surveillance procedures, and set up

new data dissemination standards - which Hong Kong signed up

to in October last year.

Wi th all this talk of East Asian prosperity, we must not forget that

there are still many poor people dependent on the world

economy. I believe we also have the responsibility to spread the

benefits of our success more widely. Let me give you t w o specific

examples of how I think we can do this.

In Hong Kong and the UK we have long recognised the benefits of

international capital flows. The challenge now is t o spread these

benefits more widely. Increased openness t o international

investment will be vital. I believe it is important for countries to

aim for capital liberalisation as an ultimate objective. That is why,

at the IMF Annual Meetings last year, I called for a revision to the

IMF's Articles, to give the Fund a new, and explicit, mandate to

promote progressive liberalisation of capital account transactions

among its members.

I am not suggesting that countries should be forced to liberalise

immediately, or when circumstances are not appropriate. That

would be counter-productive and damaging. But I believe that IMF

members should be explicitly aiming for capital liberalisation as an

ultimate goal. That would help t o convince others of the benefits

of freer capital flows. And it would clearly signal the direction in

which we want to go.


Even some of the poorest countries have benefited from capital

inflows when the fundamentals - sound macroeconomic policies,

good government and a manageable debt position - have been in

place.

That brings me to my second example. All countries prepared to

take the necessary measures to reform their economies must be

offered the opportunity of a way out of debilitating debt

problems. The Heavily Indebted Poor Countries Initiative, which

was launched successfully at the annual meetings of the IMF and

Wor ld Bank in September, is designed to reduce the debt burdens

of the poorest and most indebted countries to sustainable levels,

through a comprehensive treatment of their debts. I look forward

to seeing the first beneficiaries of this initiative.

Hong Kong wil l play host t o the leaders of the wor ld financial

community in September. I am confident they wil l depart

convinced that Hong Kong will continue to play a leading role in

Asia — and the wor ld - in the 21st century.

In this Year of the Ox, I feel very bullish about our prospects. By

sticking to our sensible economic policies, Britain, Hong Kong and

the rest of Asia can look forward to a bright future of healthy

growth and rising living standards.


E C O N O M I C I N T E G R A T I O N I N A S I A A N D

H O N G K O N G ' S S T A T U S A S A N I N T E R N A T I O N A L

F I N A N C I A L C E N T R E

Dai Xianglong

Governor


Mr Chairman, Managing Director Camdessus, ladies and gentlemen,

I am very pleased to attend this Conference. It can be recalled

that when Managing Director Michel Camdessus visited China last

year, Vice Premier Zhu Rongji and him had a substantive

discussion on the economic development in Asia and the Pacific.

Mr Camdessus made a proposal of such a conference on that

occasion, which was highly appreciated by Vice Premier Zhu

Rongji. W i th the joint efforts of the International Monetary Fund

(IMF) and the Hong Kong Monetary Author i ty (HKMA), the great

idea has now come true.

Economic Success Promotes Regional Integrat ion

Asia, which has been the fastest growing region in the wor ld for a

long period of time, will hopefully sustain the growth momentum.

From 1985 to 1995, Asia's GDP grew by 7.8% annually, more than

twice as fast as the wor ld average. A t the end of 1996, five out of

seven countries and regions wi th the highest foreign exchange

reserves were in Asia. Based on IMF estimates, the average annual

GDP growth for the Asian developing economies wi l l reach

around 7.5% between 1997 and 2001. The sustained high growth

in Asia is solidly based. First of all, the governments in Asia have

worked out the development strategies that best f i t their specific

Economic Integration in Asia and Hong Kong's Statusas an International Financial Centre

situations. They have managed to draw upon the experiences of

the developed economies in fostering market economy, and have

made continuous efforts to enhance their ability of macroeconomic

management. Second, the high savings rate in Asia constantly in

excess of 30% has helped to create the potential of long-term

economic development. Third, the favourable investment climate

and high rate of return have attracted large amount of capital

flows f rom outside the region. In 1995, net capital flows to all

developing countries reached US$164 billion, 40% of which were

to Asia. Huge capital inflows have contributed in a significant way

to the upgrading of industrial structure and technological renovation

in the region.

The successful economic development in Asia has, over time,

promoted the economic and financial integration in the region.

The diversity both in natural conditions and the level of economic

development has served as the foundation for economic co-

operat ion and integration in the region. W i t h increasing

liberalisation of the Asian economies, economic and financial

integration in the region has begun to take initial shape. In 1995,

intra-Asia trade accounted for about 40% of the total trade of the

region, close to the level of intra-regional trade in Nor th America.

Foreign direct investment between Asian economies also surged.

Moreover, as a result of the reduced exchange restrictions and

financial liberalisation, Asian economies have been increasingly

engaged in cross border financial activities.

Co-opera te for C o m m o n Prosperity

The economic and financial integration in Asia can be seen as

unique in the sense that i t is not based on a high degree of

convergence. W i th full respect to the political, economic and

cultural differences among various countries and regions, economic

co-operation in Asia is voluntary, nondiscriminatory, and to the

Economic Integration in Asia and Hong Kongfs Statusas an International Financial Centre

benefit of each party. The co-operation proceeds gradually but

firmly, w i th the aim of common prosperity. As guided by these

principles, the Asian countries and regions have been co-operating

effectively on different levels and in different areas. For example,

the APEC members have begun to take concrete actions to

liberalise and facilitate trade and investment. Meanwhile, the

ASEAN nations are currently moving decisively toward sub-

regional economic integration. Furthermore, in response to the

financial integration in the region, the monetary authorities have

strengthened their co-operation in the area of monetary policy

and financial supervision. Bilateral repurchase agreements against

US treasury notes were signed among a number of the Asian

monetary authorities in order to enhance their ability to

withstand potential financial crises. The Executives' Meeting of

East Asian and Pacific Central Banks and Monetary Authorities

(EMEAP) is instrumental in the exchange of views and information

among participating monetary authorities.

The economic and financial integration in Asia is an important

factor underlying the rise of Tokyo, Hong Kong and Singapore as

international financial centres. As an international financial centre,

Hong Kong has played an important role in intermediating

resources among Asian economies. A t the end of 1995, banks in

Hong Kong had a net liability equivalent to HK$ 1,308 billion vis-

a-vis other banks and a net claim equivalent to HK$I ,953 billion

vis-a-vis non-bank customers in Asia and the Pacific. Statistics

indicate that nearly two thirds of funds in the banking system of

Hong Kong are mobilised and employed outside Hong Kong. In

terms of capitalisation, Hong Kong stock market is second only to

Tokyo's stock exchange in Asia. Besides, a large number of

financial institutions across the wor ld have built up their presence

in Hong Kong, making it a leader in introducing new financial

products. Along with other monetary authorities, the H K M A has

actively involved itself in the regional initiatives t o stabilise


exchange rates and improve prudential supervision. The economic

reform and opening policies pursued by the Mainland of China

since late 1970s have substantially contributed to the stability and

prosperity of Hong Kong.

Status Q u o in Hong Kong A f t e r 1997

Like friends in the Hong Kong financial community, my colleagues

and I are fully convinced that the status of Hong Kong as an

international financial centre wil l be preserved and further

enhanced after China resumes the exercise of sovereignty over

Hong Kong. The confidence is also held by the international

financial circle because of the following reasons:

The prosperity in China serves to reinforce the status of Hong

Kong as an international financial centre. As the economies in Asia

and the Pacific maintain a high growth rate, Hong Kong's role in

financial intermediation between the providers and recipients of

funds wi l l become even more pronounced in the years to come.

Most importantly, Hong Kong enjoys the full backing from the

Mainland of China, whose prosperity and stability lend great

support to Hong Kong in maintaining its status as an international

financial centre. Over the past three years, China has focused on

the fight against inflation and succeeded in achieving the planned

targets for macroeconomic management, and the economy is well

positioned on the path of relatively high and steady growth. In

1996, GDP grew by 9.7% and the retail price index was kept at

6.1%. A t the end of this February, China's foreign exchange

reserves amounted to US$1 10 billion. For the next few years, the

annual GDP growth rate is projected at 8-9% and the retail price

index below 6 %. We feel confident that the targets outlined by

the Chinese government in the Ninth Five-Year Plan and the Long-

term Development Programme up to 2010 will be materialised. As

China moves ahead in its modernisation drive, the prosperity in

Hong Kong wil l be even more secured.

Economic Integration in Asia and Hong Kong's Status WGAas an International Financial Centre mtm

The Basic Law provides a legal guarantee for the maintenance of

Hong Kong as an international financial centre. According to the

relevant provisions in the Basic Law, the fundamental principles

governing the monetary relationship between Hong Kong and the

Mainland of China can be summarised as " t w o currencies, two

monetary systems and two monetary authorities under two

different social and economic systems within one sovereign

country." In other words, Hong Kong wil l keep its independent

currency issue mechanism, and the Hong Kong dollar wi l l continue

to circulate as the legal tender in Hong Kong. The People's Bank

of China (PBC) and the HKMA will perform their own functions

of monetary management in their respective currency areas

independent of each other. As an international financial centre,

Hong Kong will continue to participate in the activities of

international and regional financial institutions. Vice Premier Zhu

Rongji has reaffirmed this position on many occasions to the

friends in Hong Kong and international economic and financial

communities. In February 1996, the PBC and HKMA signed a

bilateral repurchase agreement against US Treasury notes. Last

November, the PBC and HKMA joined the Bank for International

Settlements at the same time. The PBC also actively supports the

effort of the HKMA to join the IMF New Arrangements to

Borrow. These events are concrete reflections of the above

principles, and have been well recognised by the international

financial community. The PBC wil l certainly fo l low the policy of

"One Country, Two Systems" and the Basic Law, handle and

safeguard the monetary relationship between Hong Kong and the

Mainland of China in a most appropriate way, and spare no efforts

to maintain the role of Hong Kong as an international financial

centre.

Ladies and gentlemen, China will resume the exercise of sovereignty

over Hong Kong on I July 1997, which wil l bring Hong Kong into

a new era of history. When we gather here in Hong Kong for the


forthcoming Joint Annual Meetings of the IMF and the Wor ld Bank

in September, the great concept of "One Country, Two Systems"

will become a reality. A more prosperous and stable Hong Kong is

in sight, and a more dynamic and vigorous international financial

centre is on the horizon. Thank you.


F I N A N C I A L I N T E G R A T I O N : O P P O R T U N I T I E S A N D R I S K S

Anwar bin Ibrahim

Deputy Prime Minister and

Minister of Finance

Malaysia

Ladies and gentlemen,

The phenomenal rise of East Asia as the dynamo powering the

global economy has had a profound impact on the wor ld and on

the way Asians as a whole see themselves. This economic

revolution, which has freed millions f rom abject poverty, has

imbued Asians with a sense of optimism about their future, and

instilled confidence in their ability to participate fully in global

affairs. Despite the pronouncements by the prophets of doom in

the West, this confidence in the region's prospects wil l not be

undermined by the return of Hong Kong to Chinese sovereignty

on I July. In fact, the handover provides Hong Kong wi th a new

opportunity to integrate itself more closely wi th the booming

economies of the region, including Southeast Asia, instead of

focusing almost exclusively on the northeast I believe that Hong

Kong's future is not just assured, but its prospects are enhanced

by the handover.

East Asia's Success Story

The economies in this region have enjoyed a period of strong

growth over the last several years and real GDP growth in the

region as a whole is expected t o stabilise at around 6-7% this

year. This success is no "miracle". It was brought about by

governments committed to policy reforms, dynamic private

sectors and a disciplined industrious workforce that have helped

our economies speedily integrate into the global economy. In a

Financial Integration: Opportunities and Risks

wor ld in which national borders are increasingly porous, no single

nation can isolate itself f rom the global neighbourhood and hope

to improve the livelihood of its people.

Policy Decisions Guided by Pragmatism

This reality was recognised early in East Asia. A regional mindset,

as opposed to championing purely nationalist causes, now shapes

the policy decisions of governments. Problems are resolved

through consensus rather than conflict, to the mutual benefit of all

interested parties. There are those who continue to doubt

whether this regional approach is deep rooted. Blinded by

parochial concerns, a sense of nostalgia for the past or perhaps by

growing economic and social insecurity, they are condescending

and patronising to a region which refuses to play by the rules of

the old zero-sum game that they dominated.

We in East Asia recognise that in an increasingly integrated global

environment, the region's future depends on our ability to meet

the challenges of global interdependence and tap the opportunities

for closer regional co-operation to further promote and sustain

the growth process. Pragmatism, rather than ideology, is the

governing principle in the reforms we have initiated to speed up

the integration of our economies. East Asia's growing trade share

and strong inflows of foreign direct investment have been due to

our commitment to macroeconomic stability, realistic exchange

rates and open trade and investment regimes. The consistently

high credit ratings enjoyed by a number of economies in the

region are testimony to these policies.

Capital Flows Aid Infrastructural Development

The globalisation of our financial markets and the increased accessto international financial and capital markets have brought about


both opportunities and risks. Let me first deal wi th the

opportunities. Cross-border flows of capital have helped to

promote optimal resource allocation in individual countries and

regional growth and development. External finances have allowed

domestic investment to exceed domestic saving. Given the

enormous financing requirements of development projects in

several of our economies, capital wil l have to be mobilised from

domestic as well as external sources. For example, the World

Bank estimated that to finance infrastructure development alone,

East Asian economies, excluding Japan, would require US$1.5

tri l l ion over the period 1995-2004.

Addressing such crucial needs requires the process of integration

to be stepped up rapidly as we approach the new millennium. For

example, in respect of infrastructure projects, we could move

towards accommodating cross-border listings in the region. This

means listing requirements must be flexible and market

intermediaries must be at hand to provide necessary advice and

assistance. Restrictions on the entry of intermediaries such as

merchant banks and stock-broking firms should be dismantled,

albeit at a gradual pace for some countries.

Improving capital market processes must focus on the importance

of good clearance and settlement systems in the region* We

cannot overemphasise the need to meet international standards

with respect to speed, accuracy, transparency and cost-effectiveness.

In addition, efforts must be made to lower credit and liquidity

risks and, ultimately, systemic risks, throughout the region.

If the financial systems in East Asia are expected to facilitate

regional fund-raising, then their rules and regulations must also be

co-ordinated. Areas in need of the harmonisation of such rules

include banking and security market regulations, capital adequacy

requirements, accounting and disclosure standards, corporate


governance standards and the sharing of information agreementsbetween regulators.

Financial Integration Poses Risks

The risks that accompany the move towards greater financialintegration and increasing openness are obvious. They includeinstability, increased risk-taking by financial institutions and pressureson international payment and settlement systems. To avertpotential crises before they occur, we need more frankconsultations and frequent dialogues. Regional co-operation onthis issue should be centred on three areas: the institution of an"early warning system/1 the sharing of timely information oneconomic developments and policies and the development of asound infrastructure for payment systems and co-operation inforeign exchange markets. This is in no way intended to suggestthat new forums or regional sub-groups be set up. We shouldwork with and within existing forums in the region to achieve ourobjectives. In this respect, the ASEAN finance ministers meeting inPhuket last week should be viewed not as an attempt at theformation of a new "financial bloc" but as a move to increase sub-regional co-operation within the larger regional and globalperspective.

Balance Market Forces with Intervention

I would like to conclude by touching on the philosophicalunderpinning of globalisation and economic integration. While thisprocess appears irreversible, we should ensure that the outcomeis not defined solely by market forces. Despite the seductive lureof the free-market, we must bear in mind that markets are notinanimate and inherently rational mechanisms but are governed byhuman emotions and individual interests. Leaving the future ofbillions to the mercy of market forces smacks as much of


irrationality as of foolhardiness. The answer lies, of course, not in

a return to the bankrupt system of a command economy but in

the middle path: the invisible and visible hands must work

together. The imperative is to strike a balance between market

forces and benign intervention.

Ultimately, economic growth has to be integrated into the overall

philosophy of human development. A global and supposedly "free"

market which marginalises the many while it benefits the few,

which serves the interest of the rich and powerful while ignoring

the legitimate needs of the poor and weak, which creates islands

of wealth amidst a sea of poverty wil l certainly jeopardise the

future of our children and grandchildren. On the other hand, to

continuously harp on democracy and human rights whilst abject

poverty remains rampant and other basic needs of society are

ignored is not only an exercise in futi l i ty but a serious dereliction

of the moral duty of government. Thank you.


2:Key Aspects of RegionalEconomic and Financial

Integration

(Part II)


Gabriel C Singson

Governor

Bangko Sentral ng Pilipinas

Phililpines

It is now increasingly evident that economic and financial linkages

in the region are bound to get stronger over time. This is a sub-

theme of the globalisation trend conditioned by trade liberalisation,

financial market deregulation, financial innovation, and technological

change.

The major benefits of economic integration are well known:

improved allocation of critical resources including savings as well

as the creation of larger markets. But it is also becoming clear

that there is a price to be paid in terms of much higher standards

of vigilance, of prudence, and of flexibility required of policy-

makers. W i thou t these accompanying adjustments at the national

level and at the level of international co-operation, we may yet

end up regretting getting what we have wished for.

To share their insights, we are fortunate to have wi th us two very

distinguished speakers for the second round of discussions on this

very important and interesting subject of economic and financial

integration in Asia.


G L O B A L T R A D E A N D F I N A N C I A L

I N T E R D E P E N D E N C E -

T H E K E Y T O P R O S P E R I T Y A N D

T R A N Q U I L L I T Y

£ Gerald Corrigan

Managing Director

Goldman, Sachs & Co

Good morning, ladies and gentlemen. I am honoured and delighted

to have this opportunity to join Governor Singson and Governor

Lee on this panel to discuss further the subject of "Financial

Integration in Asia and the Role of Hong Kong/* More generally, I

am especially pleased to join so many of my old friends, including

Michel Camdessus and Joseph Yam on this special occasion for

Hong Kong.

Confidence for Hong Kong's Transition

A little less than four months f rom now Hong Kong wil l become a

Special Administrative Region of the People's Republic of China,

Few dates have been the subject of more commentary and

speculation for longer periods of t ime than has been the case with

I July 1997. For some, the advent of I July has been a matter of

intellectual curiosity as to whether an approach to political

economy based on "one country, t w o systems" can work . For

others, the advent of July I has been viewed with apprehension

bordering on alarm growing out of concerns that the t w o systems

are so fundamentally in conflict that tensions and instability - or

worse - are inevitable.

Global Trade and Financial Interdependence -The Key to Prosperity and Tranquillity

Let me be very clear at the outset in saying that I do not now

believe, nor have I ever believed, that the latter result is

inevitable. To the contrary - and recognising that some bumps in

the road are inevitable - I am convinced that the transition can

occur in a manner that is good for Hong Kong, good for the

People's Republic of China, good for Asia, and good for the world

at large. I say that in part because so much is at stake that I find it

extraordinarily difficult to believe that wise and informed leaders

will not conduct themselves in a manner consistent with such a

result.

Whi le our collective preoccupation with I July is understandable,

we should keep these watershed developments in perspective.

Central to that perspective is the fact that seldom, if ever, has the

community of nations had a greater opportunity to do more good

for more people in more places than right now!! Indeed, taking

account of the global economic, political, and geopolitical situation,

I can see no good and sufficient reasons standing in the way of an

extended period of solid economic growth and rising standards of

living on a broad global scale. Achieving that Shangri-La, however,

wil l require even greater emphasis on the economic and financial

fundamentals and it wil l require much greater co-operation,

communication, and co-ordination between nations on economic

and financial matters. W i t h the coming of I July 1997, China,

Hong Kong, and the other nations in this region have a rare

opportunity to help set the standards as to how this new era of

economic co-operation and progress can deliver the promise of

prosperity and tranquillity on a global scale. In that spirit, allow

me to briefly share wi th you some thoughts on how this process

should unfold in the period ahead.

Global Trade and Financial Interdependence —The Key to Prosperity and Tranquillity

Regionalism and Globalism

Economic and financial interdependence have been a way of life inmost of South East Asia for decades, if not for centuries. Indeeddespite the vast geography, trade and commerce between nationshas been a hallmark of the region throughout much of recordedhistory. More recently, the spectacular growth in the region hasbeen fuelled importantly by the relatively free flow of goods andcapital within the region and between the region and the rest ofthe world. This process of integration in economic and financialterms has not been without stress as witnessed, for example, bythe periodic tensions between the United States and Japan - andmore recently between the US and China - over trade practicesand policies. While the economics and politics of bilateral tradedisputes are a fact of life, we must not lose sight of the fact thatinternational trade and finance are, by their very nature, amultilateral, not a bilateral, phenomenon. Thus, even as we seekto encourage still broader and deeper trade ties within the region,we must do so in a manner that is consistent with broader anddeeper trade ties on a global scale. Indeed, whether it is in Asia,Europe, or the Americas, regionalism must be seen as acomplement to, not a substitute for, globalism.

In the spirit of globalism, it is also critical that every nationrecognises that it has a vested interest in the political andeconomic stability of every other nation, even if it remains truethat the primary responsibility for achieving national stability lieswith the national authorities. Looked at in this light, it seems clearto me that the individual countries in the region need to go theextra mile to insure that national policies are compatible withnational stability. Only then will there be reasonable assurancesthat the community of nations will reap the full benefit of stillgreater interdependence in trade and financial terms. Both Chinaand Hong Kong have special responsibilities in this regard; China


because of its size, Hong Kong because of traditions, and bothbecause their essential leadership roles in setting the tone for thefuture are so important.

Public Confidence: Pivotal t o Financial Flows

In charting the course for the future it also seems clear to me that

developments in the financial sector will loom especially large.

Heightened financial interdependence is, of course, the other side

of the coin of increased trade interdependence. There is,

however, a feature of financial interdependence that must be a

matter of particular concern to policy-makers and practitioners

alike. Namely, the vast quantities of cross-border financial flows -

that are the visible symbols of financial interdependence - all

ultimately rest on that great intangible called public confidence.

Therefore, if for any reason public confidence regarding a country

or a company is called into question, financial flows can dry up in a

flash causing major instabilities to the country or company in

question. In the extreme, this process can bring wi th it the danger

of the contagion phenomenon whereby instabilities can spill over

to other countries in ways that threaten stability more generally.

In other words, maintaining public confidence is the name of the

game and it is the collective responsibility of leaders in both the

public and private sectors in all countries.

Because most countries in this region have had such remarkable

records of high growth in a setting of high domestic savings rates,

concerns about the stability and sustainability of cross-border

financial f lows have almost been taken for granted in some circles.

The fact that several countries in the region have been able to

accumulate international reserves even in the face of large current

account deficits as capital account surpluses have more than offset

current account deficits, has tended to reinforce this somewhat

relaxed attitude on the part of some toward capital flows.


Renewed Efforts a Must

While there is little reason to doubt that the region as a whole

will continue to show rapid growth, renewed efforts to insure the

reliability and sustainability of cross-border capital flows are

needed. Even more importantly, renewed efforts to insure that

national banking and financial systems effectively play their

essential roles in mobilising domestic savings are also needed.

There are a number of factors that point to these imperatives

including the following:

First, even with high domestic savings rates, the growth and

infrastructure needs of most countries in the region are such that

large quantities of foreign savings wil l be needed as far into the

future as the eye can see.

Second, as recent events have illustrated, countries in the region

are not immune from asset price induced problems wi th domestic

banking and financial systems.

Third, in most countries and for the region as a whole, financial

infrastructure including domestic and international payments,

clearance, and settlement systems are relatively underdeveloped

and carry with them unnecessarily high risks to financial institutions

and to the financial system in general.

Fourth, as noted above, some countries are incurring quite large

current account deficits in a setting in which export growth has

slowed appreciably. The conventional wisdom suggests that much

of this phenomenon is cyclical, but, as we have seen, the

conventional wisdom is not always rights.

Finally, as performance in other parts of the wor ld including, for

example, Latin America and Eastern Europe improves, international


investors have wider choices as to outlets for their cross-borderinvestments, whether portfol io or fixed in nature.

Suggested Policy Initiatives

In all of these circumstances, allow me to now briefly outline sixareas of policy endeavour which I believe warrant particularattention in the period ahead. All of these areas of endeavour, Imight add, are ones in which the International Monetary Fund(IMF), the World Bank, and the Asian Development Bank (ADB)can play a constructive role. Following the discussion of the sixpoints, I will conclude with some brief observations on: I) therole of Hong Kong and China in this process, and 2) how theUnited States fits into this picture. The six points of endeavourare as follows:

First, and foremost, all countries must redouble their efforts asthey pertain to the rnarco-economic policy fundamentals ofbudgetary and monetary discipline. Chronic fiscal deficits inparticular are a threat to both price and financial stability.

Second, all countries whether they are international deficitcountries or international surplus countries must take a moreproactive posture with regard to managing their financial affairs.Effective management in such areas as debt structure, interestrate, exchange rate, and liquidity risks are every bit as importantto sovereigns and central banks as they are to private companies.Efforts in these areas can go some distance in avoiding the pre-conditions that can deteriorate into a financial crisis. In thisregard, the authorities also need to improve their capability tounderstand and monitor private sector external liabilities especiallyin cases where private entities have sizable foreign currency debtservice obligations that are not roughly matched by corporatecash flows in the currencies in question.

Global Trade and Financial Interdependence —The Key to Prosperity and Tranquillity

Third, wi th few exceptions, countries in the region need to take

further steps to modernise their domestic banking and financial

systems in ways that wil l , among other things, enhance the

impartiality of the credit decision-making process, encourage

broad and diverse ownership of banks and other financial

institutions, facilitate the development of deep and liquid markets

for debt and equity securities and promote greater openness and

competition in the financial sector. As an extension of this,

providing a framework in which foreign financial institutions can

fully and fairly participate in national banking and financial systems

should be encouraged as has been the long standing practice here

in Hong Kong.

Fourth, as an extension of the above, most countries need to take

steps to strengthen the official supervisory oversight of financial

institutions and markets. The goal of this effort should be to bring

all countries into full compliance wi th international supervisory

policies and practices in the shortest possible t ime. This effort

need not be, and should not be, driven by a "black book"

mentality of detailed rules and regulations but rather by a f i rm yet

flexible supervisory framework that does not punish the strong

and well managed institutions for the mistakes or misdeeds of the

weak and reckless institutions. An especially critical need in the

supervisory arena is that very difficult task of training and

developing a sufficient cadre of highly professional bank

examinations personnel. A t the end of the day, the quality of the

bank examination or inspection process is the bedrock upon

which the effectiveness of the overall supervisory process rests.

Fifth, for the region as a whole there is also a clear need to

strengthen the overall financial infrastructure with special emphasis

on national and regional payments, clearance and settlement

systems. As part of this, I believe that the AsiaClear concept

deserves careful and immediate consideration. In speaking of


payments, clearance, and settlement systems, I want to acknowledgeand congratulate Joseph Yam and his colleagues at the Hong KongMonetary Authority for the leadership role they are playing in thisarea. I also want to acknowledge and congratulate Governor Daiand his colleagues at the People's Bank of China for the thoughtfuland ambitious plans and progammes for payments systemdevelopment they have put in place in China.

Sixth, new and more effective modalities for economic andfinancial co-operation and co-ordination must be framed. Both thepolitics and substance of this are difficult both within the regionand in regard to the region's relationship with the rest of theworld. Indeed, even the seemingly straightforward proposition asto which countries should be members of which group isenormously complex.

Concrete Steps

I have neither the time nor the insight to provide you with aconcrete prescription for the future in this regard and I doubt oneexists since events are likely to be evolutionary not revolutionary.Two things are, however, clear: first, there should be a regularforum in which all of the Central Bank governors of the regionand all the Finance Ministers should meet separately and jointly onan annual basis. This, together with various building blocks rangingfrom APEC to selective country representation at the BIS will helpto forge the evolution of a credible and effective institutionalframework for the future. Second, in the near term, oneimportant subject for further official deliberations is what furthersteps are needed to better insure the stability and reliability ofinternational capital flows. In those deliberations, it is inevitablethat further conversation and analysis will be devoted to whatsteps can be taken to deal with a Mexican-style financial crisis.Finding broadly acceptable solutions to such an event raises the


questions as to the possible structure and workings of some form

of an internationally sponsored emergency liquidity facility. In turn,

discussions of such a facility immediately confront a difficult

philosophical barrier and an equally difficult practical barrier. The

philosophical barrier is, of course, the moral hazard problem. The

practical barrier is the difficult issue of how an emergency liquidity

facility can be activated in a timely fashion while providing

acceptable levels of conditionally.

Due importantly to the leadership of the IMF, progress has been

made in better understanding of the ways in which sovereign

liquidity crisis can be avoided and in sorting out ways in which

they can be managed should they occur. Having said that, more

effort and analysis is needed in a setting in which the countries in

this region have - directly or indirectly - a major interest in

seeing to it that they play a constructive and active role in helping

the international community advance further the cause of stability

in the arena of international finance. Consistent wi th that, there

may be ways in which regional arrangements involving for

example, swap or repo facilities can play a role, but any such

arrangements should be framed with the global picture in mind.

More importantly, all such efforts aimed at crisis management

should remain mindful that the best approach to crisis management

is crisis avoidance.

Role of Hong Kong in Integration Process

In closing, I want to return to the central theme of today's

conference, namely, the role of Hong Kong in the financial

integration process here in Asia. For starters, I fully expect that

Hong Kong wil l remain an important international financial centre,

a result that in no way precludes the parallel development of

other important financial centres in Shanghai, for example, or

elsewhere. Beyond that, I also believe that the open and market-


based traditions of Hong Kong need to be preserved if not

enhanced. In this regard, it is plain to me that such an outcome is

unambiguously in the best interests of ail countries in the region

starting with China itself. Indeed, as I see it for the remotely

visible future, Hong Kong can play the vital role as China's

financial window on the wor ld . This role wil l assist the next

phases of China's development and help to insure the smooth

transition I spoke of earlier. Finally, as China's financial integration

with the rest of the wor ld takes f irm hold, other aspects of

integration will surely follow. That, ladies and gentlemen is a

"w in " - "w in " situation.

Needless to say, the United States has a large interest in the

manner in which the next stages of economic and financial

integration evolve here in this region. In very practical terms,

virtually all of the countries in the region are major trading

partners wi th the US. Further, the region looms very large as a

major outlet for US exports in the future. Looked at f rom another

direction, the major surplus countries in the region are - as one

would expect - significant sources through which the US current

account deficit is financed.

Having said all of that, there is more to it than deficits and

surpluses, debits and credits, imports and exports. The plainly

over-riding issue is that broad-based economic success in all

countries - but especially the largest and most influential

countries - is the best formula to achieve the dual goals of

prosperity and tranquillity of which I spoke earlier. That broad

based economic success is within reach only to the extent that we

insist upon policies, practices, and attitudes that wil l encourage

global trade and financial interdependencies play their natural role

in promoting the optimal allocation of resources in all nations.

Maintaining the vision and discipline to stick to this policy agenda

wil l not be easy, but the rewards for doing so wil l be very large. In


symbol and in substance, I July 1997 will provide a crucial

benchmark as to how the policy agenda for the future wil l be

managed. I, for one, am hopeful that with the passage of t ime we

will look back at I July and say with conviction that the challenge

was met. Thank you.


P O L I C Y D I R E C T I O N T O W A R D S

A M O R E I N T E G R A T E D A S I A :

A C E N T R A L B A N K E R ' S P E R S P E C T I V E

Kyung Shik Lee

Governor

Bank of Korea

Thank you, Mr Chairman. To begin wi th, I would like to express

my sincere thanks for giving me this valuable opportunity to speak

on the financial integration in Asia.

As you are well aware, the integration of wor ld financial markets

has been speeding up fast. This is not the result of policies chosen

by government authorities. Rather, markets themselves have

brought this about as a very natural consequence of worldwide

financial deregulat ion and advances in in format ion and

communications technology.

The capital flows from the advanced to developing countries have

become a marked phenomenon since the early 1990s. According

to a study by the Wor ld Bank, in 1985-87, only two developing

countries were classified as having a high degree of integration

into the global financial market. However, during 1992-94, the

number rose to 13.

Being driven into this integration process, Asian developing

countries are struggling to take advantage of the process

successfully and sensibly. However, this requires a new policy

framework. Needless to say, it should not be drawn f rom the old

paradigm, but should be a fundamental reform embracing both the

spirit in which policy is formulated and the policy tools employed.

Policy Direction Towards A More Integrated Asia:A Central Banker's Perspective

Liberalisation and globalisation of financial markets have also

heightened the international dimension of monetary policy making,

and opened the way for greater co-operation among Asian

countries. W i t h growing capital mobility and the potential for

external shocks spilling over into Asian markets, economic co-

ordination for responding to external shocks looks attractive.

Building a N e w Domestic Policy F r a m e w o r k

Before talking about financial co-operation in Asia, let me first

approach the domestic policy issues f rom the view point of a

central banker.

There is no doubt that our first pr ior i ty should be put on devising

macroeconomic policy tools suitable for the new economic

environment.

As integration proceeds, the extent of national autonomy in the

implementation of macroeconomic policy is inevitably limited.

Sovereign governments are losing their ability to control major

policy variables such as money supply and exchange rate. This is

simply because policymakers have to interact more and more with

overseas players under circumstances where economies are

heavily inter-dependent, rather than just domestic ones.

Even in these circumstances though, policymakers, particularly

central bankers, cannot be immune f rom their responsibility for

keeping the economy on a stable track. This is the origin of

central bankers* agony. A n e w policy framework has to be devised

in which central bankers can once again keep a firm grip on the

macroeconomic path.

Another important task is to upgrade the financial system. A


backward and inefficient financial system holds back the economy.First, it may distort the effective utilisation of capital inflowsbecause of inefficient intermediation. Second, it may erode thecountry's creditworthiness in the international financial system.Consequently, a country with a fragile financial system faces theconstant threat of a sudden reversal of capital flows. In fact, therecent financial crises in developing countries were not caused byexternal factors like a hike in international interest rates. Ratherthey were triggered by such domestic problems as a fragilefinancial system or the piling up of bad loans.

Financial deregulation, a well-functioning financial infrastructureand appropriate prudential supervision should be the mainingredients of sweeping financial reform. In many countriesincluding Japan, these reforms are already well underway. Koreatoo has been pushing ahead with financial liberalisation since theearly 1990s. Recently, the Presidential Committee for FinancialReform was set up to carry out wider-ranging reform. In line withthe upgrading of the Korean financial system, I hope that Seoulwill emerge as a regional financial centre some day.

With the progress of financial integration, the role of internationalfinancial centres has been heightened. For many years Hong Konghas served brilliantly as the main financial centre for the Asianregion. This role is expected to continue, and I believe that HongKong will contribute to the deeper integration of Asian financialmarkets in the future.

The final thrust of policy efforts should be toward strengtheninggrowth potential. Strong and sound economic fundamentalsensure a favourable environment for capital flows and financialintegration. And these in turn will make the economy more stableand prosperous, resulting in a virtuous cycle. The World Bankestimated that Asian economies would invest almost US$8 trillion


over the ten years from 1995 to 2004. Given the difficulty ofraising this huge amount in domestic markets, economic stabilityand vitality must be maintained to induce foreign capital.

The Asian economies are expected to continue their high growthtrend into the 21st century. However, there also emerge warningvoices against taking too rosy a view. Sceptics assert that Asia'shigh growth has been supported by an abundant and cheap labourforce, rather than improved productivity or technology. Thisgrowth pattern will not fit in well with the worldwide wave of ashift toward an information and knowledge-based society. In thewake of the recent fall in the economic growth rate of many Asiancountries, there are fears that this sceptical view may be provedcorrect. The Korean economy also experienced difficulties lastyear as GDP growth decelerated while the current account deficitwidened. But I understand this as a transitional phenomenoncaused mainly by the wider market opening, in particular, relatedto entry into the Organisation for Economic Co-operation andDevelopment (OECD). To overcome these economic troubles,Korea is now endeavouring to draw up reform strategies forgiving the financial and labour markets greater flexibility.

In order to follow the path of stable and sustainable growth, Asiandeveloping countries should make an effort to restructure theireconomies from labour-intensive to information and knowledge-based ones. For Asian nations, this is the less travelled, but highroad to enhancing national competitiveness. At the same time, theimportance of fostering light industries should not be playeddown. Through continued technological innovation, they can turninto high value-added producers.

However, it is no doubt that all our efforts to move into a moresound and technology-oriented economy will be in vain if we donot succeed in developing efficient financial markets. In this


context, the integration process which will serve to widen and

deepen domestic financial markets becomes much more important

than ever before.

A t t e m p t s t o Build a N e w System of Financial Co-operat ion

For the successful integration of financial markets in Asia,

harmonious co-operation among the countries involved must be

achieved. But the Asian region has not yet seen a high degree of

financial co-operation. There are various regional financial

organisations such as South East Asian Central Banks (SEACEN)

and South East Asia, New Zealand and Australia Group of Central

Banks and Monetary Authorit ies (SEANZA). However, in fact,

their roles and functions have so far focused on research and

training activities.

The reason why Asia did not develop practical policy co-operation

in financial matters may be explained by the fact that the volume

of intra-regional capital flows was relatively small until the end of

the 1980s. Besides, in contrast to Nor th America and Western

Europe, there was great diversity among Asian countries in terms

of their stage of economic development and maturity of their

financial markets. This made it very hard to reach a consensus on

any specific proposals for financial co-operation among Asian

countries.

The situation, however, is now changing beyond recognition.

Financial integration is moving forward rapidly, and is expected to

gather pace even faster in the coming years. Wha t is more, the

Mexican peso crisis in 1994 heightened the necessity of close co-

operation among Asian countries in order to prevent financial

crises and subsequent contagion. As a result, central banks in Asia,

including the Bank of Korea, have entered into repurchase

Policy Direction Towards A More Integrated Asia:A Central Banker}s Perspective

agreements on a bilateral basis. Also Asia Pacific Economic Co-operation (APEC), founded to promote the liberalisation of tradeand investment, has widened its role to the financial front with theholding of regular conferences of finance ministers since 1994.Recently, a forum for regular consultations among the financeauthorities of six countries with developed international financialmarkets was initiated. There is also a case for the setting up of anAsian BIS. All these moves have been prompted by financialintegration. But at the same time, they have acted to speed up theintegration itself.

Among the various bodies in play, Executives' Meeting of EastAsian and Pacific Central Banks and Monetary Authorities(EMEAP), which was launched in February 1991 as a grouping ofeleven Asian and Oceanian central banks, has rapidly stepped upits activities, thus transforming itself into a vehicle for more wide-ranging and practical financial co-operation.

The first EMEAP Governors' Meeting was held last July, andworking groups were formed to identify possible areas forpractical co-operation. Examples of this co-operation in thecontext of EMEAP can be found in maintaining exchange ratestability, preventing liquidity crises, and setting up an intra-regionalpayments system. With a view to encouraging such activities, theestablishment of a Permanent Secretariat is also under review.

Concluding Remarks

Finally, I would like to stress that, in my view, financial co-operation in Asia cannot be the exclusive concern of thecountries whose financial markets are highly developed.

All the financial markets of regional countries, regardless of theirdepth and level of development, are exposed to various risks


associated wi th financial integration. Therefore, it is essential that

each country co-operate with its neighbours in reducing such

risks. This is the very reason why the framework for financial co-

operation should not be something of a closed, elitist club, but an

open, broad grouping. Taking for example EMEAP which I see as

the most promising body for co-operation in Asia, the question of

expanding its membership to newly emerging countries in South

West Asia and Indochina could be reviewed.

I hope that the moves toward financial co-operation made so far

in this region will bear frui t in their own ways. And I am quite

confident that by virtue of all these efforts, we, as Asians, can

meet the challenges ahead and achieve long-lasting prosperity in

the future. Thank you.


L U N C H E O N S P E E C H :

T H E E L E V E N C O M M A N D M E N T S

Donald Tsang

Financial Secretary

Hong Kong

Mr Camdessus, honourable guests, ladies and gentlemen,

On behalf of the Hong Kong Government, I would like to extend

a very warm welcome to all of you, I am particularly honoured

and delighted to welcome Mr Michel Camdessus, who has so

generously taken time off his global schedule to come to grace

this Conference. I have a sneaking suspicion that Mr Camdessus is

really here to check that the arrangements for the Annual

Meetings in September are in good shape. I want to reassure him

that all is ship-shape, Hong Kong fashion. You can all see that the

new Extension to the Hong Kong Convention & Exhibition Centre

is being completed on time. We hope to provide the most

modern facilities for the Annual Meetings ever.

Mr Camdessus, when we met in last year's Annual Meetings, you

inspired everyone with your speech on the Eleven Commandments

for Sustainable Global Growth. I was so impressed that I wrote

you a letter to check how well Hong Kong has met those

commandments. 1 thought it might be useful to share these

findings with everyone here. As a staunch believer of those

commandments, I hope you will forgive me for paraphrasing your

commandments in biblical terms, using Hong Kong as an example.

Those lessons are of course not unique to Hong Kong. But by

following those commandments, Hong Kong has demonstrated the

paramount importance of free trade and free markets in generating

entrepreneurship, growth and prosperity.

Ef*J Luncheon Speech: The Eleven Commandments

I shall not bore you with Hong Kong's achievements, which you

can see for yourself. My message today is not about Hong Kong's

economic development, its growth model or the dynamics of our

economic performance. Instead, I want to concentrate on the

factors which have played in making this success possible, and the

importance of keeping them. It is my conviction that economic

growth can only be fully understood by looking beyond the

macroeconomic variables to free trade; to prudent, rule-based

macroeconomic policies; and to efficient market adjustment.

T h e Eleven C o m m a n d m e n t s

First, thou shalt encourage free trade. Free trade and free markets

have lifted the Hong Kong people, and indeed millions of Asians,

out of poverty. Hong Kong thrives on free trade. As a founding

member of the Wor ld Trade Organisation, we are committed to

upholding the multilateral trading system.

Second, thou shalt promote free f low of capital. Free trade is

enhanced by the free flow of capital. Hong Kong's success as an

international financial and business centre is built on the total

convertibil ity of the Hong Kong dollar, and absolute lack of

restrictions on capital flows, as enshrined in the Sino-British Joint

Declaration and the Basic Law.

Third, thou shalt promote competition and structural market

flexibility. This idea belonged first t o Adam Smith. Hong Kong has

been blessed by a succession of Financial Secretaries — immodestly

including myself - spiritually descended from him. Hong Kong has

demonstrated its flexibility in product and labour markets,

through a massive restructuring f rom a manufacturing base in the

1970's to an economy in which services account for 83% of GDP.

Let us not forget, the maintenance of a fixed exchange rate

requires a flexible economy. Exposure to international competition

Luncheon Speech: The Eleven Commandments

enables our businessmen to adjust quickly to market changes. We

need some assistance to help employment adjustments, but we

remain strong advocates of free and flexible markets.

Fourth, thou shalt save. This is stating the obvious in Asia, which

maintains the highest savings rate globally. Hong Kong follows that

good example, wi th private sector savings rate exceeding 30% of

GDP. To encourage further savings for retirement purposes, our

community has decided to introduce a Mandatory Provident Fund.

The fund will no doubt boost the savings for the economy,

contributing not only to the asset management industry, but also

providing long-term savings to finance long-term growth in a

stable manner.

Fifth, thou shalt maintain fiscal discipline. Hong Kong practises

balanced budget as a matter of policy. We have kept taxes low,

with only 40% of the population paying any salaries tax, and 2%

paying the top rate of 15%. Our public spending cannot exceed

the trend rate of growth in the whole economy. We apply

rigorously a user-pay system for setting public fees to keep

taxation low. We have no fiscal debt. W e have built almost all our

infrastructure, including our new airport, f rom our savings. And

our fiscal reserves stand at about HK$I5O billion or over US$19

billion.

Sixth, thou shalt maintain sound social infrastructure. Wi th in our

strict fiscal discipline, we have not ignored the need t o provide

the right level of governmental support for the economy. W e have

devoted considerable spending on infrastructure, housing, education,

health and the environment, to ensure growth wil l be socially

stable. Our social indicators are telling. We provide public housing

for nearly half of the Hong Kong population. One-fifth of our

eligible students go to university. We have the highest number

of newspapers and journals per capita in the wor ld . We have


health statistics which stand comparison with any in the OECD

countries.

Seventh, thou shalt maintain external balance. Through free trade,

Hong Kong has always earned its way in the wor ld . We had a

widened visible trade deficit in 1994 and 1995, due largely to

spending on infrastructure, but this has narrowed last year, thanks

to an increasing surplus on invisible trade. Over the last decade,

Hong Kong has maintained a balanced current account position,

and an overall balance of payments surplus averaging 5% of GDP.

Hong Kong has been the recipient of strong capital inflows, but is

also a major exporter of capital. Currently, Hong Kong is the

largest direct investor in China, second largest in Thailand, and

third largest in Indonesia and the Philippines.

Eighth, thou shalt maintain monetary stability. Avoidance of large

external imbalances promotes financial and exchange rate stability.

The anchor of prosperity in Hong Kong has been the stability of

the Hong Kong dollar, through its exchange rate linkage with the

US dollar. The credibility of our linked exchange rate regime is

backed not only by our fiscal discipline, but by foreign currency

reserves amounting to US$64 billion at the end of 1996. Although

inflation has been somewhat higher than the rest of the Region,

due to slower adjustment in the non-tradeables area, we have

brought inflation down to around 6% in 1996.

Ninth, thou shalt maintain a sound banking system. Our savings

are only as good as our banking system. Hong Kong's banking

system is both strong and profitable, with capital adequacy levels

of more than 17%, and a return on assets of just under 2%. We

adopt fully international regulatory standards. Last December, we

put in place one of the most modern Real Time Gross Settlement

inter-bank payment systems in Asia to minimise settlement risks

for investors.


Tenth, thou shalt maintain complementary macroeconomic policies.Although this looks as if we are saying the obvious, I am remindedthat sound macroeconomic policies comprise thousands ofconsistent, practical and widely-accepted micro-policies andregulations. I am glad to say that the Hong Kong Administration isvery proud that our civil service provides credible, consistent,predictable, and user-friendly policies that allow maximum scopeof operation for the private sector.

Last but not the least, thou shalt practise what you preach. MrCamdessus calls this good governance, by ensuring the rule of law,improving the efficiency and accountability of the publicadministration, and tackling corruption. Our Chief Secretary hasnever hesitated to remind us that the objective of public servantsis to be both civil and to be service oriented. By keeping a leanand clean public service, the Hong Kong Administration offers thepeople of Hong Kong what my Australian friends would call "fairdeal".

In sum, Hong Kong's success is no miracle. It is the result of sheerhard work, human ingenuity in the face of open competition, alevel playing field, the rule of law and the free flow of information.The rating agencies commonly assert that Hong Kong carries acertain amount of risk. But Hong Kong has been built on risk andthrives on risk. How many Hong Kong entrepreneurs started withnothing and are now world-class businessmen? It is not the riskper se that we should be worried about, but how we, thecommunity and the government, manage such risks. Hong Konghas succeeded because the Administration has not attempted tolead or direct the process. The Administration has sought tocreate a level playing field, a free flow of information, and minimaltaxation and interference, so that the private sector can managethe market risks better. Hong Kong works because it is a placewhere old fashioned ideas like hard work and initiative pay andcrime and corruption don't.

E9 Luncheon Speech: The Eleven Commandments

Managing Both Opportuni t ies and Risks

As you can see, Hong Kong has been and will continue to be a

staunch fol lower of the Eleven Commandments. We firmly believe

that these are the important criteria for our success in the past,

and will remain the keys to sustainable growth and development in

our future. Hong Kong today is irreversibly a service economy. It

is a service economy to the Asian region and the globe.

On I July 1997, Hong Kong wil l open a new chapter in its history.

Dates in themselves are not important. Beyond I July 1997, Hong

Kong wil l be here, China will be here and Asia wil l still be the

same. I am sure that when all of you come back to attend the

Annual Meetings in September, you will not find that Hong Kong's

free markets and drive have changed. No one denies that risks lie

ahead. But we live wi th risks everyday.

What is more important is to realise that opportunities and risks

are both sides of the same coin. Hong Kong has managed its

opportunit ies as well as its risks, throughout its history, by

following instinctively the Eleven Commandments. We do not take

our success for granted, nor do we take the future for granted.

We can do much better, because we wi l l work, wi th your help, to

make the markets work better. Thank you very much.


R E M A R K S O N F I N A N C I A L S E C R E T A R Y ' S

L U N C H E O N S P E E C H

Michel Camdessus

Managing Director


Mr Financial Secretary, you have inspired in me a few reflections,

and I would like to share them with all our friends here.

First, let me assure you that I am not here to check on the

arrangements for the Annual Meetings. We - the I M F - and also

the Wor ld Bank have great confidence that they are being handled

with typical Hong Kong efficiency, and the sense of excellence that

has given this city the vibrant economy that is such a good

example to the world of what can be achieved wi th the right

policies.

Ladies and gentlemen, as the Financial Secretary has just reminded

us, opportunities and risks are only t w o sides of the same Hong

Kong dollar. It is Hong Kong's excellent economic policy

framework that enabled it to sense the opportunity presented by

globalisation, even before the word "globalisation" was invented.

Its dramatic transformation over the past two decades into a

financial and service centre has raised the standard of living of the

Hong Kong people. It has also played a pivotal role in China's

integration into the wor ld economy. A t the same t ime, Hong

Kong's policy framework, with its strict adherence to the basic

principle of sound economic policies - incorporated in the Eleven

Commandments - as you, Mr Secretary, have put so well in the

proper Moses language - and with many of these principles

embedded in the Joint Declaration and the Basic Law, give all of us

Remarks on Financial Secretary's Luncheon Speech

confidence that Hong Kong will deal wi th any risk that lies ahead

by transforming this risk into further opportunities.

Wi th these few remarks, Mr Secretary, it is my privilege to tell

you on behalf of Adam Smith, Alexis de Tocqueville, Moses, and

myself of our admiration for what the Hong Kong people have

achieved. And on behalf of Joseph Yam and the Hong Kong

Monetary Authority, and on behalf of the IMF, it is my privilege to

present to you this small token of our appreciation. But I call your

attention to something very special: that it is really infrequent that

a central bank governor makes a present to a finance secretary,

and it is w i thout precedent that the IMF makes a gift. Ladies and

gentlemen, this is history.

Remarks on Financial Secretary's Luncheon Speech

Session 3:The Challenges and

Opportunities for HongKong of Growing

Regional Integration

(Part I: Policy Issues forHong Kong)


Chen Yuan

Deputy Governor


The morning sessions, which assessed the prospects of economic

and financial integration that has been taking place in the region,

turned out to be extremely interesting and thought-provoking.

N o w I have the honour to chair the third session: The Challenges

and Opportunit ies for Hong Kong of Growing Regional Integration.

Today, not only China but also international communities are

confident in Hong Kong's future as a major financial centre. Hong

Kong has played a crucial role as an intermediary between savings

and investment, thus contributing to the process of regional

integration.

On the other hand, the growing integration in Asia has significant

implications for all the economies in this region, including Hong

Kong. The positive side is encouraging; the negative side impacts

need t o be addressed.

In this session, three distinguished economists will kindly share

wi th us their insight on the role of Hong Kong as an international

financial centre in the context of growing regional economic and

financial integration.


G R O W I N G R E G I O N A L I N T E G R A T I O N I N A S I A :

S O M E P O L I C Y I S S U E S R E G A R D I N G T H E R O L E O F

H O N G K O N G

J Soedradjad Djiwandono

Governor

Bank Indonesia

Introduction

First of all, I would like to thank the Fund and the Hong Kong

Monetary Authori ty for inviting me to speak at this important

Conference. I am sure that this Conference wil l raise many

interesting issues for productive discussions. I recognise at least

there are two important subjects to be discussed here. The first

subject is on the regional integration in Asia. As we are aware,

economic integration, whether it be a simple level of co-

ordination or more formally arranged in international agreements,

is an inevitable process in this era of globalisation. There are

potential benefits that most countries wil l reap from economic

integration; certainly it wil l assist the drive to build a market

economy and thus facilitate better allocation of economic resources.

This view of course holds true in Asia, and other countries

bordering the Pacific Rim. Given the remarkable economic growth

achieved over the last decade, the next challenge of the region is

how to capitalise the progress to date in order to sustain

dynamism and high growth and respond appropriately to future

challenges. This wil l be achieved through economic integration,

which will be invariably characterised by greater intra-regional

trade and investment flows and sustained by the indispensable role

of financial integration to facilitate those flows.

Growing Regional Integration in Asia:Some Policy Issues Regarding The Role of Hong Kong

The second subject is on the role of Hong Kong in facilitating

those developments. There is no doubt that Hong Kong has been

playing a significant role in the development of Asia. We cannot

deny that the presence of Hong Kong has benefited many

countries in this region. However, as the transfer of Hong Kong

to the People's Republic of China is moving closer this year, there

are anxieties as well as expectations on the future role of Hong

Kong in Asia. Therefore I would like to address some policy issues

regarding the future role of Hong Kong within the framework of

the growing regional integration in Asia. I would like to base my

observations on the perspective of Indonesia - as, I am sure,

other countries in the region — which has viewed Hong Kong as

an important business and trading partner for years. In addition,

Hong Kong is also serving as an important financial market for

Indonesia as shown by the presence of many Indonesian banks and

financial institutions in Hong Kong. I will start by describing some

important aspects of regional integration which wil l shape the

future role of Hong Kong in this region.

Asia Approaching the N e w Mil lennium

Entering the next millennium, Asia, especially East Asia will

continue to be the most dynamic and fastest growing region in the

wor ld . The Wor ld Bank projects that by the end of this decade,

growth in the region will continue to surpass that of any region in

the wor ld . This projection is very much related to the achievements

of the past in which economic growth in East Asia over the last

two decades has averaged 7% per annum.

The region's contribution to the wor ld economy is also another

success story. Most of the developing economies in the East Asian

region have undergone rapid growth through greater integration

into the wor ld trading system over the past 15 years through

varieties of process including active participation in the past


Uruguay Round negotiations. According to a GATT study, eight

out of the top 20 leading exporters and importers of world

merchandise trade in 1992 were Asian developing economies1. In

addition, many developing East Asian economies have not only

experienced booming trade in merchandise and services, but have

also become net investors abroad.

The robust economic performance of the East Asian region has

attracted much attention due to its dynamic growth and

strengthening interlinkages. Although the degree may vary across

the countries, there are some common elements that underlie

achievements scored by Asian countries. This success cannot be

attributed to one single policy, but rather to a combination of

tangible factors. In this respect, none of the East Asian economies

have succeeded without three key attributes: outward orientation,

macroeconomic stability, and investment in people2. In this

respect, Saburo Okita argued that the region's successful economic

performance has not only resulted f rom a conducive regional

environment Rather, a number of domestic factors and policies

have also greatly contributed to the success of the developing

countries in the region. These include export oriented policies, a

high rate of investment supported by high domestic savings rate,

the active role of the private sector in the economy, tremendous

advances in agriculture, and successful economic adjustment

policies3.

1. See International Trade Statistics, General Agreement on Tariffs and Trade (GATT),1993

2. See Danny M Leipziger and Vinod Thomas, The Lessons of East Asia: An Overview ofCountry Experience, the World Bank, 1993, Page 28.

3. See Saburo Okita, Pacific Development and Its Implications for the World Economy, inJames W Worley (ed), The Pacific Basin.


Confronted with a series of adverse external shocks in 1980s -including the collapse in commodity and oil prices, the appreciationof the yen and the world economic recession - governments inAsia especially those resource based economies, have respondedpromptly to "turn-around" their economies by implementingadjustment measures. This wave of adjustment policies hascoincided with the rediscovery of market mechanisms, marked byeconomic liberalisation in many countries. As far back as 17 yearsago, many Asian countries had started to abandon protectiveinward-looking trade regimes and adopt outward-looking tradepolicies. The APEC economies have adopted many reforms,including the relaxation of investment policies. For ASEAN andChina, the outward, export oriented push was one of the mainfactors that encouraged the liberalisation of foreign investmentpolicies. Indonesia, for example, has undergone major financialreforms, trade liberalisation and liberalisation in the other sectors.The result in terms of diversification of Indonesia's non-oilexports has been dramatic. The share of non-oil goods inIndonesia's total exports increased dramatically from only 20% in1980 to close to 75% in 1996. In the non-oil sector, the role ofmanufacturing products has been continuously on the rise. ASEANcountries, India and others are joining with the rest of East Asianeconomies with their market opening policies, which have shownremarkable success.

These adjustment policies have encompassed reforms in thefinancial sector. Many countries realise that financial deepening isvital to improving and sustaining economic growth. Thereforegovernments in developing countries have undertaken variousfinancial reforms, especially in the latter part of the 1970s. Priorto liberalisation, a regime of artificially controlled low interestrates in the banking system was common in many Asian countries,a situation which is often referred to as financial repression. Insome respects, the shallowness of financial structures in such a


system often contribute to the poor resilience of the domestic

economy against external shocks. Furthermore, adjustment policies

in the financial sector wil l bring about more efficient allocation of

funds through a competitive market mechanism, whereby increased

demand for investment can be satisfied by the higher savings

generated. By liberalising the financial sector, the efficiency of fund

mobilisation and resource allocation can be improved to finance

the bulk of investment needs for economic development. In the

future it is expected that these financial reforms will continue to

take place in the region to sustain further development in Asia.

The restructuring and economic reform policies adopted by many

East Asian economies have also resulted in market driven

integration with trade-investment linkages as the central vehicle.

This market driven integration is very much fuelled by investment

to the extent that there is a trade-investment linkage4. This

ultimately means that investment liberalisation in the region is

equally important as trade liberalisation since the former can be

expected to facilitate trade flows. Furthermore, the global and

regional economy has transitioned from "trade dr iven" to

"investment driven", which has resulted in a surge of foreign

direct investment worldwide, in particular to the Asian region.

Increased intra-regional trade and investment in Asia are also a

manifestation of market-driven integration.

Role of Foreign Direct Investment and the Private Sector

Economic interdependence in Asia is characterised by trade flows

and also by capital flows, particularly Foreign Direct Investment

(FDI). Indeed, foreign investment has played a major role in the

growth and dynamism of the East Asian economies, ASEAN and

4. See Marl Pangestu, "APEC and Investment Facilitation", in Indonesian Perspectives onAPEC and Regional Co-operation in Asia Pacific, Hadi Soesastro (ed), CSIS, 1994.


China. Growth of foreign investment in the region has been rapid

due to the sound underlying fundamentals of their economies

which offer higher expected returns5. Foreign investment has also

been a key element in the integration of regional economies

through the trade-investment relationship mentioned earlier.

In 1995, the annual average of capital flows to Asia accounted for

almost 60% of the total capital flows to developing countries,

compared to the annual average during 1973-77 of only 40%6. Of

total flows, 52% represented FDI. This figure is very encouraging

given that during the period 1973-77 the annual average was only

33%. These dramatic changes underscore the importance of

foreign investment policy and co-operation in the region regarding

foreign investment. Significantly, the nature of inflows to East Asia

have tended to increase investment rather than consumption7.

This large influx of foreign investment is driven by the

internationalisation of Asian firms and investment policies, notably

the liberalising of inward as well as outward flows of investment.

Investment inflows as well as outflows from the Asia Pacific

economies have grown rapidly, wi th outflows not only f rom Japan

but also f rom East Asian Newly Industrialised Economies (NIEs).

There have been both push and pull factors underlying these

trends. The wave of Japanese investment to other countries in

Asia has been primarily driven by "push" factors - the yen

appreciation and the restructuring of the Japanese economy.

Whi le Japanese investments continued to be the primary source

5. Returns on US FDI flows to the rest of the G-7 have averaged around 8% over1992-95 while returns on FDI to the eight largest developing country recipientshave averaged around 21%. See Global Economic Prospects and the DevelopingCountries, the World Bank, Page 61.

6. See World Economic Outlook, the World Bank, September 1996, Table 12.7. See Global Economic Propects and the Developing Countries, the World Bank, Page

17.


of FDI, there has also been dramatic increases in FDI from theNIEs to nearby countries. In Indonesia, for example, the traditionalFDI from industrialised countries is rivalled by investment from allthe NIEs such as Singapore, Taiwan, Hong Kong and Korea8. It isexpected that if East Asia can maintain the momentum of growthof intra-regional investments in general and FDI in particular, theregion's economic growth and dynamism can be sustained.

Pull factors are tied to trade and investment deregulation whichhas substantially improved the investment climate and conditionsin developing countries. Considering its substantial contribution toeconomic development, most Asian economies have long beenconsidering the policy to attract FDI as a priority in formulatingtheir development and liberalisation policies. Asian countries havegone to great lengths to maintain a conducive climate essential forattracting foreign investment. In many developing Asian countries,especially Thailand, Malaysia, Indonesia and China, there has beena shift from inward to outward oriented development strategyaccompanied by substantial deregulation in trade and investmentregulations and restrictions. These developments have improvedthe investment climate of these countries, and along withcompetitive labour, have enhanced the "pull" factor of thesecountries for direct investment.

Another important factor driving the growth of FDI is theexpanding role of the private sector in the region. It is recognisedthat without the active participation of the private sector, the AsiaPacific region would not have achieved such high growth rates.Market forces are fostering stronger intra-East Asia economic tiesamongst private sector players. The integration of the private

8. Another push factor is the liberalisation of outward capital flows from Taiwanand South Korea, which in the past had imposed restriction on such flows.


sector in the region and the internationaiisation of East Asiancompanies has thus become a major driving force for regionalintegration.

N e x t Challenge: Growing Interdependence and RegionalCo-operat ion

W i t h the increasing size of Asia Pacific trade, interdependence in

the form of intra-regional trade is also projected to continue to

increase. Past statistics supports this outlook. In 1993, intra-

regional merchandise trade in Asia was around 6.5% of total world

trade, while total Asian merchandise exports to the rest of the

wor ld represented 17.3% of the world9 . The contribution of Asia

to wor ld trade is expected to rise. Asia's increase in exports to

industrial countries during the same period was I 1%, while the EU

was only 7.3%. Moreover, in terms of growth, intra-regional trade

in Asia has been more encouraging with annual growth at 15.6%

during 1982-93, the highest of any region in the wor ld .

Increasing interdependence and cross-border trade have spurred

efforts for the creation of a regional trading mechanism. There

have been various types of formal and informal economic co-

operation in the Asia Pacific region. A t the formal level there are

ASEAN and APEC. There are also growth triangles. In the region,

APEC is the largest established regional trading mechanism. The

presence of this regional trading mechanism has brought new

meaning to Asian countries. To date the region has undertaken

various unilateral liberalisation measures and built up intra-

regional economic linkages in the absence of any formal agreement

Therefore, the main issue is whether the market-driven trends

toward integration would continue independently or be "facilitated"

9. See Global Economic Prospects and the Developing Countries, the World Bank, 1995,Table 8.


by some regional mechanism, such as improved co-operation or

even a formal agreement. If the objective of regional co-operation

is to sustain rapid growth in the region, it is crucial that national

policies, which rely on unilateral trade and investment liberalisation,

be continued within the framework of the existing regional trade

mechanism.

Financial Integrat ion in the Asia Region

In Asia, the growing integration of financial markets has been

spurred by the liberalisation of financial markets in the region. The

greater openness of Asia's financial markets and the underlying

fundamentals of the economies have attracted capital inflows. The

development and brighter prospects of Asian capital markets also

attract many institutional investors, mainly f rom outside the

region. In fact, a significant port ion of port fol io flows from

industrialised countries has been directed to Asia. Many fund

managers have become very active in Asian equities. Market

capitalisation in the region has steadily increased, in particular in

recent years. This has added to the increasing role of Asian capital

markets in the global capital markets. W i t h the rising demand for

infrastructure financing in Asia, there is no doubt that Asian

capital markets will continue to grow to accommodate this trend.

How financial integration in Asia wil l evolve is one issue that

depends on many circumstances, such as the development of

financial markets and cross-border financial activities. There are

some possible routes of integration such as through "international

asset price integration" and "integration of onshore and offshore

markets". So far, we have seen the evidence that the process is

taking place, whether in the form of institutional, functional or

market price integration. To some extent we witness the

existence of arbitrage activities which link the currency and capital

markets across the region. There has been a sharp increase in

Growing Regional Integxation in Asia:Some Policy Issues Regarding The Role of Hong Kong

international borrowing activity by the private sector. Theemergence of overseas Asian currencies and debt market will alsobe an important factor.

In the coming years, financial integration in Asia may acceleratefurther through the development of financial markets and paymentssystems in each country. Further financial and investmentliberalisation in Asia will increase cross-border financial activities,which will require more secure and sophisticated paymentssystem. Payments system linkages among Asian countries willfacilitate financial integration in the region. In this area, someprogress can be seen through the co-operation among the centralbanks in the region. The most important co-operation is in theExecutives' Meeting of East Asian and Pacific Central Banks andMonetary Authorities (EMEAP) countries covering three areas:financial market developments, central bank facilities and bankingsupervision. This co-operation may lead to the development ofregional payments system to sustain the development in thosethree areas.

Role of Hong Kong: Some Policy Issues

Growing economic and financial integration will provide manyopportunities and challenges for Hong Kong to contribute greatly.This role of Hong Kong will be supported by some positiveelements that have been existing in Hong Kong economy such asmodern infrastructure, relatively lower cost compared to otherfinancial centres in the region, strategic location, and its familiaritywith Asian business communities. Combined with the aspects thatwill drive regional integration, these elements could enhancefurther integration in Asia.

However, one question arises here is whether these attractivenesswill still be in place after Hong Kong officially becomes a Special


Administrative Region of the People's Republic of China in July

1997. Considering the important role of Hong Kong for years, we

can hardly imagine any development of this region taking place

without the role of Hong Kong. Therefore it is essential to

maintain those positive elements given the conviction that it will

not only benefit Hong Kong and the People's Republic of China

but also the entire business communities in Asia Pacific.

Therefore, the first aspect to consider is related to the policy

direction of the "one country, two systems" adopted in Hong

Kong after the transfer of Hong Kong to the People's Republic of

China. From our perspectives, it is essential that the emphasis is

more on the notion of " two systems" rather than "one country".

The future of this " two systems" policy should not eliminate the

existing system in Hong Kong which has been work ing well in

sustaining economic growth in the region, particularly for those

countries that have been familiar wi th the system. In fact, the

combination of this " two systems" can be directed to produce

greater gain, not only for China but also for other Asian

countries.

Closely related to this aspect is the policy to maintain the

openness of market access in Hong Kong. For trading activities,

access to Hong Kong is crucial given its established modern port

facilities and its business and trading network. Besides China and

Hong Kong, this access is used as export destination by other

Asian countries. Therefore, if Hong Kong is willing to contribute

greatly to regional integration, i t is imperative to maintain this

access after the transfer of Hong Kong to the PRC. Many

countries in Asia will benefit f rom the access to mainland China,

which is a huge potential market for their export products and

services. In the financial sector, similar policy should be pursued

to maintain the status of Hong Kong as one leading financial

centre. In this respect, entries for financial activities in Hong Kong


should not become more restrictive and discriminatory in thefuture.

Third, i t is essential to maintain stability in Hong Kong, which

includes maintaining Hong Kong's monetary and currency stability.

Maintaining currency stability is important due to the implication

might be resulted f rom the " two systems" practice and the

prominent role of the Hong Kong dollar in this region. Monetary

stability in Hong Kong is one important aspect in ensuring a high

level of business confidence in Hong Kong which, in turn, is

essential for maintaining Hong Kong as an important source of

foreign investment in Asia. Future foreign investment from Hong

Kong is still important in meeting the increasing demands of

investment in this region.

Fourth, wi th growing interdependence in Asia, Hong Kong has the

opportunity to strengthen its role as an important financial centre.

The presence of many leading international financial institutions in

Hong Kong, along with its modern financial infrastructure, wil l

serve as valuable assets in promoting more financial integration in

Asia. Therefore it is important t o link the development of Hong

Kong's financial markets with other regional financial markets.

Other Asian countries may thereby benefit f rom Hong Kong's

financial market development. The development of regional

payments system is one area in which Hong Kong may contribute

significantly in facilitating the financial market linkages. Given its

well advanced payments system in both fund transfer and debt

securities clearing system, Hong Kong should continue its primary

lead in fostering more co-operation in the area of regional

payments system. Eventually, this wil l lead to greater integration of

capital markets in the region.

One evidence of this important role is the co-operation among

the central banks in this region which has been focusing on the


importance of Hong Kong's financial markets in the region. In this

regard, we cannot underemphasise the important role of the

Hong Kong Monetary Authority. Its contribution was substantial in

the past as it was in promoting co-operation among central banks

through bilateral repurchase agreements in 1995. Although,

individually, Bank Indonesia has conducted co-operation with

other central banks prior to those repo agreements signed in

Hong Kong, we recognise the crucial role of the HKMA in making

those historic agreements as the beginning of closer regional co-

operation.

Fifth, along with the expected greater role played by Hong Kong's

financial markets in promoting more financial integration in the

future, we should not overlook the greater systemic risk in

regional markets. Given the enormous size of financial markets in

Hong Kong, it is essential to protect i t f rom any failure which may

spread quickly across the regional financial markets. This effort

requires more co-operation among the authorities in Asia, in

particular in maintaining monetary stability, supervising and imposing

prudent practices in banking and financial systems, and safeguarding

the payments system. Indeed, the role of the Hong Kong

Monetary Authori ty to protect and secure Hong Kong's financial

and payments systems is crucial fo r monetary stability in this

region.


H O N G K O N G ' S E C O N O M I C T R A N S F O R M A T I O N :

P O L I C Y C H A L L E N G E S A N D F U T U R E P O T E N T I A L

Hubert Neiss

Director, Asia and Pacific Department


In assessing Hong Kong opportunities in the future, it is useful to

consider first how Hong Kong has used the opportunities of

regional economic integration over the past 15 years. The story

has been often to ld: Hong Kong underwent a remarkable

economic transformation towards a service economy while

maintaining growth and stability, and became a major financial

centre in Asia.

During this period, the service sector expanded from about one

thi rd GDP to almost 85%, while the share of manufacturing

decreased to 10%, as production activities were relocated to

China. This was an appropriate response to Hong Kong's changing

comparative advantage, as China opened its economy and other

countries in the region with low labour costs expanded their

manufacturing production. Hong Kong's shift to services has

allowed it t o utilise its advantages of having a well educated labour

force, managerial skills, and a favourable geographic location; it

also limits the use of land which is the most scarce resource. It is

even more remarkable that this economic transformation has

taken place wi thout major disruptions and wi thout a large

transitional increase in unemployment.

Past performance, therefore, augurs well for the future, if the

favourable external environment continues. In this respect, Asian

economies are likely to grow at a high rate and one that is above

Hong Kong's Economic Transformation:Policy Challenges and Future Potential

world average. Also, these economies are likely to continue toliberalise the flows of trade, services, and capital. This will meanincreasing regional integration and, therefore, opportunities forHong Kong to further develop its service economy and, inparticular, its role as a financial centre.

The future potential is, thus, there, and the challenge for HongKong is to fully use it by remaining competitive and by maintaininginternational confidence. To achieve this, Hong Kong must buildon its existing strengths. There are, in fact, no major new policiesthat one could suggest, but rather the continuation of the basiccourse of policy followed in the past, and its adaption to evolvingneeds. I will mention three elements of this approach:macroeconomic strategy, market-orientation of the system, andstrengthening the economy's adaptability to change.

Macroeconomic Strategy

First, macroeconomic strategy. Continued macroeconomic stabilitymust be assured by the existing policy framework, the basicelements of which are a conservative fiscal policy - the budget isusually in surplus - and a monetary policy geared to maintain astable link of the Hong Kong dollar with the US dollar. The HongKong Monetary Authority is in a good position to maintain thelink, given the high level of foreign reserves, the proven resilienceof its currency board arrangement, the adaptability of financialinstitutions to changing economic conditions, and - last but notleast - the credibility which the Hong Kong Monetary Authorityhas acquired.

Maintaining the exchange-rate link will have some costs: cyclicaldevelopments in Hong Kong will be more closely in line withthose in mainland China, while the changes in monetary policy willfollow those in the United States, and these two developments


may not always be appropriately correlated. However, the strongelement of confidence that by now is associated with the existingpolicy framework that is stable and transparent, is an overridingargument in its favour. Moreover, the traditional flexibility offactor and product markets in Hong Kong has always allowed theeconomy to adjust relatively quickly to changing circumstanceswithout the need for a more active monetary policy.

Market-Oriented System

Second, the market-orientation of the system. Continuedadaptability of firms will importantly depend on maintaining amarket-friendly environment with minimum governmentinterference: absence of controls on trade and capital flows and ofprices, absence of burdensome regulations of economic activity,and low taxes (16.5% on income). Under these conditions, thelarge structural changes over the past years were market-drivenand, as mentioned already, occurred with little short-termdislocations. The efficiency of this market-oriented system must,of course, continue to be ensured by the rule of law, theneutrality of the civil service, and the free flow of information.

Adaptability to Change

Thirdly, while upholding the principle of a non-interventionistgovernment, there are, nevertheless, important areas wheregovernment has to play a role in strengthening the economy'sadaptability to change. I will mention three: the financial system,non-traded services, and education.

Hong Kong's banking system, with a large representation ofinternational banks, is highly profitable, and capital adequacy ratiosrank among the highest in the world (17% on average). Continuousvigilance, nevertheless, is essential, and the authorities have rightly


placed high priority on banking supervision, in line with international

prudential standards.

Non-traded services - such as telecommunications, public utilities,

broadcasting - are used as inputs for traded goods and services,

and their cost wi l l , therefore, affect Hong Kong's competitiveness.

To foster productivity and keep costs down in this sector,

competition should be increased through deregulation. The

government has started this process, but there is still scope for

further improvements.

Education and training are essential t o keep labour markets

flexible and increase the potential for growth of the service

economy. The government will have to explore, in co-operation

with the private sector, ways and means to best gear Hong Kong's

educational system to the requirements of the economy.

These are the main policy challenges to realise Hong Kong's

opportunities in the future. As I said, most of these policies are

already in place, and it is only a matter of perfecting and adapting

them further. Ultimately, of course, the future of Hong Kong will

depend on the ingenuity and adaptability of its people. In this

respect, past experience can only inspire high confidence.


T H E I M P O R T A N C E O F R E G I O N A L C O - O P E R A T I O N

Rafael Hui

Secretary for Financial Services

Hong Kong Government

Mr Chairman, Members of the Panel, ladies and gentlemen, I am

very honoured to address this distinguished gathering.

W i th under four months to go before China resumes sovereignty

over Hong Kong, I am certain that many of you would have felt a

sense of expectation in the Hong Kong community in anticipation

of a new epoch. What I intend to do in the next quarter of an

hour is t o share wi th you some of the financial services issues

facing Hong Kong in the coming years through the turn of the

century and beyond. I would focus on the unique situation of

financial intermediation in the Asian region, the opportunities and

challenges it means for Hong Kong and the policy implications for

the Government.

1997: Changes and Continuities

Evolving f rom relative obscurity back in the 1960s, Hong Kong

has, t o name a few yardsticks, become the world's eighth largest

trading entity, fifth largest banking centre in terms of volume of

external transactions, fifth largest foreign exchange market and

seventh largest stock market. It is apparent that Hong Kong is fast

integrating into the wor ld economy. However, there appears to

be a knowledge gap in some international circles about the East

Asian region where the opportunities and challenges are often not

fully explored and appreciated and about Hong Kong where our

so-called unique "1997 risk", if any, is sometimes not fully

assessed. There are those misinformed who are led t o believe that

The Importance of Regional Co-operation

the only issue of " integration" that Hong Kong will be focusing on

is that wi th China. This, I suggest, is not the complete picture.

I should perhaps start off by laying that misconception to rest by

conveniently quoting, at some length, if I may, f rom the December

1996 issue of the authoritative "OECD Economic Out look" -

"Under its status as a Special Administrative Region of

China, Hong Kong is to remain autonomous for a further

50 years in all areas except defence and foreign affairs.

Under the "One Country, Two Systems" principle, Hong

Kong's market-oriented economic system is to remain

unchanged, with private property rights, including foreign

investment, protected by Hong Kong's legal and regulatory

framework. On public finances, the budget will remain

independent from China, and Hong Kong wil l continue to

maintain separate monetary and exchange rate systems,

with its own currency and free movement of foreign

exchange and capital. Hong Kong is also to maintain an

independent trade policy and keep its current status in

the Wor ld Trade Organisation as a separate customs

area.

The short-run economic effects of the transfer of

government are likely to be fairly minor, to the extent

that much of the necessary adjustment has been under

way for some time. Over the longer term, Hong Kong is

expected to play a continuing and crucial economic role

for the rest of China as a major trading partner and as a

provider of efficient services. A t the same time, other

cities, such as Shanghai, may come to rival Hong Kong as

China's 'door' to the rest of the wor ld , and some

international firms may move t o other locations.

Nonetheless, Hong Kong's international reputation as an


economy strongly committed to the application of therules of law in business practices, may make it animportant catalyst for the diffusion of these rules to therest of China. If so, the process of China's integrationwith the rest of the world will be significantly eased andgains for China and the rest of the world increase."

I think the OECD's expert analysis illustrates succinctly some ofthe unique challenges and opportunities facing Hong Kong in theyears ahead. It is very clear but still worth emphasising that, in thecontext of our monetary and financial policy-making, Hong Kongwill continue to see itself as a significant player in its own rightwith positive contributions to make in our dynamic and growingrelations with China, the rest of the region and the global financialcommunity. Indeed, we are constitutionally mandated to continuethe outward-looking system of Hong Kong. Under Article 109 ofthe Basic Law of the Hong Kong Special Administrative Region,the Government "shall provide an appropriate economic and legalenvironment for the maintenance of the status of Hong Kong asan international financial centre". The key word appears to be"international", which of course is broader than 'national' or'regional'.

Intra-Asian Trade and Financing

Deprived of any natural resources, the conventional wisdom isthat Hong Kong owes much of its success to its strategic locationin the heart of the fastest growing economic region of the world.We serve as the gateway to China, but one should not lose sightof the fact that Hong Kong is also the geographical centre of theeconomic region spanning from East Asia comprising Japan, Koreaand China to Southeast Asia, consisting of ASEAN and otheremerging economies.


The Asian region has been for some time and is believed toremain the fastest growing economic region in the world. Duringthe last 35 years, growth in the region has been one and a halftimes the global average and, according to the World Bank, theaverage annual growth rate over the next decade is forecast to be8%. Intra-regional trade has played a large part in this equation,increasing by more than 400% over the past decade. Thisrepresents more than twice the growth in trade between Asia andthe rest of the world. Intra-Asian trade now accounts for 40% oftotal Asian exports which is twice the level of 15 years ago.

Questions have been asked by sceptics, quite understandably, asto whether this phenomenal growth is sustainable. These are fairquestions, and I believe that the sceptics have played a very usefulrole in pressuring us policy-makers to devise long-term policies tosustain that momentum. One of the key policy end-products is thecontinued heavy investments in infrastructure. Governments inthe region are convinced that a sound and up-to-date infrastructureis a prerequisite for sustained growth. Without the necessaryingredients such as an advanced communication network, reliablepower and water supplies, efficient land transport links, port andairport facilities, cargo and container terminal handling systems,etc, further growth will be constrained as bottlenecks in theseareas emerge. This common belief is being translated intoconcrete programmes of action. The World Bank forecasts thatthe region's infrastructural demands over the next decade will beenormous. Total financing need in East Asia alone is estimated toamount to US$5 trillion between 1995 and 2004.

Asian Financial Intermediation

How can the region fund such infrastructural demands? Here, Iwould echo what my distinguished colleague, Joseph Yam of theHong Kong Monetary Authority, has alluded to on several


previous occasions regarding financial intermediation in theregion. I concur with him that the huge investment demand in Asiawill ultimately have to be funded through high domestic savings.An estimated saving ratio of well over 30% of GDP speaks foritself. Nevertheless, the focus and the policy challenge are howsavings could be mobilised. Policy-makers must address thequestion over the effectiveness of financial intermediation in theregion, where there is much room for further improvement.

Let us first look at savings in the official public sector. Certaincritics have suggested that Hong Kong Government does notreally practise the policy of balanced fiscal budgets. True — werepeatedly end up with fiscal surpluses. Insofar as the region isconcerned, the bulk of the government reserves are believed tobe invested in assets of OECD countries. In the case of HongKong, over 95% of our foreign reserves of some US$65 billion areinvested outside Asia. Specifically, in the management of foreignreserves, our Monetary Authority works against a preferredneutral position of about 75% in US dollar assets, mostly in USTreasury paper.

The corresponding picture for savings in the private sector ismore divergent in the region. There are those who are relativelymore sophisticated in financial management and where permitted,there is significant diversification of savings into foreign assets.This is particularly true in the case of economies where savingshave been and are being institutionalised through professionallymanaged pension and provident funds. On the other end of thespectrum there are those economies where there are captivedomestic markets for domestic savings as the process of financialliberalisation has only begun in recent years.

In sum, the overall picture seems to be that a significant portionof Asian savings have gone to OECD markets. In the other


direction, there has been much foreign direct investment and

foreign portfol io investment f rom OECD countries in Asia.

Hence the central question to ask is why there is such a

phenomenon in Asia. As the channelling of savings into investments

is one important role of domestic financial systems, perhaps

policy-makers and central bankers who have responsibility over

their domestic financial systems should seek to answer. Is financial

intermediation effective enough in Asia? Small savers and large

institutional investors alike base their decisions on the risks

involved in choosing where to invest their savings. If the risk-

return profile is unacceptable, the money will simply go elsewhere.

Have policy-makers and central bankers in Asia provided an

environment in which investors feel adequately comfortable,

about such risks as currency, interest rate, liquidity, payment,

settlement and legal risks? These questions illustrate the focus in

Asia when we are talking about savings and investments. There is

more than prima facie evidence that we need to do more about

financial intermediation in Asia.

The Answers: Financial Prism

1 do not pretend to know the full answers to these highly complex

questions but 1 would be prepared to explore further a number of

related issues. I believe that in order to improve the financial

intermediation function in Hong Kong, we must continue to work

hard to build what we call a sound financial "pr ism", which

summarises the five pre-condit ions fo r effective financial

intermediation -

• "P" for abundance and sophistication in financial products

"R" for effectiveness in risk assessment and management

" I " for robustness in financial market infrastructure• "S" for supervisory prudence

"M" for monetary stability.


These five pre-conditions are self-explanatory. Instead of addressing

them one by one, perhaps I should illustrate briefly by citing Hong

Kong's experience in two areas that the market have done in

collaboration wi th the Government to sharpen our financial prism.

H-Shares

Since 1993, the term "H-shares" has been added to the ever

lengthening financial market practitioners' dictionary. It refers to

shares issued as a result of f lotation of Chinese state-owned

enterprises on the Stock Exchange of Hong Kong. To date, there

are 24 Chinese state-owned enterprises listed on our Stock

Exchange, having raised more than HK$29 billion through such

listings. In fact the success of H-shares is preceded by an

otherwise lesser known, at least internationally, phenomenon of

"red chips", i.e. Hong Kong or overseas-incorporated companies

control led by China principals and usually with the majority of

their assets in China. H-shares and red chips typify a very close

and special relationship between Hong Kong and China. In this

regard, the relationship is especially of mutual benefit. These

listings have added substantial breadth and depth to the equities

market of Hong Kong by, among others, introducing heavy

industries into the range of available stocks, which have hitheto

been largely absent. For China, such listings not only provide an

important source of new capital to the enterprises but also

indirectly help t o upgrade their accounting and disclosure standards

to the international level.

H-shares and red chip listings are set to continue. So far, this is

perhaps a relatively modest start in matching savings in one

economy w i th demands for funds in another within the region.

But the important conclusion is: it works.


Having seen the success of H-shares and red chip listings, our

Stock Exchange believes that it is possible to enhance Hong

Kong's role in meeting China's capital formation needs. It is

therefore liaising closely with its Chinese counterparts to explore

the possibilities of listing in Hong Kong of B-shares, i.e. shares of

Chinese state-owned enterprises listed on Chinese exchanges the

trading of which is restricted to foreign investors. For such

initiatives to come to fruit ion, the endorsement of the Chinese

authorities will of course be required, as wi th the case of H-

shares listing. But this is illustrative of the opportunit ies for co-

operation between different economies within the region.

But our Stock Exchange is not complacent wi th its achievements

so fan It has embarked on another ambitious programme. To help

infrastructure project companies to access capital in Hong Kong,

the Stock Exchange has relaxed its listing rules to allow those

companies which do not meet the general three year profit

requirements to be listed, and has clarified the circumstances

under which applications for listing may be approved. The Stock

Exchange is also preparing for the listing of regional derivative

warrants and convertible bonds here, and is studying the feasibility

of launching regional depository receipts and a second board for

trading, amongst others, regional stocks. These important

endeavours by the Stock Exchange, once materialised, would allow

infrastructure developers and other enterprises in the region to

tap Hong Kong for supply of funds.

Ironically, you may notice an absence of a specific reference to the

China angle in these new ideas being pursued by our Stock

Exchange. I believe this is not unintentional. To serve as the

business fund-raising centre of China of course is an essential and

invaluable function for Hong Kong. But at the same t ime, our

sights must also include the regional and international markets by

maximising our advantages in location, time-zone, infrastructure,


experience and expertise. In the present day borderless financial

markets, we must never forget that Hong Kong's value to China

lies in our international advantages. Otherwise, in the final

analysis, there wil l be little difference between Hong Kong and

Shanghai as financial centres for China.

Mandatory Provident Fund System

Another initiative Hong Kong is undertaking which will impact

most significantly on the financial intermediation function is the

implementation of a Mandatory Provident Fund System in Hong

Kong for the three million local workforce, most of whom are

currently wi thout any formal retirement protection. The primary

legislation governing such a system has already been enacted in

1995, and the Government has pledged to complete the necessary

subsidiary legislation this year. So, before the turn of the century,

we will start to see a significant accumulation of retirement assets,

wi th an annual figure of HK$30 billion in retirement savings from

employers and employees.

Whi le the primary objective of the Mandatory Provident Fund

System is to provide retirement protection, the "side effects" to

financial market development are very significant. No doubt the

savings under the Mandatory Provident Fund will spur the further

development of Hong Kong's financial markets. For example,

there wi l l be a substantial increase in the demand for debt

instruments of larger issue sizes and longer term maturities. There

wil l also be demands for quality bonds meeting minimum

investment grade ratings given by well recognised rating agencies,

which wi l l , in turn, lead to more quality, rated issues. I should

imagine that this should give a substantial push to the Hong Kong

dollar debt market, given the attractiveness in terms of currency

matching of Hong Kong dollar denominated debt paper. Overall,

there wi l l be higher liquidity in the financial markets in Hong

Kong.

The Importance of Regional Co-operation H E

The Mandatory Provident Fund investment guidelines to be

prescribed will be flexible, as we are fully aware of the danger of

over-regulation. The guidelines will encourage diversification of

investments. In particular, they wil l allow non-Hong Kong

investments. Up to 100% of the Mandatory Provident Funds can

be invested in foreign currency assets, as long as there is

appropriate currency hedging to bring the foreign currency

exposure to within 70% of assets. The free inflow and outf low of

investment capital under the Mandatory Provident Fund System

will add much vibrancy and vitality to the financial services scene

in Hong Kong.

Moreover, there will be new opportunities for banks and other

institutions in their roles as trustees and custodians of Mandatory

Provident Fund assets. As the assets must be kept under trust,

separate from those of the sponsoring employer, and under safe

custody of qualified financial institutions, many banks and their

trust subsidiaries will stand to benefit f rom the new opportunities

arising from the introduction of the Mandatory Provident Fund

System.

Hong Kong: A n Integral Part of an Integrated Global

Market

The H-shares and Mandatory Provident Fund System experiences

serve to illustrate many of the basic tenets of Hong Kong's

philosophy towards the development of financial markets, including

perhaps most evidently our outward-looking approach in the face

of global integration. Such an integration entails risks, in particular

an increasing exposure to external fluctuations which the Barings

collapse and the Mexican peso crisis made abundantly clear.

The counter-measures to external risks lie with increased

external co-operation. We must continue to be outward-looking.

The Importance of Regional Co*operation

Bilaterally, Hong Kong's financial services supervisory authoritieshave enhanced co-operation with their counterparts, such as theconclusion of a number of repo agreements with central banks inthe region as well as memoranda of understanding. Multilaterally,Hong Kong has renewed and indeed reinforced our commitmentto the international financial community by actively participating inmany eminent organisations, including the Bank for InternationalSettlements when Hong Kong became a member last year; theInternational Organisation of Securities Commissions, or IOSCO,where Hong Kong continues to make considerable contribution,especially in the Asia-Pacific Regional Committee; and perhapsmost fitting for me to mention on this occasion, the InternationalMonetary Fund, where Hong Kong now participates in the NewArrangements to Borrow.

I can assure you that these worthy efforts to enhance regional andglobal collaboration will continue, as Hong Kong clearly recognisesthat it is in our interest to facilitate further integration with theregion and the world and at the same time to contribute activelyto international co-operation in financial intermediation.


S e s s i o n 4 :

T h e C h a l l e n g e s a n d

O p p o r t u n i t i e s f o r H o n g

K o n g o f G r o w i n g

R e g i o n a l I n t e g r a t i o n

( P a r t I I : T h e C h a l l e n g e s o f

G r e a t e r R e g i o n a l I n t e g r a t i o n )


Kunio Saito

Director, Regional Office for Asia and the Pacific


This session wil l address the same topic as the previous session,

namely the challenges and opportunities created by the increasing

regional economic and financial integration.

A t this session we look at the topic f rom the viewpoint of other

financial centres and from the region as a whole. We have

speakers f rom Australia, Japan and Singapore, as well as a staff

member f rom the Fund. This is one session where we don't have a

speaker f rom Hong Kong.


F A C T O R S I N F L U E N C I N G E A S T A S I A N P E R F O R M A N C E

David Borthwick

Deputy Secretary

Department of the Treasury

Australia

For two good reasons the wor ld has focused on the East Asian

experience. Firstly, the region's rapid economic growth has

created export and investment opportunit ies; and secondly, other

countries - developed and developing - have been curious to see

what "lessons" there are for their own situations.

Di f ferences and S im i la r i t i es

Notwithstanding the intense interest in the East Asian experience,

the situations of East Asian economies are markedly different in

some important respects.

* A key feature of the region is its diversity: in population,

resource endowments, and levels of development.

• And, although sometimes too much is made of the point, East

Asian countries have also pursued, to varying degrees,

alternative development paths: some, like Hong Kong, have

placed considerable emphasis on market disciplines; others,

while having a heavy market focus, have relied more on

government regulation and intervention to direct investment

But behind these key differences are far more important

similarities among the better economic performers of the region.

Factors Influencing East Asian Performance

There is no magic way of achieving solid economic performanceother than the steadfast application of fairly orthodox policies -albeit adapted to meet each country's circumstances. My premise,therefore, is that those countries who look to East Asia forinspiration will find plenty to draw upon but they will find nonovel solutions, only the tried and true.

Monetary policy, directed at keeping inflation low or, at least,at moderate and relatively stable levels.

Prudent fiscal policy, oriented toward ensuring that nationalexpenditures do not exceed national product such as to avoidinstability in the external accounts and, consistent with that,in a way which preferably contributes to national saving,rather than detracts from it.

• And policies across product and factor markets which areunambiguously directed toward facilitating growth, includinghigh rates of saving, flexible labour markets, competitiveproduct markets and high levels of investment in humancapital through education and training.

Measured in terms of these yardsticks, the East Asian economieshave been remarkably successful over a long run of years.

Whenever macroeconomic imbalances have threatened, decisiveaction has been taken; and microeconomic policies have beenconsistently directed at raising productivity.

Pressure Points

My purpose is not to catalogue the specific factors behind thepolicy successes; rather, in the time allotted, I want to touchupon, although hardly do justice to, some of the pressure pointsconfronting East Asian countries.

Factors Influencing East Asian Performance I B ]

Basically, my near-neighbour view is that what is required for the

success to continue is more of the same: macroeconomic stability

and policies to enhance growth. But to say that is easy; the task,

as policy makers know all too well, is formidable. Economies

never stand still and the policy challenges are constantly changing.

Success in one area can bring problems in another. Let me focus

on several inter-related elements which wil l continue to test these

economies.

Macroeconomic Stability

First, let me address factors that may impinge on macroeconomic

stability.

In an era when capital movement - sometimes driven by lemming-

like behaviour - can wreck the best laid plans, the hallmark of a

successful macroeconomic strategy is one that is directed toward

maintaining international investor confidence.

And in this regard, I cannot improve upon the findings of the

World Bank Policy Research Report1 which attr ibuted East Asian

macroeconomic success to

keeping budget deficits manageable;

• maintaining moderate to low inflation;

• keeping external debt under control ;

• keeping the exchange rate in line; and

responding quickly to macroeconomic shocks.

I. The International Bank for Reconstruction and Development, The East AsianMiracle, Economic Growth and Public Policy, Oxford University Press, 1993.


Impressive though the performance has been in these areas,

continued success cannot be taken for granted. Let me touch on

longer te rm pressures that may build to challenge fiscal policy and

those which, to varying degrees, are already affecting financial

markets.

Fiscal Pressures

Continued high rates of economic growth and rising living

standards are likely to lead to increased demands upon governments

in East Asia. So far most East Asian economies have held

government revenues and expenditures relatively constant as a

proport ion of GDP. Some have even strengthened their revenue

raising capacity.

Based on the success of the past twenty years, we should have

every confidence that East Asia wil l continue to manage fiscal

policy effectively. However, I have a sneaking suspicion that there

may come a point where the demand for government expenditures

- especially those oriented toward consumption and transfers -

will rise. Expenditures of this sort are, in effect, luxury goods the

demand for which rises wi th income. Such demands can be

difficult t o resist and, once embedded in national budgets, are

difficult t o control .

Taking a long-term view, therefore, the high levels of national

savings in East Asia should not be taken for granted. There wil l be

pressure on government saving. And, with greater affluence in the

private sector, consumption may increase at the expense of

saving. Thus, although East Asian economies can take great

comfort because of their high savings rate, this is an area of

strength that needs to be carefully watched and maintained.


Financial Markets

Despite high domestic savings, East Asian economies are heavily

reliant on capital inflows. International financial markets are very

efficient but they can be subject to market disturbances and the

total funds available are ultimately l imited. What may this mean?

First, a pick-up in growth and interest rates in the major capital

exporting countries could cut back the funds available for East

Asia in the short term. Secondly, increasing competit ion from

emerging "t igers" elsewhere could have a longer term impact.

It is in the interest of East Asian countries therefore - Hong Kong

and Singapore apart - to develop depth and diversity in their

financial markets. This in itself wil l build international confidence

in the integrity of the markets. It will also improve the efficiency

with which domestic savings are allocated between alternative

investment opportunities.

Another issue is how far countries wi th a heavy reliance on capital

inflows should be concerned about dependence on these flows

and their susceptibility to reversal.

To the extent that those capital inflows reflect direct and

firmly rooted investment that is sufficiently profitable to

cover servicing costs, and is associated directly or indirectly

with export-oriented output, there is little to wor ry about. In

these circumstances, upward pressure on the real exchange

rate should not be resisted; rather, it is the means of

translating capital flows into real and sustainable purchasing

power.

However, short-term portfol io flows can be more volatile and

are more problematic. To some extent, disturbances in these

flows that are expected to be of only limited duration may be


able to be ridden out - for example, through sterilised

intervention or through temporary regulatory or taxation

measures. But such measures can be difficult to sustain for

long, as markets tend to find their way around artificial

barriers. Any action therefore needs to be carefully tailored

to the circumstances of the particular disturbance and the

country concerned. And in the longer term, policies should

be pursued to help avoid the occurrence of disturbances. This

requires the provision of regular and full economic information

to markets, a sound structure to the financial system including

through adequate prudential supervision, and a stable

macroeconomic environment.

Experience shows that financial markets tend to give more leeway

when there is a record of credible macroeconomic policy, where

national savings are high and where the focus is on high quality

direct investment. This has been the predominant influence

throughout East Asia.

High Productivi ty G r o w t h

Whi le success will not come wi thout macroeconomic stability,

over the longer haul the success of all economies is dependent on

how productive they are. Let me turn, therefore, to the

importance of policies to unleash the supply side potential of

economies. This is an area where East Asian economies have

excelled. But this very success means that they have to jump

higher, o r at least, other hurdles.

Let me explain. Developing economies undergo rapid structural

change: f rom an initial emphasis on relatively labour-intensive

activities they become more capital-intensive; simple processes

change t o a greater focus on technology and innovation; just as

capital is upgraded, so i t is necessary to raise the stock of human

capital.

Factors Influencing East Asian Performance lEU

This is a well trodden path and in no small measure it contributesto the waves of growth spreading through East Asia. The continualuplifting of the industrial base, combined with macroeconomicstability, becomes a reinforcing tendency in each country withflow-on benefits for the region as a whole.

But as those waves of industrial change and industrial upgradingsweep through the region, there is a need to upgrade human andphysical capital. Much written about the East Asian success hasemphasised the importance of education. I was particularly struckby the far-sighted remarks by Dr Teh Kok Peng, Deputy ManagingDirector, Monetary Authority of Singapore, at an IMF/BankIndonesia Conference in Jakarta last year.

He compared Singapore's education credentials with the threeother East Asian tigers and remarked how his country needed todo better if they were not to fall behind in the longer term interms of competitive capacities. There is a lesson here for all ofus.

Apart from the need to advance skills levels, another area whereit is all too easy to fall behind is through failure to adequatelydevelop the potential of our cities and business districts - orinfrastructure more generally - which are so vital for nationaleconomic success. Hong Kong and Singapore in particular haveshown what can be done; they had little choice. Confronted bysmall land masses and little more than the skill of their people,they had no alternative but to make their city states a success.Again there are lessons here for the rest of us.

But the key to keeping on the high growth path is not toconcentrate excessively on any one area. What is required is tocontinually adapt and make changes across a very broad front. Ihave been struck by how some countries can get their


microeconomy so wrong for so long - a death by a thousand cuts

- before it dawns on them what the real source is of their

economic woes.

Let me conclude where I started. The economic touchstones to

fol low are straightforward. But making a success of economic

policy involves a lot of hard work and hard decisions and at the

political level.

Fortunately, the ingredients of success are being pursued around

the globe more widely than ever before. Global competion is

tough but i t is the means by which we all benefit. Thank you.


T O K Y O ' S " B I G B A N G " P L A N A N D I T S I M P L I C A T I O N S

F O R A S I A N F I N A N C I A L M A R K E T S

Yukio Yoshimura

Deputy Director-General

International Finance Bureau

Ministry of Finance, Japan

Mr Chairman, ladies and gentlemen. It is a great honour for me to

address this important Conference sponsored by the Hong Kong

Monetary Authori ty and the International Monetary Fund.

Today I would like to comment on the development of the

Japanese financial markets and their impact on other Asian

markets, including those of Hong Kong.

Towards Free, Fair and Global Markets

Because I relinquished my last assignment - as Deputy Director-

General of the International Finance Bureau at the Ministry of

Finance - at the end of last month, and because I still have some

time before I assume my next assignment, as Executive Director

for Japan at the IMF, which I will do on 16 March, I think I can take

the liberty of expressing my personal views here today, not

necessarily constrained by the official views of the Japanese

government Last November, Prime Minister Ryotaro Hashimoto

took the initiative of introducing the Tokyo Big Bang Plan. Mr

Hashimoto emphasised three key words in his proposal. Those

words are "free," "fair," and "global." The Tokyo Big Bang is an

extensive, well-structured plan for the Japanese financial markets

to realise truly free, fair, and global transactions in the market. It

is epoch-making, as the Prime Minister promised to complete this

Tokyo's "Big Bang" Plan and Its Implications for Asian Financial Markets

plan by the beginning of the year 2001, so as to make the Tokyo

market competitive with those of New York and London.

Now I wi l l explain the current status of the Japanese financial

markets. Whi le the Japanese government has been making steady

efforts t o liberalise our financial markets, especially since the

1980s, many regulations remain, such as the compartmentalisation

of each financial industry and of the banking and securities

businesses, and insurance, among others, as well as the fixed rate

commission on financial transactions. It is therefore difficult for

me to say at this moment that the Japanese markets are totally

free and fair.

Furthermore, because of certain regulations and market practices

in the Japanese financial markets, some popular transactions in the

major foreign markets cannot be executed with enough flexibility

in our markets. In this sense, some conditions in the Japanese

markets are not up to global standards.

Many observers have expressed concern about whether the

Japanese markets can go along with the trend of intermediation

and securitisation, as widely seen in the global financial markets.

I would now like to explain how adversely these regulations could

affect the development of the Japanese financial markets and the

economy. If these regulations should continue, financial activities

in Japan would gradually shift in the direction of freer foreign

markets. N o t only the regulations but also the tax system and the

accounting standards could be disadvantageous to the Japanese

financial markets in competing wi th other markets. This is a

syndrome often referred to as the hollowing out of the Japanese

financial markets.


In addition, the future development of the Japanese economy itself

could be undermined by the inflexible conditions of the financial

markets. Due to the high savings ratio in Japan, we have large

personal financial assets amounting to 1,200 tr i l l ion yen. However,

the compartmentalisation of each financial industry and the

comparatively low competition among them make the Japanese

market less efficient for managing these assets. As we are facing

very rapid aging of the population, and since the high savings ratio

will not be maintained in the future, I am concerned about the

efficiency of our asset management. If we can significantly improve

the level of asset management, the future of the Japanese

economy will become much brighter.

Implement ing in Stages

Let me now explain how we are going to implement this Big Bang

initiative. The spearhead of the initiative is the abolition of foreign

exchange controls. To be more concrete, the following changes

will become effective next spring if the Diet - our Parliament -

approves the amendment of the foreign exchange control law

during the current session.

First, prior permission or notification requirements on the cross-

border financial transactions wil l be abolished. Any companies or

individuals in Japan will be free to make financial transactions with

any counterparty in Hong Kong, in New York, or anywhere in the

world.

Second, the authorised foreign exchange bank system wil l be

abolished, and foreign exchange transactions wil l not be limited to

banks but open to securities companies, trading companies, and

other companies and individuals.


Then, the next stage of the Big Bang - the reform of capital

markets - wil l begin. One of its main aspects will be the

liberalisation of the fixed commission on securities transactions.

As you may know, this was one of the major issues in the

deregulation process in the United States and the United

Kingdom. The removal of the ban on holding companies in Japan is

also a subject of heated discussion now. Depending on the results

of this ongoing discussion, we may see a new legal framework

whereby a holding company could own various types of financial

organisations, including banks, securities companies, insurance

companies, etc.

Last but not least, the adjustment of the legal, accounting and tax

systems to be in line with global standards will be explored.

Concerns Expressed

Since the Prime Minister's announcement, I have heard a number

of concerns or criticisms about this Tokyo Big Bang plan. Some

concerns commonly voiced are the following: first, that the pace

of implementing the plan is too slow. Second, that the reform plan

wil l not be sufficiently implemented because of the lack of resolve

on the part of both the authorities and the financial institutions.

Third, that Japanese financial institutions may not survive after the

painful process of extensive deregulation and, fourth, that since

other Asian financial markets are now benefiting f rom the shift in

transactions f rom the Japanese markets, the activation of the

Japanese market could mean less transactions left for other Asian

markets.

I would now like to comment on these concerns one by one.

First, on the pace of implementing the Big Bang, I am sure that

today's audience - after listening to my explanation - wil l no

longer have these concerns. The Tokyo Big Bang is a very


ambitious plan. It covers various financial institutions, as well as

legal and accounting issues. Its scope is therefore larger than was

true of the original Big Bang, implemented in the United Kingdom

in the mid«80s, which was limited to the liberalisation of the

securities business. Furthermore, all necessary measures will be

taken by the beginning of the year 2001. We have only three years

and ten months until then.

Second, concerning our resolve to implement this initiative, I

would like to point out that the momentum for reform is very

high, on the part of both the authorities and the private financial

institutions in Japan. This is because the abolition of foreign

exchange controls will have a great impact on the Japanese

markets over time, since companies and individuals in Japan will be

able to make financial transactions directly wi th foreign financial

institutions. If the Japanese financial institutions do not improve

their efficiency, they could lose in international competit ion with

financial institutions abroad. Therefore, to be competitive, we,

both the authorities and private institutions, have no choice but to

implement the extensive deregulation measures affecting domestic

financial markets following the abolition of foreign exchange

controls.

Third, regarding Japanese financial institutions, there is no doubt

that they will face great challenges as a result of this initiative.

Many people expect further consolidation of our financial industries.

As I have already mentioned, foreign financial institutions might

get a larger market share of our domestic markets if Japanese

institutions do not improve their efficiency. However, it wil l still

be beneficial to our economy insofar as it contributes to job

creation and increases domestic incomes. Furthermore, consumers

wil l benefit f rom more efficient financial markets in Japan.


On the other hand, I firmly believe that some Japanese financial

institutions wil l remain very important international players no

matter how severe future competit ion will be. Some competitive

financial institutions in Japan have already overcome the problem

of non-performing loans, and they are prepared to play a key role

in international financial markets.

Finally, I would like to touch on the relationship between Japanese

markets and other Asian markets. In Asia, each market has its

own advantage in the region. Hong Kong has an advantage in

relation t o China. Singapore has an advantage in relation to

ASEAN countries. If the Tokyo market is revitalised, it wil l

certainly promote the activities of Asian markets and countries as

a whole. In this sense, I believe that the roles of the Tokyo market

and of other Asian markets are complementary, and other Asian

markets wil l also benefit f rom the Tokyo Big Bang. However, it

goes wi thout saying that co-operation among the Asian authorities

is vital. W e have been exchanging views with the authorities of

three other Asia-Pacific countries for five years now. They are:

Hong Kong, Singapore, and Australia. This year the United States

and China also participated in the Four Markets Meeting, and we

have just arranged a new Six Markets Meeting in Tokyo. I firmly

believe that this new arrangement will make co-operative

relationships between the Tokyo market and other Asian markets

even stronger. Thank you.


E C O N O M I C A N D F I N A N C I A L I N T E G R A T I O N

S I N G A P O R E ' S P E R S P E C T I V E

Khor Hoe-Ee

Deputy Director and Advisor

Economics Department

Monetary Authority of Singapore

Singapore and Hong Kong have a lot in common. They were both

colonised by Britain in the 19th century and have since prospered

as trading ports because of their strategic geographical location.

They have also developed into major regional hubs and financial

centres and have become focal points of global economic

integration.

There are also some major differences between Singapore and

Hong Kong. Hong Kong is known for its laissez-faire policy of

minimal government intervention and regulation. Singapore, on

the other hand, has played a more proactive role in fostering an

environment that is conducive to doing business.

Economic Integration

In our view, the process of economic integration has been ongoing

for about two centuries now, at least since the establishment of

Singapore as a Southeast Asian trading post in 1819 by the British

East India Company. The process has evolved over t ime and, in

the last decade, appears to have accelerated and deepened,

particularly in the East Asian region.

Rising intraregional investment and trade bear testament to this.

Trade among the countries of East Asia has been rising much

Economic and Financial Integration ~ Singapore's Perspective

faster than trade with the outside wor ld. Intra-regional trade

made up 37% of the region's total wor ld trade in 1985, but has

since risen to 50% in 1995. W i th regard to foreign investments,

intra-regional Foreign Direct Investment (FDI) stock among East

Asia economies (excluding Japan) rose from 25% of total FDI

stock in 1980 to 37% in I993.1

An integrated production network has emerged in the region with

Japan playing a lead role. Japanese FDI flows into the region in the

aftermath of the Plaza Accord was systematic and took advantage

of the differing levels of development among the economies in the

region to create a regional division of labour. In what has been

described as the "flying geese paradigm", f irst-t ier Newly

Industrialised Economies (NIEs) such as Taiwan, Hong Kong,

Singapore and South Korea, which industrialised after Japan, have

themselves become major investors in the region. They have been

followed by countries like Malaysia and Thailand in recent years. In

the process, the linkages among the different countries have

helped transmit development f rom country to country.

Rapid growth in the region has led to labour shortages in some of

the countries. As a result, labour mobility within Asia has risen in

recent years. Whi le the labour market is far f rom being

integrated, there are now large numbers of foreign workers in

some of the countries in the region including Singapore, Malaysia

and Hong Kong. It is estimated that there are about 13 million

migrant workers in Asia.

1 See World Investment Report 1995, United Nations.2 In 1992, first-tier NIEs made up one-quarter of the FDI stock in ASEAN-4,

comparable to Japan's share. In China, share of first-tier NIEs in FDI stock was71% compared with Japan's share of 8.4% and US's share of 8.5%. See Trade andDevelopment Report 1996, United Nations.

Economic and Financial Integration — Singapore's Perspective

Perhaps the most notable aspect of economic integration is the

large inflows of portfol io capital into the region and the

globalisation of financial markets. Here Singapore and Hong Kong

have played pivotal roles in financial intermediation (See Table I).

Thus, about half of all loans extended by banks in industrialised

countries to Asia was done through Singapore and Hong Kong

banks.3 Singapore and Hong Kong have also developed into major

centres for forex trading in Asia.

Table I

H o w

International issues

Equity/equity-linked

Straight bonds

Syndicated loans/

FRNs**

FRCDs***

Direct Investment

Other capital flows

Total

the capital f lowed intoi

1990

0.8

I.I

36.5

1.2

16.2

16.5

72.3

(US$bn)

1991

1.7

1.3

34

0.4

18.5

29.5

85.4

1992

2.5

3.6

37.9

I.I

23.5

19.8

88.4

Asia*

1993

6.1

10.7

52.6

2.4

42.6

18.0

132.4

1994

13.9

9.8

72.7

5.4

47.3

26.6

175.7

1995

5.8

11.6

81.5

7.9

NA

NA

-

Source: Data compiled by Citicorp, published in Financial Times 29 April 1996.

* All figures excluding India, Pakistan and Japan** Floating rate notes*** Floating rate certificates of deposit

3 See Nikkei Weekly, 18 December 1996.

Economic and Financial Integration - Singapore's Perspective

Opportuni t ies of Economic Integration

The opportunities of greater regional integration are obvious as

manifested in the growing prosperity of the region. Indeed,

Singapore and Hong Kong would not be where they are

otherwise.

Despite the cyclical slowdown in 1995, the region still promises

better growth than other parts of the wor ld in the medium to

long te rm. East Asian growth (excluding Japan) is projected to

average about 7% in the first decade of the 21st century. The pie

is big and expanding and there is more than enough for both

Singapore and Hong Kong and other up and coming economies to

partake in this prosperity.

In spite of being rivals, Singapore and Hong Kong's financial

services have tended to complement each other. Singapore has

developed a niche market in foreign exchange and futures trading,

while Hong Kong's traditional strength is in fund management and

loan syndication.4 (See Table 2).

Singapore and Hong Kong serve different geographic markets.

Hong Kong is a natural gateway to China's huge and growing

market of L2 billion consumers, both geographically and culturally.

Hong Kong provides a business environment that is familiar to the

West and hence acts as a bridge to China.

Singapore has the fourth largest foreign exchange market in the world whileHong Kong has the fifth largest. On the other hand, funds under management inHong Kong is about eight times that managed in Singapore. Of syndicate loansarranged in the Singapore, Hong Kong and Tokyo markets in 1993, Hong Konghandled 64%, Singapore 24% and Tokyo 12%.


Table 2

Relative position of banking assets, equity and bonds

Foreign

exchange

average

Stock market Futures daily

Bank assets Bond market capitalisation turnover turnover

(1994) (1994) (1996) (1996) (1996)

US$bn X of GDP US$bn % of GDP US$bn X of GDP (contracts) (US$bn)

278 5,749,955 90Hong KongAT \Ur\tf*n*or wnicn.

GovernmentPrivate

Singapore

of which:

Government

Private

257

IIS

195

186

19,8

(W)(13.0)

44.8

(42.3)

(2.5)

15.1

(5.2)

(9.9)

60.5

(57.1)

(3.4)

449 271

165 17-174 22,568,545 131

Sources: Official national sources; and Financial Times 29 April 1996.

Singapore, on the other hand, is a regional hub for Southeast Asia,which in aggregate, has an economy almost as big as China andexpanding just as rapidly.5 Singapore has some natural advantagesthat Hong Kong does not have in doing business in the region,such as proximity and indigenous knowledge of the region.

5 GDP of the ASEAN-6 amounted to US$620 bn in 1995, compared with US$698bn for China.


Wi th economic integration, Singapore will be better able to

leverage on its limited domestic land and labour resources. On

this score, the Singapore government has been at the forefront of

a regionalisation drive to invest our surplus savings in the region

to earn higher returns. Singapore is the second largest investor in

Thailand and Brunei, the fifth largest in China and sixth in

Indonesia and Vietnam.

Challenges of Economic Integrat ion

Economic integration also poses challenges. Some of these have

been highlighted by the Fund staff in their background papers and

by other speakers. I wil l just highlight some key aspects here.

W i t h economic integration, the environment has become

significantly more competitive, making it necessary for countries

to constantly restructure and upgrade in order to remain

competitive. Fortunately, countries in the region are at different

stages of development which has facilitated the restructuring

process.

Economic integration leads to a greater interdependence among

the economies in the region. This has made countries more

susceptible to spillover effects f rom their neighbours. Adverse

economic developments in some countries within the region will

have a greater impact on economic prospects of other countries

in the region. For instance, Hong Kong's business cycle is now

more closely influenced by that of China because of its close

integration wi th China's economy. In this respect, there is a need

for closer consultations and dialogues among countries in the

region.

Macroeconomic management is also being challenged by the

greater integration of financial markets. Policy makers now need

Economic and Financial Integration - Singapore1 s Perspective

to take into account market sentiments, which tend to be fickle, in

conducting macroeconomic policy. Countries, especially those

with relatively open capital accounts, are now susceptible to

major shifts in capital flows, which can precipitate a financial crisis.

Hong Kong's Economic Prospects

In about four months' time, Hong Kong wil l revert to Chinese

rule. Much of the political risks in the handover have been

discounted; instead, market and investors are increasingly

emphasising the opportunities in the post transition period.

Singapore is optimistic on Hong Kong's economic prospects. We

feel that 1997 will only be a marker, albeit one of great symbolic

importance. Since the opening up of China in 1978, Hong Kong's

economy has become closely integrated wi th the booming

Guangdong province.

Singapore's optimism is reflected in our growing investments in

Hong Kong. The Government of Singapore Investment Corporation

(GIC), for example, has invested and is continuing to invest in

Hong Kong. Singaporean investors have joined Hong Kong

developers to build office and shopping complexes at several new

stations of the MTR to the new airport.6 To date, Singapore's

outstanding investments in Hong Kong stand at S$7 billion, up

from S$400 million in I984.7

Singapore companies have been increasingly active in Hong Kong's propertymarket. Hong Leong tied up with GIC to buy an 80% stake in Hong Kong*s JWMarriot. Hong Leong and GIC are also part of a consortium that won a tender todevelop a HK$9 billion property project next to a station along Hong Kong'sproposed airport railway line."Multinational marriages for HK", business Times, 13 January 1997.


Other countries share our sentiments as reflected in the rising

foreign direct investments in Hong Kong. According to a recent

survey, the number of regional headquarters and regional offices

has increased by 12% in the year to June 1996, with the US and

Japan leading the pack. In 1995, the value of external investments

in manufacturing increased by 10% over the previous year.

Compared against 1984, it has quadrupled.8

From Singapore's perspective, Hong Kong wil l continue to play an

important role as a gateway to China. Of course, other centres,

such as Shanghai, will emerge and compete with Hong Kong. This

is a healthy competit ion as China is large enough to accommodate

two "hong kongs". However, Shanghai and Hong Kong will also

complement each other. Shanghai, the gateway to developments,

along the Yangtze River Delta, wil l function as China's domestic

hub while Hong Kong will remain a regional financial centre.

Value of external investment totalled HK$48 billion at original cost at the end of1995, a 10% growth over that of 1994. This is based on a survey conducted byHong Kong's Industry Department (See Business Times, 6 December 1996).


P O L I C Y C H A L L E N G E S F R O M I N C R E A S E D G L O B A L A N D

R E G I O N A L I N T E G R A T I O N

David Goldsbrough

Senior Advisor, Asia and Pacific Department


I would like to focus my remarks today on some of the challenges

for economic policy stemming from increased global and regional

integration.

The pace of globalisation in Asia and the wor ld economy has

quickened considerably over the past decade. Trade has increased

nearly twice as fast as GDP. Net private capital flows to

developing countries have increased about sixfold, reaching almost

US$200 billion in 1996, with about half going to Asia. And

opportunities for more rapid integration lie ahead, driven not just

by trade and financial liberalisation in individual economies but,

more fundamentally, by technological advances that continue to

shrink the economic distances between national markets. This

deepening of trade and financial linkages offers great opportunities

for a dramatic improvement in living standards, as the experience

of Hong Kong and the other advanced Asian Newly Industrialised

Economies (NIEs) - Korea, Singapore, and Taiwan — has already

shown. As a group, these four economies increased their per

capita incomes from 18% of the average industrial country level in

1965 to 66% in 1995. Hong Kong and Singapore now have living

standards that are higher than many of the " o l d " industrial

countries. More generally, Asia is the only major developing region

to have made significant relative progress, in the sense of having

achieved a marked "catching up" wi th industrial country living

standards.

Policy Challenges from Increased Global and Regional Integration

Growth-friendly Policies

So, the benefits can be enormous for those countries that alignthemselves with the forces of globalisation by liberalising marketsand pursuing sound macroeconomic policies. Is there a "one sizefits all" policy prescription that will ensure faster growth in therapidly integrating world economy? Obviously not. Even thesuccessful economies of East Asia have pursued policies thatdiffered in some important respects. But there is by nowsubstantial evidence, including from research done in the IMF,World Bank, and elsewhere, that there are importantcomplementarities between growth-friendly policies; it is not justone type of policy - say, conservative financial policies, or heavyinvestment in human capital - but rather a comprehensive set ofpolicies and reforms that are mutually reinforcing. The InterimCommittee in its September 1996 "Declaration on Partnership forSustainable Global Growth" set out such a range of policyprinciples. While there is no need to repeat here the full list -often referred to as the "Eleven Commandments" - theyemphasise the importance of sound macroeconomic policies thatyield lower inflation, strengthen fiscal discipline and budgetarytransparency, and improve the quality of fiscal adjustment; fosterfinancial and exchange rate stability and avoid currencymisalignments; maintain the impetus toward trade liberalisation;press ahead with labour and product market reform; ensure thesoundness of banking systems; and, last but not least, promotegood governance in all its aspects. This is quite a long list, but oneach point it is evident that Hong Kong scores highly. So, there isno great secret to its record of sustained strong economicgrowth. And the fact that many of these principles are firmlyembedded in the Joint Declaration and the Basic Law givesconfidence in Hong Kong's continued economic success.


At the same t ime that it enhances the potential rewards from

good policies, the increased globalisation of markets increases the

costs of economic distortions and imbalances. Let me give a few

examples:

• In an increasingly integrated wor ld , unsound macroeconomic

policies wil l be more costly because the resulting instability

wil l drive savers to seek safer havens and greater uncertainty

wil l influence some investments to be located elsewhere.

• Distort ing trade and investment incentives to encourage

favoured industries that would not develop under more

competitive conditions is likely to be even more harmful to

growth because it is especially important not to misalign price

signals in a wor ld of open trade and capital f lows. In this

regard, Hong Kong's noninterventionist policies have served

it particularly well and should be continued. It is important to

recognise that the marked decline in the share of manufacturing

employment - a trend that has been even more dramatic in

Hong Kong than in other advanced economies - is a normal

feature of economic development, primarily reflecting different

rates of productivity growth in manufacturing and services,

and is typically associated wi th rising living standards. But it

does indicate that maintaining dynamism and flexibility in a

service economy will be the critical test for future prosperity,

in Hong Kong as in other advanced economies.

• In many respects, labour market flexibility wil l be critical to

how successfully an economy deals wi th the challenges of

globalisation. This may seem strange at f irst sight, since labour

markets remain the least integrated segment of the global

economy. But as capital markets become more integrated,

risk-adjusted rates of return increasingly match " w o r l d " rates.

This means that the labour market must absorb more of the


impact of any shocks to the economy. If structural rigidities in

the labour market hamper the necessary adjustments to

wages, the result wil l be higher unemployment - as we have

seen in Europe. Rather than attempting to limit globalisation,

the appropriate policy response - which Hong Kong has

clearly adopted - is instead to address the underlying

structural rigidities that prevent labour markets from adjusting

to external shocks or technological change. In this respect,

education and training have important roles to play, in Hong

Kong and elsewhere.

Contagion Effects

Another consequence of highly integrated financial markets is that

shocks which occur in one market may be quickly transmitted to

other markets. Such contagion effects have so far been largely

confined to specific markets. Shocks to asset prices in one

country - the stock market, for example — have at times spread

quickly t o similar assets in other countries. But, generally, they

have not spilled over into other asset markets, thus limiting the

systemic consequences. The most likely channel for such a

spillover would be through a weak and inadequately supervised

banking system. To minimise the risks of larger spillover effects, as

banks become increasingly exposed, directly or indirectly, to

shocks originating in other countries, supervisors wil l find it

increasingly necessary to apply, on a global basis, a common

minimum set of prudential standards and supervisory guidelines. In

this respect, Hong Kong and Singapore have already adopted

improvements similar to those implemented in the Group of Ten

countries. Moreover, the agreements between the HKMA and the

People's Bank of China, setting out clear principles for the

regulatory treatment of Chinese financial institutions in Hong


Kong on the same terms as foreign institutions, provide a good

basis for dealing wi th such cross-border supervision issues within

a transparent statutory framework.

Finally, let me say a few words about why the availability of timely

and accurate information is so crucial in a wor ld of highly

integrated financial markets. We all know that markets react

negatively to uncertainty. A number of studies have shown that

"herding" behavior - where countries wi th very heterogenous

fundamentals are indiscriminately grouped together by investors -

may play an important role in some asset markets. The "tequila"

effect following the Mexico crisis is but one recent example.

Governments can help reduce the risks of such contagion effects

by providing more timely and accurate information that wil l help

market participants to assess countries on a more individual basis.

In this regard, the Hong Kong authorities have taken some

important and commendable steps t o improve public access to

economic data, including the enhancement of disclosure

requirements to cover commercial banks' inner reserves and

subscription to the IMF's Special Data Dissemination Standard.

The recent decision to publish data on foreign exchange reserves

on a monthly basis is an important step toward meeting that

standard.


C l o s i n g S e s s i o n


Joseph C K Yam

Chief Executive


Good afternoon, ladies and gentlemen,

After a very full day of thought-provoking speeches by many

distinguished speakers on the subject of "Financial Integration in

Asia and the Role of Hong Kong", we now come to the closing

session of today's Conference.

I have certainly found today's discussion enlightening and I am

sure you feel the same, too. In his keynote this morning, Mr

Camdessus has systematically set the scene for the discussions in

the main session of this Conference and he is going to draw

conclusion for us. But before I ask Mr Camdessus to speak again,

may I take this opportunity to thank all those who have so kindly

expressed their support for Hong Kong in this Conference.

Indeed, Hong Kong as an international financial centre, has an

important role to play in financial integration and more specifically

financial intermediation in Asia.

We have been actively promoting more effective financial

intermediation in this region both domestically and internationally

and in the prudent management of the risks arising therefrom. We

have been putting forward ideas to central banks in this region,

calling for greater co-operation in a number of areas, including the

provision of liquidity in macro-monetary management to cope

wi th the volatil ity of capital flows.


Another area of co-operation is the formation of an Asian

Monetary Ne twork of payment, clearing and settlement systems

for money and securities in order to enhance the robustness of

financial infrastructure in this region. Harmonisation of supervisory

and regulatory standards respectively for banks and financial

markets wil l also uphold the integrity of financial intermediaries.

It seems clear f rom the discussions today that we have been doing

the right things here in Hong Kong. Thank you also for your

confidence in Hong Kong's future under the "one country, two

systems" concept, in particular your confidence in the monetary

arrangements for Hong Kong after the resumption of sovereignty

over Hong Kong by China on I July 1997, which is a hundred and

fifteen days and seven hours away. Under these arrangements

there will be "one country, two currencies, two monetary systems

and two monetary authorities" which are to be mutually

independent. These arrangements are admittedly new but definitely

not as novel and complex as EMU with one currency for many

countries.

In any case, we are merely maintaining the status quo. They are

entirely suitable and essential for the situation of Hong Kong and

they will work.


C O N C L U D I N G R E M A R K S

Michel Camdessus

Managing Director


Mr Chairman, Mr Chief Executive, ladies and gentlemen. First, let

me thank the Hong Kong authorities, and Mr Joseph Yam, in

particular, for co-hosting this Conference and for the excellent

arrangements.

To provide you wi th concluding remarks of the Conference is, in

fact, a very easy task since we have had today a striking

convergence of views on the central themes.

As I said in my remarks this morning, the issues we have discussed

today are part of a broader process of globalisation - the rapid

integration of economies through trade, financial flows, technology

spillovers, and more rapid availability of information. As Minister

Anwar stressed this morning, Asia's success in harnessing the

process of globalisation has instilled the people of the region with

renewed confidence. Overall, there is no doubt globalisation is

contributing enormously to global prosperity. But its benefits do

not come automatically. They require good policies. Let me briefly

summarise what those policy requirements are and how, as

today's discussion has illustrated, Hong Kong's policy framework

makes it so well positioned to benefit from globalisation in the

decades ahead.

Sound Policy F ramework

The first requirement is stable macroeconomic policies and the

absence of major market distortions. Globalisation is likely to

Concluding Remarks

greatly increase the cost of imbalances, and financial markets will

be ever quicker to impose their own discipline. In this respect, the

policy framework in Hong Kong - now and after the transition of

sovereignty - could hardly be better. Governor Patten and

Chancellor Clarke made these points eloquently in their opening

remarks, and Governor Dai has stressed the continuity of the

rules-based macroeconomic framework under the "one country,

two systems*' approach.

As the Financial Secretary has said, Hong Kong has already

practised for many years the "Eleven Commandments" of sound

economic policies drawn up by the Interim Committee in its

September 1996 "Declaration on Partnership for Sustainable

Global Growth" . And this will not change after I July: prudent

budgetary principles, the free flow of trade and capital, a well-

justified and soundly supported exchange rate link to the US

dollar as the anchor and principle objective of monetary policy. All

these critical elements will continue and give me great confidence

in Hong Kong's future.

Flexible Product and Factor Markets

The second requirement to achieving the full benefits ofglobalisation is flexible product and factor markets, a pointemphasised by Mr Borthwick this afternoon. Here Hong Kong hasmuch to teach other advanced economies about coping with thechallenges of a post-industrial economy. One of the principalsymptoms of this is so-called deindustrialisation - the decliningshare of the labour force engaged in manufacturing - is, despitepopular misconceptions, a sign of economic success. It should notbe a cause for concern and certainly not a reason to pursue anindustrial policy that favours certain economic activities overothers. But, with the shift to an economy based on trade, financial,and other services, maintaining the economic success that has

Concluding Remarks

given Hong Kong's population its high standard of living will

require policies that enhance competitiveness in the nontraded

sectors. This is a challenge Hong Kong has already met wi th more

success than most advanced economies, as witnessed by its low

unemployment rate. But continued deregulation wil l be needed to

maintain a dynamic and flexible service economy. Moreover, for a

major financial centre like Hong Kong, the free flow of information

is especially important. So the steps taken by the Hong Kong

Monetary Author i ty to promote transparency about both the

underlying strength of the financial system and the supervisory

framework are to be greatly commended.

Regional and International Co-operation

Let me make one final point. More globalised economies increase

the importance of regional and international co-operation. There

are many reasons for this and we have discussed a number of

aspects of such co-operation today. And Mr Yoshimura has noted

in the afternoon session, as I did this morning, that we can look

forward in the next few years to a major transformation of

Tokyo's role as an international financial centre as its "Big Bang"

proceeds. One central message from all these developments is

that the growing interdependence of financial markets along with

continuing extensive financial innovation will increasingly demand

a broad, multilateral approach to maintaining a sound and efficient

international financial system. And, as Mr Corrigan has emphasised,

a critical element of this process wil l be to build the necessary

expertise and quality of supervision, which is the bedrock on

which effective oversight of financial systems is based. Of course,

as Minister Anwar has emphasised, co-operation does not mean

the loss of independence - as the sound arrangements for the

continuation of two mutually independent monetary institutions in

Hong Kong and mainland China described today by Mr Joseph Yam

and Mr Chen Yuan illustrate so well. Indeed, the pragmatic and

Concluding Remarks

far-sighted approach to the organisation of economic management

during and after the transition of sovereignty that has been shown

by the Chinese, Hong Kong, and United Kingdom authorities is yet

another reason why I have such great confidence in Hong Kong's

future. Thank you.

Concluding Remarks

C L O S I N G R E M A R K S

Tung Chee-hwa

Chief Executive

Hong Kong Special Administrative Region

Mr Camdessus, distinguished guests, ladies and gentlemen,

I am very honoured to be speaking at this closing session of the

joint HKMA-IMF Conference on "Financial Integration in Asia and

the Role of Hong Kong". Many experts have spoken today. There

is not much I can add to their views on the subject of regional

financial integration, but I wish to share with you my thoughts

about Hong Kong at present and in the future.

Stability and Continuity

In slightly more than 100 days, on 1 July, Hong Kong will return toChina. It is a proud moment for Hong Kong, for China and indeedfor all Chinese people, as we close the chapter on more than 150years of colonial rule. We shall become masters of our ownhouse. In historic term, this is a momentous change. But changesneed to be managed to ensure smooth transition and prosperityfor years to come. Our emphasis is on stability and on continuity.

The Sino-British Joint Declaration and the Basic Law give us theframework for stability and continuity. Under the concept of "OneCountry, Two Systems", Hong Kong will continue in the waywhich we have come to know. The Basic Law has gone a long wayto set out the constitutional basis for stability and continuity; andto preserve the systems which underpin Hong Kong's success.

Closing Remarks

Hong Kong has enjoyed uninterrupted economic growth fordecades. We have achieved this through low taxes, unfetteredmarket forces and free flow of capital and information. Theterritory is now a major economic powerhouse, bringing Asiacloser together through trade and investment. Hong Kong hasgrown into a mature international financial centre, built on astrong currency, robust banking and equity markets, a level playingfield for all and a sound regulatory framework which meetsinternational standards of market supervision.

Article 109 of the Basic Law requires the Government of theHong Kong Special Administrative Region (HKSAR) to provide theeconomic and legal environment for Hong Kong to remain as aninternational financial centre. As Chief Executive of the HKSAR, Ipledge that I will uphold this continuity.

For those of you who are not familiar with the Basic Law, let mequickly highlight the key elements of this continuity which may beof interest to you - the Hong Kong dollar will continue to remainfully convertible, fully backed by the substantial Exchange Fundreserves, and the linked exchange rate system will continue. TheHKSAR Government will continue to pursue strict fiscal discipline.The Exchange Fund will be managed and controlled by the HKSARGovernment and will be used primarily for regulating the value ofthe Hong Kong dollar.

Co-operation

Continuity and stability are necessary but not sufficient guaranteeof future success. Hong Kong's success, China's success and Asia'ssuccess depend on co-operation from all. As a start, we must co-operate to ensure the prosperity of Asia. In so doing, there willbe benefit for all to share within the region. We must commitourselves to a free market economy where government involvement

Closing Remarks

is kept to the minimum. We must work together to provide a

pro-business environment where healthy and free competit ion can

flourish.

Wi th in our community of Asian economies, we must seek to

forge co-operation through dialogue and understanding. Much of

our economy is intertwined with Mainland China. As Hong Kong

becomes the Special Administrative Region of China on I July

1997, this relationship will be further strengthened. A t the same

time, we will continue to develop mutual trust and co-operation

with our friends in Asia. China's prosperity is Hong Kong's

prosperity. Indeed, Asia's prosperity is Hong Kong's prosperity. As

an international financial centre and a service-based economy, that

is our future, and that is our challenge. As soon as possible, I hope

to be able to visit our neighbours in Asia to extend my hand in

friendship and co-operation.

How should we proceed to build a prosperous Asia together?

Development of a sound infrastructure is a major task for co-

operation within the region. First, we must work together to build

the financial markets that wil l finance our growth in a safe and

stable manner. These will include the provident funds that provide

for our ageing population, as well as the bond markets that ensure

long te rm infrastructure will be funded by long term savings. To

better ensure that the financial instruments yield their intended

purposes, we must develop high international standards of

financial market regulation and surveillance, the importance of

which has been eloquently spelled out by Mr Camdessus.

Second, we must ensure that the financial infrastructure, such as

the payment and clearing systems, is working efficiently and

robustly in a sound network, linking not only the region but also

internationally. Hong Kong is prepared to work closely wi th all

Closing Remarks

our neighbours to build strong regional and international markets.

We have to ensure that shocks emanating f rom outside the region

will not constitute a threat to our own markets.

Third, as a demonstration of our effort to co-operate, Hong Kong

has worked closely within the Asian Development Bank, Asia-

Pacific Economic Co-operation, Wor ld Trade Organisation and

central banking forums to promote regional growth and financial

stability. The Hong Kong Monetary Author i ty has helped initiate

bilateral repurchase agreements wi th nine central banks in the

region and has also joined, together wi th China, Korea and

Singapore, the Bank for International Settlements to further

monetary co-operation. The HKMA is also one of the participants

in the IMF-managed New Arrangements to Borrow, whose aim is

to help prevent international financial crises. We fully support the

efforts of Mr Camdessus and the IMF in this area. And I can assure

you that the HKSAR Government that I wil l lead wil l continue to

support any measure that enhances closer regional and international

financial co-operation.

Challenge

I am confident and optimistic about Hong Kong's future way into

the 21st century but I am also conscious of the tremendous

challenges ahead. Let me now take up some of the challenges. As

we all know, growth and prosperity cannot be taken for granted.

In a competitive environment, we wil l be left behind simply staying

where we are. The knowledge-based society and the information

technology revolution that is taking place in America and

elsewhere has totally changed the way we do business. In order to

maintain our long term competitiveness which is essential for our

economic vitality, we have to provide the right education and skill

for our entire population particularly for our youth.

Closing Remarks

Hong Kong's prosperity was built on the sheer hard w o r k of our

people. As more and more of our youth enter the job market, and

more and more of our older workers retire, Hong Kong is facing

the same challenges that are facing the Organisation for Economic

Co-operation and Development countries. In order to meet these

challenges, Hong Kong needs to provide adequate safety net for

those who are aged and less fortunate. In this respect, although

somewhat late, Hong Kong is working on a Mandatory Provident

Fund.

A t this historic juncture in Hong Kong, it is important that we

renew our commitment to the traditional Chinese values which

have been with us for thousands of years. A t the same time, we

need to reaffirm our commitment to preserve the rule of law and

life style. In this way, we can create a social fabric that combines

the best of the east and the west. And this wil l make our society

strong and cohesive.

To ensure sustained and stable growth, we, in Hong Kong, must

also ensure that our people are proud to be a part of the

community. This means that we have to provide them with decent

standards of living, such as adequate housing and a clean

environment, and a satisfying way of life, with cultural stimulation,

and personal freedoms. How do we achieve this in a changing

environment and within strict budgetary discipline, will be one of

the greatest challenges of the HKSAR Government. I sincerely

hope that you, the IMF and our neighbours, will continue to offer

your views and advice to us on these important issues.

Confidence

In slightly more than 100 days, Hong Kong wil l return to China. I

wish to take this opportunity to impress upon you of my

confidence that the transition will be smooth and that Hong

Closing Remarks

Kong's prosperity and way of life wil l be preserved well into the

21st century. I do not want to undermine the magnitude of the

challenges, but my confidence is based on the following:

i) There is tremendous commitment of the senior leadership in

Beijing to the "One Country, Two Systems" concept and to

uphold the Basic Law. I have always believed in this

commitment. This has been reaffirmed in both words and

deeds during the two and a half months since I became the

Chief Executive.

ii) Hong Kong's success has been, as a result of a free and

compet i t ive economic env i ronment which features a

conservative fiscal policy, a simple tax system, low tax rates,

the rule of law, free enterprise, free trade, minimal corruption

and bureaucracy and a level playing field, provided and

supported by an efficient civil service.

Furthermore, Hong Kong has been successful because of the

commitment of its people. We are the most entrepreneurial

people in the wor ld - always adaptable to new economic

conditions, ready for changing competit ive realities and quick

to seize new opportunities and take on new challenges as

they arise.

There is tremendous determination by the people of Hong

Kong for the "One Country, Two Systems" to become a

reality and that the return of Hong Kong to China a great

success. The latest poll shows the confidence level of the

people in Hong Kong and the international community who

has investment in Hong Kong has never been higher,

iii) I also want t o assure everyone of the commitment of the SAR

Government under my leadership to uphold the "One

Closing Remarks

Country, Two Systems" concept and the Basic Law and itsproper application after I July 1997.

When we begin the 21st century, i am confident andexpecting to see Hong Kong

• as a stable, equitable, compassionate and democratic

society wi th clarity of direction and unity of purpose and

based on equal opportunities and fair competition.

• wi th an increasingly affluent and well-educated population,

proud of our new identity, proud of our Chinese

heritage, confident in our destiny and global in our

outlook.

• as a truly international and cosmopolitan city taking

advantage of its Asian location and global perspective to

capitalise on a wor ld of opportunities.

• in co-operation with the rest of Asia, will continue to

develop its role as an important financial, trade,

t r a n s p o r t a t i o n , commun i ca t i on , educat ion and

entertainment centre in Asia. International investors and

multi-national corporations including those from Asia will

w o r k closely and compete fairly with their counterparts

f rom Hong Kong and the Mainland.

as a Special Administrative Region making significant

contributions to the modernisation of China and playing

an important role as China emerges as a leader amongst

the community of nations.

In conclusion, Hong Kong has always been, and will always be, a

good partner in trade and finance, both in Asia and in the wor ld .

Closing Remarks

Wi th your co-operation and help, Hong Kong wil l work and

contribute to the growth, prosperity and stability in Asia. As Chief

Executive of the HKSAR, I promise you that we wil l ensure that

the free, fair, enabling and encouraging economic environment,

the hallmark of Hong Kong, wil l be maintained.

Finally, let me congratulate you on the success of this Conference

and thank you all for being here wi th us today. I value very much

your advice and your support. I want to thank especially Mr

Michel Camdessus for his strong support and faith in Hong Kong.

In September, Hong Kong wil l play host to the Wor ld Bank/IMF

Annual Meetings. I very much look forward to welcoming you

again to Hong Kong, which wil l then become the Special

Administrative Region of the People's Republic of China. You will

be able to see for yourself that the dynamism of the free market

in Hong Kong has not and will not change. Thank you.

Closing Remarks

A S I A : R E C E N T E C O N O M I C T R E N D S A N D P R O S P E C T S ,

A N D T H E C H A L L E N G E S O F G L O B A L I S A T I O N 1

Mahmood Pradhan2


Overview

Robust growth in Asia has been associated not only with sound

macroeconomic policies but also typically with increasing openness

to trade and greater integration into the world economy.

Moreover, trade within Asia has increased markedly over the past

decade, signalling a greater interdependence of economic prospects.

At the same time, Asia has received a large and increasing share

of private capital flows to developing countries, indicative of

increasing integration with global financial markets.

The recent slowdown in export and output growth in a number of

Asian economies reflects cyclical factors such as a slowing of

world demand and a downturn in the global electronics market,

as well as the depreciation of the yen against the US dollar. Some

countries are also facing increased competition in labour-

intensive, low-value-added industries. Concerns about overheating

This paper was prepared for the Conference on Financial Integration in Asia andthe Role of Hong Kong, held in Hong Kong on 7 March 1997. The viewsexpressed are those of the author and do not necessarily reflect those of theIMF. The author thanks, without implication, Edwardo Borensztein, DavidGoldsbrough, Manual Guitian, Joaquin Ferran, Se-Jik Kim, Paul Masson, and KunioSaito for helpful comments and suggestions.This paper was prepared by Mahmood Pradhan, with additional contributionsfrom Jonathan D Ostry and Gabrielle Lipworth. Mahmood Pradhan and JonathanD Ostry are Senior Economists, and Gabrielle Lipworth is an Economist in theAsia and Pacific Department of the IMF.

Asia: Recent Economic Trends and Prospects, and the Challenges of Globalisation

eased in 1996, but high current account deficits remain a central

issue in several economies of the region. However, there is no

evidence to suggest a marked shift in the region's impressive

growth performance, provided that the good policy track record is

maintained. Infrastructure requirements over the next decade will

be large, requiring improved public saving and strengthened

financial systems to handle the necessary intermediation of

private and foreign saving.

The globalisation of trade and financial markets offers large

potential benefits for Asia, but it also poses important policy

challenges. Macroeconomic policies that create the right

environment for high saving and investment will be even more

crucial in a world of mobile capital, and the costs of persisting

with protectionist trade policies are likely to be higher in an

increasingly integrated regional and world economy. In many

countries, moreover, prudential regulation and supervision

capabilities have not kept pace with the increasing complexity of

financial systems, with consequent risks for financial and external

stability. Regional initiatives in both trade liberalisation and

financial sector issues can be of considerable benefit, but they

should not be a substitute for strengthening co-operation through

existing multilateral frameworks.

I Introduction

Asia's sustained economic growth performance, which has been

the focus of widespread attention amongst policy makers and

researchers in all parts of the wor ld , masks large differences

within the region. Many countries that pursued macroeconomic

stability, liberalised trade, and implemented market-based reforms

in the late 1970s and early 1980s are now well-established as the

high performers in the region. Their policies have enabled them to

mj] Asia: Recent Economic Trends and Prospects, and the Challenges of Globalisation

better withstand adverse external developments, to sustainincreases in productivity growth and substantially reduce theincidence of poverty. More recently, many other developingcountries in Asia have adopted similar policy frameworks and havemade significant progress in fostering macroeconomic stability andimplementing market-oriented structural reforms that have alreadyspurred private sector economic activity. For many of thesecountries growth has exceeded expectations and their prospectsare better than they have been for some time.

The developing countries in Asia currently account for about onequarter of world output - as compared with only one sixth asrecently as 1985 - and over half of the world's population.3 Withthe strong momentum of growth in the region and the greateropportunities for all countries to catch up with the bestperformers — stemming in part from greater global and regionalintegration of trade and financial markets - Asia's share of worldoutput is expected to increase further over the medium term.The ongoing globalisation of markets will also, however, lead to amore competitive external environment for all countries and giverise to new policy challenges.

This note provides a broad overview of economic performance inthe region, the increasing integration of both trade and financialmarkets, and the policy challenges if Asian economies are to seizefully the large potential gains from globalisation. A companionpaper discusses what these developments mean for Hong Kong.

This note uses the IMF's World Economic Outlook classification of developingcountries in Asia. This excludes Australia, Japan, and New Zealand.

Asia; Recent Economic Trends and Prospects, and the Challenges of Globalisation

II Economic Performance of the Region

Strong fundamentals complemented by strong policies

Although there is no single blueprint underlying the successful

growth performance of east Asian countries, domestic policies

that increased incentives for saving and investment, including in

human capital, were of paramount importance. Moreover, by

reducing instability and uncertainty, the policies pursued by these

countries encouraged innovation and adoption of modern

technology and enabled the private sector to respond speedily to

market signals. The outward orientation of trade and exchange

regimes exposed domestic producers to foreign competit ion that

was instrumental in promoting efficiency in resource allocation.

High saving and high investment enabled a number of countries in

Asia to industrialise faster than any other region, but the quality of

investment has been instrumental in sustaining productivity

growth. Some, including Krugman, have argued that there is no

Asian "miracle" because the region's faster growth reflected

largely a very rapid expansion of inputs. But maintaining efficiency

as capital is accumulated at high rates is itself no small feat.

Moreover, recent studies, including some undertaken in the IMF,

suggest that gains in efficiency, as measured by total factor

productivity, have been quite significant in east and south east

Asia, and markedly higher than that recorded in other developing

country regions. The emphasis on human capital accumulation has

also been critical. Indeed there are marked differences in human

capital development within Asia. Korea and India, for example,

were both characterised by a literacy rate of roughly 30 percent

in the mid-1950s, but by the early 1990s Korea's literacy rate had

increased to over 95 percent, while India's had increased to only

about 45 percent.


Maintaining a stable macroeconomic environment - low fiscal

deficits, low inflation, and relatively stable real exchange rates -

helped to sustain very high saving rates in east Asia, particularly

during the 1980s when saving rates in a number of these countries

were almost twice as high as in other developing country regions

(Table I) . Thus, while other developing countries - such as, for

example, the high-growth countries in Latin America - relied

heavily on foreign saving to sustain investment, domestic investment

in Asia was financed largely by domestic saving. Moreover, a high

proport ion of foreign capital inflows were in the form of non-debt

creating foreign direct investment.

The openness of most Asian countries has been associated with a

strong growth of exports, including a rising share of intra-regional

exports. Although, in principle, causation in the relation between

economic growth and trade can go both ways - the experience of

many Asian countries suggests that output and productivity

growth are positively associated wi th growth in exports and the

Table I • M a c r o e c o n o m i c Stab i l i ty , Saving, I nves tmen t , and

Openness (1985-1995)

(Annual averages, in percent of GDP, unless otherwise noted)

Real GDP1

Fiscal Balance

Saving

Investment

Openness2

Africa

2.5

-5.5

17.4

20.8

25.7

As ia

7.8

-2 .9

29.9

30.7

32.1

Middle

East

3.4

-9.3

19.2

22.5

28.0

Western

Hemisphere

2.7

-2.3

19.1

20.4

14.0

I Annual percent change.Average of exports and imports of goods and services.


elimination of impediments to trade. In addition, the foreign direct

investment flows associated with the expansion of trade have

allowed recipient countries to gain greater access to industrial

country production technologies and have boosted productivity

growth.

Evaluating the recent slowdown

Several countries in east Asia experienced a decline in output and

export growth in 1996, raising concerns in some quarters that this

might signal a downward adjustment in the pace of sustainable

growth in the region (Chart I). During the second half of 1996,

most forecasters, including the IMF staff, revised downwards their

growth projections for 1996 and 1997, although the broad

consensus for output growth in 1997 remains in the 6-8 percent

range for the region as a whole, wi th almost all east Asian

economies expected to achieve growth of at least 5 percent. The

downward revisions in projections notwithstanding, i t should be

recognised that, f rom a longer-term perspective, growth in east

Asia in 1994-95 was well above its long-run average, with the

moderation in the pace of economic expansion in 1996 essentially

representing a slowing to nearer the average (6-7 percent) of the

past twenty years.

Indicators of overheating in 1996 vary considerably across

countries in the region. In China, growth moderated f rom the

exceptionally fast pace of recent years but remains strong and is

estimated to have been in the 9-10 percent range in 1996, with

consumer price inflation in single-digits, and the current account is

estimated to have registered a small deficit for the year as a

whole. In Indonesia, the current account deficit remained high,

despite some slowing of growth and inflation, while in Korea it

widened sharply reflecting the severity of the export slowdown,

though it remains moderate in relation to the size of the


Chart 1. Export Growth(Percent change from a year ear her; 3-month moving average; U.S. dollars)

1983 84 85 86 87 88 89 90 91 92 93 94 95 96

1983 84 85 86 87 88 89 90 91 92 93 94 95 96

7060

50

40

30

20 ~ t.

10 " LM

10 •/

Asean cxd.

/

Y V*

70

I 60China II

(1.A

- 50

- 40

- 30

- 20

- 10

— 0

-201983 84 85 86 87 88 89 90 91 92 93 94 95

Source. IMF, Direction of Trade Statistics.

- -10

-' -2096Oct


economy. In Malaysia, wi th activity slowing and inflation remaining

low, the current account deficit fell significantly in 1996, in

reflection of the slower pace of demand and import growth.

While the recovery continued in the Philippines, the external

deficit widened as imports continued strong, although inflationary

pressures subsided. In Singapore, which experienced a significant

moderation in growth in year-average terms, inflation remained

under 2 percent while the current account surplus fell. Finally, in

Thailand, real GDP growth fell below 8 percent for the first time

in several years, with inflation declining and the external current

account deficit rising slightly from its 8 percent of GDP level in

1995.

Most forecasters, the IMF included, would not take the view that

the growth slowdown in east Asia signals a permanent downward

adjustment in the region's sustainable growth rate. To the

contrary, the slowdown is seen to represent a relatively mild

cyclical correction following the above-trend growth of the

previous two years, and it is not expected to be either deep or

prolonged. In a number of cases, moreover, it has stemmed from

appropriate policy tightening, and it has been helpful in reducing

inflationary pressures. A weakening of the external environment,

however, and consequently in export demand, has accentuated

the slowdown. The consequence has been that external current

account deficits remain high in a number of countries in the

region.

Wi th respect to exports, the regional slowdown in 1996 reflects

not only the less favourable external environment in that year, but

also a range of other factors, including cyclical developments in

the global electronics market, increased competit ion in low value-

added industries, the appreciation of the US dollar against the yen,

and country-specific factors. As regards the yen/dollar exchange

rate movement, it bears noting that dollar weakness in early 1995


inflated the 1996 first half export base, while its subsequentstrengthening dampened the 12-month increase, tending toexaggerate the slowdown in dollar-terms. In SDR-terms, forexample, the export slowdown appears both less sharp and lesswidespread, clearly affecting only China, Korea, Malaysia, Singapore,and Thailand (Chart 2). For these five countries, the slowdownappears primarily to reflect country-specific factors, although theirimpact may have been amplified by the growing importance ofintra-regional trade.

Among these country-specific factors, the drop in the growth ofChina's exports in early 1996 was largely due to the unwinding ofthe effect of bringing forward exports in 1995 in anticipation of areduction in the VAT rebate on exports; Chinese exports haverecovered strongly in recent months. Korea and Singapore havebeen adversely affected by developments in the world electronicsmarket and the sharp fall in semiconductor prices. Malaysia'sexports have also been affected by developments in the electronicsmarkets, but even more so by poor performance of commodityexports, which are now beginning to turn around. Finally, inThailand's case, the slowdown reflects almost exclusively muchslower exports of labour-intensive products (such as garmentsand footwear) which have been depressed by an ongoing processof structural adjustment towards higher value-added production.

Developments in the world economy in 1997 should be favourableto a recovery of output and exports in the east Asian region.Recent data point to stronger growth in the United States and theUnited Kingdom and a promising upturn in Canada, while strongergrowth in Japan at the end of 1996 appears likely to carry overinto early 1997. The momentum for world growth, moreover,should be sustained by the strength of equity markets (except inJapan), the decline in long-term interest rates which has beenaided by fiscal consolidation in a number of industrial countries,


and by subdued inflation. Apart f rom the industrial countries,

growth in the non-Asian developing countries should also remain

strong, wi th the recoveries in Argentina and Mexico being

particularly noteworthy, and encouraging performance and

prospects among the early reformers of central and eastern

Europe. Al l to ld, these prospects point to a recovery in output

and imports in Asia's main export markets in 1997.

What, then, are the prospects for exports in the region in 1997?

Clearly, the faster pace of wor ld output and trade growth augurs

well for a recovery in regional exports this year. In addition,

activity in some key markets, such as electronics, has already

picked up, while prices in commodity markets appear to have

stabilised. W i t h foreign investment in export sectors remaining

strong, the momentum of export growth should increase from

1996 and should be sustainable at this higher level. On the other

hand, prospects may be dampened somewhat by the probability

that the full effects of the weak yen on exporters competing with

Japan have yet to be felt.

I l l Increasing Regional Integrat ion and the Changing

N a t u r e of Trade and Financial Linkages wi th Industrial

Countr ies

Robust growth in Asia has been associated with increasing

openness of most countries in the region and their greater

integration into the wor ld economy. Traditional trade linkages

with the industrial countries have been deepened by greater

diversification of Asia's exports and, at the same time, new

linkages have developed - especially within the region - through

greater diversification of export markets. Wi th more open capital

markets and the substantial increase in capital flows to the region,

closer financial linkages wi th the industrial countries have helped

to increase the resilience of many Asian countries to growth


slowdowns in Europe and Nor th America, in part because of the

countercyclical nature of capital flows f rom industrial to emerging

market countries. Since the 1990s, growth rates in Asia have

diverged markedly f rom growth in Europe and Nor th America,

indicating some decoupling of economic cycles between industrial

countries and Asia's developing countries (Chart 3). W i t h greater

regional interdependence, moreover, economies wil l be more

subject to spillover effects from their neighbours. Hong Kong is

one important example, as its business cycle has become

increasingly influenced by developments in China. Greater regional

integration, therefore, also underscores the increasing dependence

of economic prospects of individual countries on economic

developments and policies within the region.

Trends in intra-Asian trade

In recent years the growth of wor ld trade has far exceeded the

growth of wor ld output, and much of the buoyancy in trade

reflects the strong increase in trade in the developing countries of

Asia, including intra-regional trade. Intra-Asian trade has increased

substantially over the past two decades wi th 40 percent of the

region's exports now destined for other Asian countries, close to

the level of intra-regional trade in Nor th America. In contrast,

even in the relatively strong performing economies in the

Western Hemisphere region, intra-regional trade accounts for

only about 20 percent of total exports, while intra-regional trade

in other areas remains below 10 percent (Chart 4).

The strong growth of trade in Asia has also coincided with

significant changes in the composition of exports. Whereas in the

1970s and early 1980s, exports of primary products (including

fuel) constituted a dominant share of total exports, by the late

1980s, over 70 percent of Asia's exports consisted of manufactures

(Table 2). This changing composition has been aided by the


Table 2. Composi t ion of Developing Country Exports1

(Percent of merchandise exports)

Middle East WesternAfrica Asia and Europe Hemisphere

1970 1980 1990 1970 1980 1990 1970 1980 1990 1970 1980 1990

Non-fuel primary

products 618 17.0 31.2 49.4 30.7 16.0 10.7 1.8 5.7 64.5 42.1 39.9

Fuel 22.8 56.0 47.2 8.8 2L4 10.2 80.1 93.0 73.6 23.7 39.9 26.6

Manufactures 14.5 27.0 21.6 41.8 47.9 73.8 9.2 5.1 20.7 11.8 18.1 33.5

Source: United Nations Conference on Trade and Development data base.1 Based on 65 developing countries for which data are available.

removal of distortions in domestic markets and reductions in

trade barriers, but it mainly reflects the underlying shift in the

comparative advantage of many Asian countr ies toward

manufacturing. Low wage costs coupled wi th rising investment

have made some of these countries highly competitive in the

production of manufactured goods. And wi th in Asia, the

comparative advantage of countries with relatively high wage costs

has shifted toward higher value-added products.

An expanding manufacturing sector and the corresponding decline

in the share of commodity exports has reduced countries*

vulnerability to external shocks. Compared wi th manufactured

goods, the demand for primary commodities has been more

cyclical and has risen less rapidly. Exporters of manufactures and

countries with diversified export bases have experienced higher

export growth and smaller terms of trade losses (Table 3).

The increase in intra-Asian trade over the past decade is reflected

in a somewhat lower proport ion of exports to industrial

countries. However, Asian exports to industrial countries still


Table 3. Trade and Economic Performance in Developing

Countr ies, 1988-95

(Annual percent change, unless otherwise indicated)

Exporters of nonfuelprimary products

Exporter of fuels(mainly oil)

Exporters of servicesExporters of

manufacturesDiversified exporters

AfricaAsiaMiddle EastWestern Hemisphere

Real GDP

3.3

2.82.7

7.33.8

2.37.93.72.3

Terms of

Trade

-

-0.9-0.5

-0.60.2

-1.4-0.2-0.5-0.3

Terms of

Trade

Volatility'

6.9

8.33.3

3.01.3

4.42.55.61.6

Export

Volumes

5.0

7.07.5

9.77.8

3.89.98.67.6

Investment2

18.7

22.921.2

30.923.0

20.731.623.020.7

Source: IMF, World Economic Outlook.1 The standard deviation as a percent of the mean.2 In percent of GDP.

account for just over half of the region's total exports (Table 4),

Asia is also taking an increasing share of industrial countries'

exports, a factor which helped to cushion the impact of the

economic downturn in industrial countries during 1990-93. The

expansion of markets in Asia has benefited other developing

country regions as well, all of which have increased the share of

their exports going to Asia.

The pattern of trade within Asia reflects the interdependence

between countries that are at different stages of development. In

countries at an earlier stage of industrialisation, labour-intensive


Table 4. W o r l d Trade Patterns(Percent of total exports)

Exports fromDeveloping countries

AfricaAsiaMiddle East and EuropeWestern Hemisphere

Industrial countriesNorth AmericaPacific2

Europe

Exports fromDeveloping countries

AfricaAsiaMiddle East and EuropeWestern Hemisphere

Industrial countriesNorth AmericaPacific2

Europe

Exports to

Africa Asia

1985 1995 1985

4.91.71.82.3

1.81.64.1

9.9 3.31.3 27.62.0 12.51.0 4.3

1.0 10.51.4 26.02.5 4.2

1995

8.640.322.25.8

16.143.07.1

Developing <

Middle East

Countries

Westernand Europe Hemisphere

1985

1.75.011.73.1

4.87.26.3

1995

2.82.98.71.6

3.22.54.2

1985 1995

3.4 2.11.7 2.34.0 1.912.7 19.4

10.8 12.83.8 3.82.2 2.6

Exports to Industrial Countries

North America

1985

14.028.08.5

42.6

38.036.411.0

1995

15.720.810.047.9

36.126.27.8

Pacific2

1985

3.419.119.55.6

II. 17.62.3

1995

4.514.616.24.4

11.26.03.1

Europe

1985

54.012.832.224.0

19.914.364.7

1995

44.715.326.518.1

18.616.166.5

Total1

1985

13.235.930.022.3

27.938.616.8

1995

23.446.834.827.8

33.250.816.4

Total1

1985

71.459.960.272.1

69.058.378.0

1995

65.050.752.770.4

65.848.377.3

Source: IMF, Direction of Trade Statistics.' Export shares of each region to all developing and industrial countries do not add to 100 percent because

trade with the countries in transition is excluded and because of some underreporting of trade.2 Australia, Japan, and New Zealand.


manufactures account for a relatively large share of exports, while

capital goods and capital-intensive manufactures constitute a high

proport ion of imports. By contrast, in the more advanced

economies, although capital goods imports continue to be

important, there has also been an increase in intra-industry trade

in a number of capital-intensive products. This regional

redistribution of production is also linked to the pattern of capital

flows, especially foreign direct investment, within the region.

Capital flows and financial market development

The strong growth, increasing openness to trade, and greater

export orientation of many Asian countries - compared with

other developing countries - is reflected in the large share of the

developing economies of Asia in the recent surge in private capital

flows, as well as in the composition of these flows (Chart 5). Net

resource flows to all developing countries increased over four-

fold between 1990 and 1995 to reach US$164 billion, of which

flows to Asia - mainly the emerging market countries in east and

southeast Asia - accounted for over 40 percent. Foreign direct

investment (FDI) flows accounted for almost half of private capital

flows to Asia, in contrast to other developing country regions,

including Latin America, where port fol io flows to bond and equity

markets were predominant.

Important changes in the composition of net private capital flows

to Asia have occurred over recent years (Chart 6). FDI has

increased sharply; portfolio investment flows have emerged from a

negligible role to become a relatively important, if sometimes

volatile, source of capital inflows; and, in contrast, other

investment flows, mostly commercial bank lending, have declined

substantially t o around one-third of net private financing. In

addition, the data on net FDI flows to the Asian developing

economies mask an important development: increasingly Hong


Kong and, the other Asian NIEs have become sources of FDI flows

to other developing economies in the region.4

There have been striking differences in the extent to which Asian

economies have relied on FDI: they have played the most

prominent role in Malaysia, where they averaged almost 7 percent

of GDP, but have also gained in importance in China and

Indochina, and to a lesser extent, in India and the Philippines

(Table 5). For the most part, the surge in FDI flows has been

spurred by the attraction of a number of countries as low-cost

locations for production by multinational enterprises, and in some

cases, by large privatisation programmes. In countries such as

China and India, FDI has also been attracted by rising per capita

incomes and an improvement in policies towards foreign

participation in domestic economic activity.

Table 5. Selected Asian Countr ies: N e t Foreign Direct

Investment, 1985-96

(In percent of GDP)

ChinaIndiaIndonesia

1985

030.10.3

1936

0.50.10.3

1987

0.50.10.7

1988

1.20.10.6

1989

0.8O.I0.7

1990

0.80.0I.I

1991

1.00.11.2

1992

1.70.11.2

1993

5.30.21.2

1994

5.90.41.4

1995

4.90.62.4

1996

4.50.82.6

Korea 0.2 0.3 0.3 0.4 0.2 -0.0 -0.1 -0.2 -0.2 -0.3 -0.4 -0.4Malaysia 2.2 1.8 1.3 2.1 4.4 5.5 8.5 9.0 8.0 6.1 4.7 6.3Philippines -0.0 0.5 1.0 2.6 2.0 I.I 1.4 1.3 1.6 2.0 1.5 2.1Singapore 4.6 8.5 12.7 13.8 6.6 9.5 8.8 2.1 5.5 4.8 5.0 4.9Thailand 0.4 0.6 0.4 1.8 2.4 2.6 1.4 1.4 I.I 0.6 0.8 0.8

Source: IMF, World Economic Outlook.

Balance of payments data typically do not identify capital flows by sourcecountry, but recent estimates suggest that intra-regional foreign direct investmentflows within Asia increased from below US$20 billion in 1992 to over US$50billion in 1995. Some of this may reflect "round-tripping", especially betweenChina and Hong Kong. (Barings Securities, 1995).


The importance of such medium term considerations is underscored

by the fact that direct investment flows, as well as portfol io equity

flows, were litt le affected by the Mexican financial crisis. Indeed, in

contrast to Latin America, net private capital flows to Asian

developing countries were higher in 1995 than in 1994 and appear

to have risen further in 1996.

The substantial increase in portfolio flows in recent years reflects

the ongoing process of asset securitisation and international

diversification of investment portfolios in industrial countries. In

the Asian region, portfol io flows grew rapidly in the early 1990s

(Chart 6), driven by the higher returns of Asian investments and

their low correlation with returns on industrial country investments,

and aided by capital account liberalisation in several recipient

countries. These flows have, in turn, provided an import stimulus

to the deepening of domestic capital markets, including an

expansion of bond and equity markets. In some Asian countries,

the size of equity markets now matches that of many industrial

countries.5 For instance, in Hong Kong, Korea, Malaysia, and

Singapore, stock market capitalisation as a share of GDP exceeds

that of Germany, France and Italy.

The developing countries of Asia continue to reply heavily upon

London and New York to channel foreign savings to the region.6

This is the case even though Japan has been the world's largest

5 The Investor base for equity investment, both portfolio and direct investment, inAsia highlights the high degree of regional financial integration compared withother regions, in particular, Latin America. Between 1989 and 1995, close to 60percent of net equity flows to Latin American countries came from the UnitedStates. For Asian countries, in contrast, the role of intra-regional flows havebeen important during the period: equity flows within Asia (excluding Japan)constituted around 60 percent of net equity flows, while Japanese investment inAsian developing countries accounted for less than 20 percent of total inflows.

6 The bulk of Asian offshore bond activity continues to occur in the Eurobondmarket, while UK and US banks remain the region's largest supplier of loans.


exporter of capital since the early 1980s and reflects theconcentration of the Tokyo market primarily on serving domesticintermediation needs. But Japan's new government recentlyunveiled far-reaching reforms of its financial markets, intended topromote competition among foreign and domestic financialinstitutions in all sectors and to transform the Tokyo market overthe next five years into an international financial market comparableto London and New York. The deregulation - likened to London'sBig Bang - would give banks, securities companies and insurancecompanies greater access to each other's markets, would reducethe tax burden on investors, and would lift rules governingJapanese pension systems, opening up Japan's huge pensionmarket. Moreover, Hong Kong and Singapore - with their wellcapitalised banks, efficient clearing and settlement systems, andexpanding range of financial products - have emerged as majorfinancial centres, increasingly providing channels for intermediatingsavings within Asia as well as from other regions. They have alsogrown to be, respectively, the fourth and fifth largest foreignexchange trading centres in the world (surpassed only by the UK,US and Japanese markets).7 The two centres have also developedtheir own natural specialisations. Hong Kong is the main conduitof funds to China, and has specialised in loan syndication, fundmanagement and equity trading. Hong Kong-based banks alsoarrange a significant proportion of Asia's syndicated borrowingneeds. While Singapore has evolved as the main banking centrefor south east Asia. In addition, smaller regional centres, includingBangkok's International Banking Facility in Thailand and Malaysia'sLabuan Island, have gained in importance in recent years inchannelling funds to their domestic markets.

Hong Kong and Singapore have become the focal points in Asia for foreignexchange trading in transactions not involving the yen, while dollar-yen tradesaccount for over three quarters of total foreign exchange turnover on the Tokyomarket.


IV M e d i u m - t e r m Prospects and Policy Challenges

Providing countries adhere to prudent macroeconomic policies

and sustain structural reform efforts, growth in Asia will continue

to exceed growth in industrial countries, further increasing the

region's share of wor ld output. The IMF staffs medium-term

projections indicate that Asia's share of wor ld output wil l rise

from the current level of about one quarter to one-third by 2005.

Asian countries are also projected to account for well over 25

percent of wor ld exports by 2005 (Table 6). These projections

assume not only that domestic macroeconomic and financial

policies stay on track, but also that policy makers address

challenges stemming from the closer integration of product and

factor markets in the region. W i t h increased openness, the

economic environment in the region promises greater opportunities

to all countries, but it will also be more competitive and more

demanding.

Policy requirements to sustain growth

Asia's aggregate growth performance and medium-term prospects

mask considerable differences among individual economies. The

strong performers - the NIEs, China and the major ASEAN

countries - have managed to sustain a rapid pace of economic

growth and improvements in living standards, while a number of

other countries, where policy settings have improved more

recently, are catching up slowly. In some countries, state

involvement in economic activity is still extensive. By contrast, in

economies such as Hong Kong and Singapore, economic activity is

governed, for the most part, by market mechanisms. These

divergences in economic performance and in stages of development

give rise to somewhat different priorit ies and policy challenges

across countries, although the basic requirements of market-

oriented, outward-looking policies combined wi th a steadfast

Asia; Recent Economic Trends and Prospects;, and the Challenges of Globalisation

Table 6. Developing Asia's Growing Share of W o r l d

O u t p u t and Trade1

(In percent of world total)

World Output

Developing AsiaAll developing countriesTransition countriesIndustrial countries

1985

16.034.88.5

56.7

1990

18.935.88.1

56.1

1995

24.441.24.9

53.9

2000

28.345.4

5.049.6

2005

33.049.95.3

45.0

World Exports (goods and services)

Developing AsiaAll Developing countriesTransition countriesIndustrial countries

10.025.072

67.7

12.223.24.6

72.2

17.527.04.1

69.0

21.931.44.5

64.2

26.935.84.9

59.3

Source: IMF, World Economic Outlook.1 The projections for 2000 and 2005 assume annual output growth rates of 2.5

percent in the industrial countries, 5 percent in the transition countries, 6.5percent in all developing countries, and 7.5 percent in the developing countries inAsia. These projections should be considered indicative of broad trends ratherthan forecasts of the most likely outcome.

adherence to the pursuit of macroeconomic and financial stability

are common to all.

Many of the strong performers are faced with the challenge of

sustaining productivity growth as the composition of output shifts

away f rom agriculture and labour-intensive industrial production,

and more towards higher value-added industries and services. In

this regard, Hong Kong's rapid, successful transformation into a

mature, services-based economy is especially noteworthy and

owes much to the flexibility of its labour market. Some countries,


such as Korea, Malaysia, and Thailand have experienced relatively

tight conditions in labour markets in recent years, wi th wages

rising faster than productivity growth. In part this reflects skills

shortages, especially in key growth sectors such as engineering,

computing and services that are replacing the traditional, less skill-

intensive manufacturing activities. Sustaining productivity growth

over the medium term will require a significant expansion in the

supply of workers wi th higher education, particularly in the

ASEAN countries where the development of secondary and

tertiary education lags considerably behind the NIEs. Over the

longer term, however, most Asian countries will need to expand

and improve higher education systems.

Higher investment in infrastructure to keep pace with growth

represents a major challenge for many countries in the region. In

China, India, Indonesia, the Philippines, and Thailand, poor

infrastructure, particularly in transportation, communication, and

power supply will increasingly constrain growth. Moreover,

regional disparities in infrastructure development have typically

resulted in a concentration of growth around the larger cities and

limited economic development in rural areas, which still account

for most of the population. Some estimates of Asia's infrastructure

needs suggest that infrastructure spending wil l rise f rom about 4

percent of GDP in the 1980s to around 7 percent of GDP over

the next decade.8

The challenge for many of these countries is to address their

infrastructure needs, including environmental requirements, without

putting undue strains on public finances o r on external positions.

Some countries have already implemented large scale privatisations

programmes. Malaysia has successful ly pr ivat ised te le -

communications, electricity supply, and a container port .

8 See World Bank, World Development Report 1994.


Privatisation has also helped reduce chronic power shortages in

the Philippines. Korea and Thailand are also actively encouraging

private sector participation in infrastructure development. Despite

these successes, however, the amount of capital raised through

privatisation in Asia remains relatively small compared wi th Latin

America. This largely reflects the reluctance of both domestic and

foreign investors to finance projects in countries where the

regulatory regime governing the private provision of services,

formerly operated by the public sector, is not sufficiently

transparent. Electricity supply, for example, is heavily subsidised in

a number of countries: private investors in these industries would

need reasonable assurances that the government wil l have the

political resolve to phase out such subsidies and implement pricing

policies that reflect market conditions or, continue to finance

these subsidies. Faced with uncertainties about future regulations

and pricing policies for private provision, privately-managed

projects are more likely to need backing by sovereign guarantees,

with potential implications for external debt burdens.

Although private sector participation is being encouraged in a

number of countries, at present the private sector accounts for

only about 10 percent of aggregate investment in infrastructure in

Asia. Even if this share expands considerably, the public sector is

likely to remain heavily involved in the task of developing and

improving domestic infrastructure over the medium term. This

will require more determined efforts to contain fiscal imbalances

and strengthen public finances by reducing expenditure in other

areas, including military spending.

Financial market reform programmes, especially in countries where

financial market development has lagged behind, will also need to be

appropriately geared toward mobilising and efficiently intermediating

saving to meet future investment needs. Strengthening financial


markets and instituting corporate bankruptcy procedures is

particularly urgent for economic growth in countries such as China,

India, and Vietnam where extensive state-ownership of banks and

state-directed lending programmes have reduced the efficiency of

investment allocation, with potential consequences for banks*

portfolios. In Indonesia and Korea, where state-directed lending

programmes and controls on interest rates were prevalent in the

1980s, bank regulators have yet to fully resolve weaknesses in the

state banking sector. Wi th the widespread recognition of the

benefits of market determined credit allocation systems, however,

differences within the region are narrowing as deregulation spreads

across a number of these countries.

In many of the emerging market economies in Asia, the

liberalisation of financial markets and domestic institutions' access

to international capital markets are relatively recent phenomena.

These reforms, including more liberal regimes of bank licensing,

have not only promoted competit ion and efficiency in the financial

sector, but have also exposed the system to a number of risks

that need to be properly addressed. Most important, deregulation

has also led to greater exposure of credit and foreign exchange

risk, and increased the danger of banks being inadequately

capitalised, with consequent incentives to offer above-market

interest rates and engage in less prudent lending. In most

countries, prudential regulation and supervision capabilities have

not kept pace wi th the increasing complexities of banking business

and this poses dangers for external and financial stability. When

the need to safeguard external confidence calls for monetary

policy to be tightened, concern about the effect of higher interest

rates on the cost of funds and the loan portfol ios of weak banks

may delay policy action, and thereby exacerbate the risk of sudden

reversals of capital flows.


Policy requirements stemming from increased global andregional integration

The increasing integration of the global economy, of which, thedeepening of trade and financial linkages within Asia is but onefacet, clearly offers large potential benefits to Asia and the rest ofthe world economy, notably through the gains in efficiency anddynamism that can result from access to broader and deepermarkets. But this globalisation also poses challenges for domesticpolicies and for regional and international co-operation.

The most important implication for domestic policies is likely to bethat the impact on the domestic economy of unsoundmacroeconomic policies can be even higher in an increasinglyintegrated world as financial or exchange rate instability will drivesavers to seek safer havens and greater uncertainty will influencesome investments to be located elsewhere. For c ntries wherethere are still significant barriers to trade, the risks of falling furtherbehind are likely to increase as trade relations among others in theregion strengthen with the continuing increase in intra-regionaltrade. Trade restrictions in the less advanced countries, especiallyrestrictions on imports of capital goods, will prevent the movementof labour-intensive, lower value-added industries toward thesecountries. Consequently, they may forsake growth in areas where,in principle, they have a comparative advantage. Thus, to fullybenefit from the dynamic nature of trade and production in theregion, a number of countries including India, China and Indonesiawill need to expand their trade reform programmes.

Regional trade agreements, such as the ASEAN Free Trade Area(AFTA), and the Asia Pacific Economic Co-operation (APEC), haveprovided some of the impetus for trade liberalisation in Asia, butare not a substitute for continued progress within a multilateralframework. Given the differences between the nature of the two


organisations - APEC emphasises unilateral trade liberalisation

whereas AFTA, a much smaller grouping, is set up as a free trade

area - trade liberalisation among AFTA members has been more

extensive. Although there is a potential for trading bloc agreements

to expand trade between member countries at the cost of trade

with non-members, the ASEAN countries trade much more with

countries outside the region than wi th each other9, and, the

existence of AFTA does not appear to have significantly affected

trade relations with other countries. Prospective reductions in

trade barriers in the region wil l , of course, generate greater

efficiency gains if they are designed and implemented in a manner

that fosters trade creation rather than trade diversion. The best

way to ensure this is through a continued commitment to global

trade liberalisation commitments under the W o r l d Trade

Organization (WTO). The importance of pursuing global trade

liberalisation is also underscored by the fact that, despite the

growth of intra-regional trade, more than half of Asia's exports

are destined outside the region.

A number of countries in Asia are confronted wi th the challenges

of dealing with large and potentially volatile capital flows. While

offering considerable potential gains, such flows impose additional

constraints on the conduct of monetary and exchange rate

policies. Moreover, a key concern for national authorities is to

effectively monitor and contain risks t o the domestic banking

system, particularly credit, foreign exchange, and market risk. This

will require strengthening prudential oversight through the adoption

of improvements in risk management and supervision. (Hong Kong

and Singapore have already adopted improvements similar to

those implemented in the Group of Ten countries.) Moreover, as

banks become increasingly exposed, directly or indirectly, to risks

9 The momentum of trade growth within ASEAN will likely be sustained ascountries implement their recent agreement to reduce tariffs further (to below 5percent by 2003), and to accelerate the liberalisation of non-tariff barriers.


originating in neighbouring countries, the effectiveness of supervision

will be enhanced by greater co-operation between national

supervisors in the region.10 But a regional approach alone wil l not

suffice in the longer run, because financial institutions increasingly

operate globally in the market for wholesale funds. Therefore,

supervisors wil l find it increasingly necessary to apply on a more

global basis, a common minimum set of prudential standards and

supervisory guidelines.

Some particular features of capital flows may also have implications

for policy co-operation among countries in the same region.

Several studies have argued that "herding" behavior - where

countries wi th very heterogeneous fundamentals are indiscriminately

grouped together by investors - may play an important role in

foreign exchange markets. Such "contagion" effects, whereby

other countries suffer from policy mistakes of individual countries,

provide an argument for enhanced regional co-ordination, in

order to internalise some of the associated externalities. For

similar reasons, there is a good case for strengthening and

extending the existing network of bilateral swap arrangements

among the region's central banks. Of course, these mechanisms,

useful as they are, cannot be a substitute for dealing with systemic

risks in a global manner, through the strengthened surveillance

activities and financial resources of the IMF. As part of these

strengthened surveillance efforts, the IMF's recently established

Special Data Dissemination Standard is an important step towards

providing, on a timely basis, internationally comparable and

adequate statistical information. This will help market participants

to assess countries on a more individual basis.

10 The Executives' Meeting of East Asian and Pacific Central Banks and MonetaryAuthorities (EMEAP) has recently established a working group on bankingsupervision to enhance regional understanding of supervision issues andtechniques. EMEAP consists of central banks with representatives from Australia,China, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, thePhilippines, Singapore, and Thailand.

Asia; Recent Economic Trends and Prospects, and the Challenges of Globalisation IKM

There is now widespread recognition within the region of the

policies underlying the successful performance of east Asian

countries. A growing number of countries are seeking to replicate

their experience. In a number of countries, however, there is a

lack of institutional expertise to implement policies, especially in

the areas of fiscal management, monetary control techniques and

also in how best to limit the distort ionary impact of state

intervention policies.

For countries that have only recently embarked on market-

oriented policy regimes and are in the process of implementing

structural reform programmes, policy advice and technical assistance

from the successful performers would help in ensuring that

reform programmes yield tangible benefits. Greater regional co-

operation in this area could help to increase the consensus for

reforms and ensure that policy improvements in the countries

lagging behind are sustained over the long term.


H O N G K O N G : S T R U C T U R A L C H A N G E , I N T E G R A T I O N ,

A N D E C O N O M I C P O L I C I E S 1

Aasim Husain2


Overview

Hong Kong has achieved an exceptionally strong economic

performance over the past fifteen years. Real GDP growth has

averaged almost 7 per cent annually, while per capita GDP has

increased fourfold reaching US$22,770 in 1995. Since 1980,

Hong Kong's economy has undergone a dramatic structural

change as it has become increasingly linked through trade and

investment to China. While the importance of the manufacturing

sector and domestic merchandise exports declined, Hong Kong

has emerged as a mature services-based economy

In view of the massive structural changes, policy makers have

pursued a transparent and broadly rules-based economic policy

framework consisting primarily of a linked exchange rate system,

a prudent fiscal policy stance, and a general noninterventionist

approach to economic policies. These policies, in combination

with flexible markets, have promoted efficient allocation of

resources and macroeconomic stability.

This paper was prepared for the Conference on Financial Integration in Asia andthe Role of Hong Kong, held in Hong Kong on 7 March 1997. The viewsexpressed are those of the author and do not necessarily reflect those of theIMF. The author thanks, without implication, John Dodsworth, David Goldsbrough,and Dubravko Mihaljek for helpful comments and suggestions.Aasim Husain is an Economist in the Asia and Pacific Department of the IMF.

Hong Kong: Structural Change, Integration, and Economic Policies

Over the medium term, given the rapidly changing domestic and

global economic environment, economic policies will need to

remain focused on maintaining stability and promoting market

flexibility Continued adherence to the rules-based policy framework

will be helpful in this respect In addition, to enhance its position

as an international financial centre, Hong Kong will need to

maintain a high level of prudential supervision to protect the

soundness of its banking system, and continue to make progress

in liberalising the nontradeable sectors of the economy

I Structural Transformation

During the 1960s and 1970s, an abundant supply of inexpensivelabour supported rapid growth of Hong Kong's manufacturingsector. By the late 1970s, however, Hong Kong's competitivenessin manufacturing activities had started to erode as land and labourcosts rose. When China began its policy of reform and opening upin late 1978, manufacturing activities began to relocate tosouthern China, where labour and facility costs were up to 15times and 5-10 times lower, respectively. Private estimatesindicate that, by the mid-1990s, about 25,000 Hong Kong firmswere operating plants in southern China, employing 4-5 millionworkers. The expansion in outprocessing operations, as well asthe sustained rapid increase in China's export activity, boosted thedevelopment of supporting service industries in Hong Kong , mostnotably in trade and financial services sectors.

The dramatic structural shift of Hong Kong's economy that tookplace during the 1980s and early 1990s was reflected in asubstantial change in the respective shares of the manufacturingand services sectors in employment and overall GDP (Chart I). Interms of GDP, the manufacturing sector's share declined fromabout one fourth in 1980 to less than 10 percent in recent years,

Hong Kong: Structural Change, Integxation, and Economic Policies

while the share of trade and financial services rose f rom about 40

percent to over one half. For the services sector as a whole, the

share rose f rom two thirds to almost 85 percent. The change in

the structure of private sector employment was even more

dramatic, wi th the share of manufacturing falling f rom about one

half in 1980 to less than 15 percent in mid-1996, compared with a

rise in the employment share of trade and financial services from

less than one third to over 60 percent.

The change in the overall economic structure was also reflected in

the structure of Hong Kong's exports. Total exports of goods and

services rose f rom about 70 percent of GDP in constant prices in

the early 1980s to almost 200 percent of GDP in recent years,

one of the highest degrees of openness in the world.3 However,

domestic merchandise exports have declined, both relative to

GDP and, since 1992, in absolute terms, while the other

components of exports - re-exports (which are closely related to

export activity and industrial production in China), and exports of

services - have expanded at a steady pace (Chart 2). Wi th

imports rising sharply from the late 1980s, there has been a

significant decline in the balance of trade in goods and services

from a surplus of over 10 percent of GDP in 1989 to a deficit in

1994-95. The decline in the trade balance has, however, been

offset in part by a rise in factor income f rom abroad.

The structural shift f rom manufacturing to services took place

without significant disruption in the pace of economic activity or a

marked pickup in unemployment. Indeed, the growth of real GDP

and of labour productivity remained strong throughout the

period. Although the initial structural shift and heightened

3 Owing to the steady shift in relative prices in favour of nontradeables, export toGDP ratios in current prices are markedly different from the ratios of the twovariables in constant prices. Trend developments in both ratios during the 1980sand 1990s, however, have been broadly similar.


immigration f rom China led to temporari ly higher unemployment

in the early 1980s, much of the 1980s and 1990s was characterised

by a shortage of labour, with the unemployment rate remaining

around 2 percent (Chart 3). The work force has grown only

gradually (by about 1.5 percent per year). However, during the

1980s, labour productivity growth averaged close to 4.5 percent a

year. Even in the 1990s, as Hong Kong became an increasingly

services-based economy, productivity gains have averaged almost

4 percent annually. Total factor productivity growth in Hong Kong

during the 1970s and 1980s has been estimated at almost 4.5

percent a year, well above the pace experienced in most OECD

countries over the same period (Chart 4).4

During this process of structural change, Hong Kong has grown to

become an important international financial centre. Over 500

banking institutions are present in Hong Kong, including 80 of the

100 largest banks in the wor ld. The external assets held by banks

and deposit-taking institutions exceed US$600 billion, making

Hong Kong one of the largest banking centres in the wor ld . About

70 percent of banking business is denominated in foreign

currencies, and Hong Kong ranks fifth in the wor ld in terms of

foreign exchange market turnover. Hong Kong's stock market is

the seventh largest in the wor ld and second largest in Asia in

terms of market capitalisation.

II Economic Integrat ion wi th China

With the relocation of manufacturing operations to China and the

development of supporting services industries in Hong Kong,

cyclical fluctuations in economic activity in the two economies

have become more closely linked. The correlation between the

J. Hawkins, The Best of Times, the Worst of Times: Developments in Productivity,HKMA Quarterly Bulletin, August 1995.


cyclical components of Hong Kong's GDP and industrial production

in China rose sharply in the late 1980s and has remained high

during the 1990s (Chart 5). In part this is explained by the

development of bilateral trade flows between Hong Kong and

China. The share of exports to China in Hong Kong's total

exports rose f rom 6 percent in 1980 to one third in 1996. Over

one fourth of domestic exports have gone to China in recent

years, while about 60 percent of re-exports have been of Chinese

origin, and about 35 percent have been destined for China.

CHAJBT 5HONG KONG

CYCLICAL COMPONENTS OF REAL GDP ANDCHINA'S INDUSTRIAL PRODUCTION, 1986-96

(5-year moving correlation)1.0

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

Sources: Hong Kong Monthly Digest of Statistics; IMF International Financial Statistics and staff estimates.


Hong Kong has also developed in its role as a financial

intermediary for China. On the banking side, however, the degree

of integration remains limited. Total claims of Hong Kong banks on

banks and nonbank customers in China represented only 4

percent of the Hong Kong banking system's total assets in 1996,

while liabilities to entities in China, including both banks and

nonbanks, comprised just 3.5 percent of Hong Kong banks* total

liabilities. On the other hand, it is estimated that about one

quarter of total Hong Kong dollar bank notes in circulation are

circulating in southern China. In regard to resource mobilisation,

the Hong Kong Stock Exchange has a capitalisation about four

times that of the Shanghai and Shenzhen stock markets combined

and, since 1993, Chinese enterprises have been able to raise

capital by issuing shares traded in Hong Kong. Investors from

China have also accumulated significant property and equity assets

in Hong Kong, including stakes in some strategic companies.

I l l Economic Policies

Hong Kong's dramatic structural change was essentially market-

driven. The economic policy framework — comprising the linked

exchange rate, p rudent fiscal pol icy, and a generally

noninterventionist approach to economic policies - provided a

conducive environment for market forces to reallocate resources

across the economy efficiently by adhering to a stable, transparent,

and broad "rules-based" set of policies. This approach helped the

Hong Kong authorities maintain business confidence in an

uncertain situation during the run-up t o the return to Chinese

sovereignty in 1997,

Noninterventionist Approach and Competition Policy

An important part of the policy f ramework has been a

noninterventionist approach to goods and factor markets. Hong


Kong has maintained its status as a free port and tariff-free zone

with complete freedom from foreign exchange controls. The

authorities do not have an industrial policy and have refrained

from the use of fiscal subsidies or preferential tax treatment to

promote particular sectors or industries. In addition, social

welfare benefits have been narrowly targeted and labour market

policies have focused on providing assistance in retraining rather

than on unemployment insurance. The absence of policy distortions

has helped promote flexible markets and ensure that factors of

production move smoothly across sectors in response to changes

in market conditions.

In recent years, as the economy has become increasingly services-

based, the role of domestic competition policy in affecting the

efficient allocation of resources has become more important. In

this connection, the government recently commissioned a number

of sectoral studies reviewing the state of competition in Hong

Kong, and on the basis of these studies it is taking steps to

liberalise the nontradeables sectors. Whi le the studies generally

found that Hong Kong's nontraded sectors performed well with

regard to the price and quality of services provided, they

concluded that some scope remains for greater efficiency and

m o r e c o m p e t i t i o n in a number o f areas, inc lud ing

telecommunications, broadcasting, accounting and legal services,

medical and educational services.

The Linked Exchange Rate, Prudential Supervision, and

Financial Infrastructure

Following a period of sustained exchange rate depreciation in the

late 1970s and early 1980s - which accelerated sharply with

uncertainties created by negotiations between the United Kingdom

and China regarding the future of Hong Kong - a linked exchange

rate system was adopted in October 1983. Under the linked rate

Hong Kong: Structural Change, Integration, andEconomic Policies

system (which is based on a form of currency board arrangement)

the overriding objective of monetary policy is to maintain a stable

exchange rate between the Hong Kong and US dollars (Chart 6).

The link, together wi th the freedom f rom controls on capital

flows, implies that Hong Kong's interest rates are essentially

determined by US monetary conditions. Whi le the Hong Kong

Monetary Author i ty (HKMA) has some limited tools to influence

interbank liquidity and thereby affect local short- term interest

rates, these instruments have been used sparingly, mainly to

smooth temporary fluctuations, and the authorities consider such

smoothing very much a secondary objective to the primary goal of

defending the exchange rate link.

Hong Kong's external competitiveness has been preserved through

the flexibility of markets and prices. W i t h substantial gains made

in labour productivity in the tradeables sector, along wi th strong

demand for property and land, there has been a long-term trend

towards higher relative prices for nontradeable goods. In the

context of the linked exchange rate system, these underlying

productivity developments have meant that an appreciation of the

real effective exchange rate has been required, and this has been

effected primarily through a higher rate of inflation in Hong Kong

than in its trading partners. Since end-1987, the inflation differential,

reinforced by an appreciation in nominal effective terms, resulted

in a real effective exchange rate appreciation of about 60 percent.

In support of the exchange rate link, the authorities have

accumulated substantial international reserves and placed a high

priority to maintaining a high-quality banking supervision system in

line with international prudential standards. Their strategy in this

area has been to supplement on-site bank examinations wi th off-

site review and analysis and to promote a freer f low of

information about the financial sector by enhancing banks'

disclosure requirements. In addition, increased emphasis has been


placed on ensuring that banks' internal risk management systems

are well-functioning.

The banking system has, in fact, been highly profitable and loan-

loss provisioning rates are below those in most industrial

countries. Overall asset quality is strong. The use of conservative

loan-to-value ratios and variable rate mortgages has kept loan

default rates for property lending - which accounts for a

substantial proport ion of bank loans - quite low. The overall risk-

weighted capital adequacy ratio for the entire banking system is 17

percent, while even the lowest-capitalised banks have capital

adequacy ratios of 12 percent. Banking sector assets and liabilities

are repriced quickly, so that changes in interest rate generally

have a small and short-lived impact on lending and deposit interest

rate spreads.

The authorities have played a limited, hands-off role in developing

the financial sector, concentrating on providing financial

infrastructure and leaving the development of financial products to

the market. In this context, recent initiatives have included the

extension of the benchmark yield curve of Exchange Fund Notes

to 10 years; helping to standardise mortgage-backed securities by

the establishment of a Mortgage Corporat ion; and bringing

interbank clearing into the HKMA through the introduction of a

Real Time Gross Settlement system. This last initiative should

improve the efficiency of the payments system, reduce settlement

risk, and improve the authorities' control over interbank liquidity.

Fiscal Policy

A critical ingredient in the rules-based policy framework has been

a prudent fiscal policy aimed at keeping government small,

avoiding deficits, and not pursuing countercyclical stabilisation

policies. The authorities have by and large adhered to the


approach that, despite the constraints on monetary policy, thefiscal stance should be kept broadly neutral. Budgetary strategyhas been guided by four broad principles: to maintain a simple andstable tax system with low tax rates; to keep current spending inline with GDP growth; to provide funding for key infrastructureprojects; and to maintain an adequate level of fiscal reserves.While balanced budgets have generally been projected, conservativerevenue projections together with capital shortfalls in spendinghave tended to result in fiscal surpluses. Indeed, the budget deficitrecorded in 1995, primarily as a result of spending on the newairport, was the first deficit since 1983 (Chart 7).

The basic approach with regard to taxation has been to deriverevenue from a limited number of sources and to maintain low taxrates and a simple tax structure. Income taxes, which are leviedonly on income derived within Hong Kong, are the main source ofrevenue - accounting for about 40 percent. Corporate profits aretaxed at the rate of 16.5 percent, while personal income is subjectto a maximum tax of 15 percent. Although 25 percent of fiscalrevenue in recent years has been related to land and property,Hong Kong's revenue-to-GDP ratio has remained quite stable.5

On the expenditure side, the guiding principle has been to providea relatively narrow range of public goods for which governmentsupply is deemed efficient. As a result, total public spendingrelative to GDP has been low in Hong Kong in comparison withthe OECD countries. Within the overall conservative expenditurestructure, however, spending priorities have shifted somewhat inrecent years. Expenditure on social welfare, health, and the

Revenue related to property and land includes profit tax on property-relatedbusiness, premia from land sales, stamp duty on property assignments and leases,land transactions, revenue from property, estate duty, property tax, and generalrates.


CHART 7HONG KONG

FISCAL DEVELOPMENTS, FY 1980 - FY 1995 1 /

5.0

4.0

3.0 •

2.0

1.0

0.0

-i.0

-2.0

FISCAL BALANCE AND RESERVES (IN PERCENT OF GDP)

Fiscal reserves(right scale)

1980 1982 1984 1986 1988 1990 1992 1994

1.0

0.5

0.0

-0.5

-1.5

-2.0

FISCAL IMPULSE AND REAL GDP GROWTH

Real GDP growth(right scale)

Fiscal impulse(in percent of GDP;left scale)

14.0

- 12.0

1980 1982 1984 1986 1988 1990 1992 1994

Sources: The 1996/97 Budget; Government Secretariat, Finance Branch; and staff estimates.

1/ Fiscal year beginning April I.


environment has expanded, and infrastructure spending has been

boosted by the implementation of the Airport Core Programme

starting in 1991. Relatively less spending has been directed

towards security, housing, and community and external affairs.

IV Future Prospects

Uncertainties over the implications of Hong Kong's return of the

Chinese sovereignty have gradually narrowed during the transition.

The institutional arrangements expected to be put in place after

1997 are set out in Annex I. In the area of economic

management, the fundamental elements of the policy framework -

openness, freedom from foreign exchange and trade controls,

small government, and the avoidance of budget deficits - are

embedded in the Joint Declaration and the Basic Law. Policymakers

are expected to retain considerable independence and autonomy.

Under the Basic Law, budgets are expected to be independently

set by Hong Kong policymakers. In the monetary areas, China and

Hong Kong wil l continue to have two separate monetary systems,

two currencies, and two independent monetary authorities. Hong

Kong wil l also continue to participate in international organisations

and subscribe to international treaties.

Continuation of the rules-based policy framework that has

contributed to Hong Kong's past success augurs well for

maintaining confidence and stability in the coming years. In the

area of fiscal policy, budget surpluses are expected to continue

over the medium term. Whi le some concerns have been

expressed that these surpluses, along with a high level of fiscal

reserves, wi l l intensify political pressures for more interventionist

policies, the tradit ion of small government appears well entrenched

in Hong Kong and continued moderate budget surpluses should be

considered appropriate from the viewpoint of macroeconomic

policy. Continuity of the exchange rate link will also be important


for maintaining confidence. It is well reorganised that closer

integration wi th China will increase the possibility of conflict

between Hong Kong's business cycle and monetary conditions

imported f rom the United States. However, past experience

suggests that the adaptability of Hong Kong's firms and the

flexibility of factor and commodity prices - even during a period

of massive structural change - are sufficiently high to preserve

competitiveness and continued strong macroeconomic performance.

With in the context of a sound economic policy framework, Hong

Kong's medium-term prospects appear highly favourable. On the

domestic side, recent public infrastructure investment and massive

imports of capital goods have raised the productive capacity of the

economy. In addition, with many emigrants returning to Hong

Kong, labour supply has become more abundant after a decade of

labour shortages. On the external side, the recent "soft landing"

of the Chinese economy suggests that China will be able to sustain

solid and more stable growth over the coming years, which will be

highly beneficial for Hong Kong. In addition, Hong Kong has strong

potential to develop further as an international financial centre. As

China liberalises its controls on capital account transactions, Hong

Kong will be able to play a central role in the subsequent rise in

financial flows into and out of China. More generally, Hong Kong

can benefit as an intermediary for savings and investment flow

within Asia as these are, to a large extent, intermediated outside

the region. Thus, while growth is unlikely to reach the levels of

the 1980s, Hong Kong appears to be well positioned to mature

further as a services-based economy wi th development of trading

and financial links both to the rest of China and the rest of the

wor ld.


Annex I

Institutional Arrangements for Hong Kong after 1997

The constitutional framework for the Hong Kong SpecialAdministrative Region (HKSAR) has been laid down in the Sino-British Joint Declaration (1984) and the Basic Law of the HKSARof the People's Republic of China (1990). Under this framework,the HKSAR is to remain autonomous in all but two areas - foreignaffairs and defence - for 50 years after July I» 1997.

Key provisions with respect to the economic and legal systemof the HKSAR are:

The socialist system and policies shall not be practised in theHKSAR, and the previous capitalist system and way of lifeshall remain unchanged for 50 years;

• The rights of private ownership of property and investmentsshall be protected by law;

• The land and natural resources within the HKSAR shall bestate property and shall be managed by the HKSAR;

• The laws previously in force in Hong Kong - the commonlaw, rules of equity, ordinances — shall be maintained, exceptfor any that contravene the Basic Law.

On public finances, the Joint Declaration and the Basic Lawprovide for:

Independent finances of the HKSAR and use of its resourcesexclusively for its own purposes;


Freedom f rom taxation by the Central Government of China

in the HKSAR;

Independent tax system and own tax laws of the HKSAR,

taking the low tax policy as reference;

Prudent budgetary principles consisting of: (i) keeping

expenditure within the limits of revenue in drawing up the

budget; (ii) striving to achieve fiscal balance; (iii) avoiding

deficits; and (iv) keeping the budget commensurate wi th the

growth rate of GDP.

On the monetary and exchange rate system, the key

provisions are:

Independence of the HKSAR in monetary, financial, regulatory,

and supervisory policies;

• The Hong Kong dollar shall remain the legal tender and a

freely convertible currency fully backed by foreign exchange;

• Freedom from all foreign exchange controls in the HKSAR;

Free movement of capital within, into, and out of the HKSAR;

• Management and control of the Exchange Fund by the

Government of the HKSAR primarily for regulating the

exchange value of the Hong Kong dollar.

The HKSAR shall also maintain autonomy in its external

economic relations (including the status of a free por t and a

tariff-free zone, separate customs terr i tory, and participation - in

an appropriate capacity - in relevant international organisations),

immigrat ion controls on foreign persons (entry of people from


the other parts of China will be controlled by the Central

Government in consultation with the HKSAR Government), and

other policies (land leasing, shipping, civil aviation, social

services).

Details for implementation of these provisions are being worked

out on an ongoing basis. In September 1996, the Chinese

authorities have defined the monetary relationship betweenChina and H o n g Kong under the concept of "one country, two

systems" as one country wi th two currencies, two monetary

systems, and two monetary authorities which are mutually

independent.


H O N G K O N G ' S M O N E T A R Y

A R R A N G E M E N T S T H R O U G H I 9 9 7 1

Hong Kong Monetary Authority staff

Overview

The principle of "one country, two systems" forms the backbone

of China's policy toward the Hong Kong Special Administrative

Region (HKSAR) after I July 1997. "One country, two systems"

means that after 1997, the socialist system and policies shall not

be practised in Hong Kong, and the capitalist system and way of

life shall remain unchanged for fifty years. The concept of uone

country two systems" is firmly embedded in the Sino-British Joint

Declaration and the Basic Law, or the mini-constitution for Hong

Kong after 1997.

According to the Joint Declaration and the Basic Law, Hong Kong

will enjoy autonomy in all areas other than foreign affairs and

defence matters. In particular, the HKSAR shall, on its own,

formulate monetary and financial policies. The Hong Kong dollar,

as the only legal tender in Hong Kong, shall remain freely

convertible, with free flow of capital and no exchange controls.

The Hong Kong dollar shall also continue to circulate, and the

existing mechanism of currency issue shall continue. The

Exchange Fund shall be managed and controlled by the

government of the HKSAR.

This paper was prepared by the Hong Kong Monetary Authority staff for theConference on Financial Integration in Asia and the Role of Hong Kong, held inHong Kong on 7 March 1997.

Hong Kong's Monetary Arrangements Through 1997

These provisions form the foundation for Hong Kong's monetary

arrangements, and they can best be summonsed as one country,

two currencies, two monetary systems, and two mutually

independent monetary authorities. "Mutually independent" is

defined to mean that one does not have precedence over the

other, one is not superior to the other, and- one does not take

instructions from the other.

As regards prudential supervision, Hong Kong's high financial

regulatory standards will be maintained, and the level playing

field will continue after 1997, Under the Basic Law, Hong Kong's

common law framework and courts system will be retained. The

Hong Kong government will continue to supervise financial

institutions in Hong Kong, including financial institutions from the

mainland of China. Financial institutions from the mainland will

be treated in the same way as any other foreign institutions in

Hong Kong - they will not enjoy any special privileges. In

particular, financial institutions front the mainland in Hong Kong

shall abide by the law of Hong Kong and be regulated by the

relevant supervisory authorities in Hong Kong. Furthermore, the

People's Bank of China has also pledged to support the currency

stability of Hong Kong. When requested by the Hong Kong

Monetary Authority, China stands ready to use its foreign reserves

to support the Hong Kong dollar. However, China will not draw

on or resort to Hong Kong's Exchange Fund or other assets in any

way, for any reason.

The above provisions form the basic framework that allows Hong

Kong to discharge its responsibility under the Basic law to

provide an appropriate economic and legal environment to

maintain Hong Kong's status as an international financial centre.


I Introduct ion

Under the Sino-British Joint Declaration of 1984, China will

resume its exercise of sovereignty over Hong Kong on I July

1997. After that date, Hong Kong wil l become the Hong Kong

Special Administrative Region (HKSAR) of the People's Republic

of China, governed by the Basic Law, the applicable constitution of

Hong Kong,

Both the Joint Declaration and the Basic Law enshrine the

principle concept of "one country, t w o systems". Under this

framework, Hong Kong shall enjoy a high degree of autonomy

after 1997, except in foreign affairs and defence matters. This

concept of "one country, two systems" wil l also apply to the

monetary and financial arrangements between the mainland of

China and Hong Kong.

The practical issues under the legal f ramework have beentranslated into a set of comprehensive principles, which seniorChinese officials have clarified in different occasions. Theseprinciples define the post-1997 monetary relations between themainland of China and Hong Kong as "one country, twocurrencies, two monetary systems and t w o mutually independentmonetary authorities". Mutually independent means that one doesnot have precedence over the other, one is not superior to theother and one does not take instruction f rom the other.

There are practical and sound reasons why t w o separate

currencies wil l be maintained. The Hong Kong dollar is an

established, freely convertible currency that is widely accepted for

trade and investment purposes. It is more than five times backed

by foreign exchange reserves. It is the only legal tender in Hong

Kong and is treated as a foreign currency in the mainland of

China. The Renminbi is convertible for current account purposes

but is not yet convertible on the capital account. It is the only


legal tender in the mainland, and is treated as any other foreigncurrency in Hong Kong.

Significant structural differences between the economies in the

mainland of China and Hong Kong also support monetary

segregat ion. The Chinese Government recognises that

corresponding to two currencies will be two monetary systems,

reflecting the differences between the two economies. Both

monetary systems are of equal importance to China in its reform

and liberalisation. The close trade and investment ties between

the two economies would be facilitated by close co-operation in

such areas as development of financial markets, financial

infrastructure and prudential supervision.

II Constitutional Safeguards

While the Joint Declaration elaborates the basic policies of thePeople's Republic of China regarding Hong Kong after 1997, theBasic Law prescribes the systems for implementing such basicpolicies in the HKSAR after 1997. Regarding financial andmonetary affairs, both legal documents secure a high degree ofautonomy. These are outlined in Parts V and VII of Annex I of theJoint Declaration; and Article 106 and Articles 109 to 116 of theBasic Law2. Specifically, it is provided that, after the transition, theHKSAR Government (HKSARG) may decide its monetary andfinancial policies on its own. As to currency arrangements, theexisting system will continue, and the Hong Kong dollar shallcontinue to circulate and remain freely convertible. Furthermore,Hong Kong's foreign exchange reserves, namely the ExchangeFund, will be managed and controlled by the HKSARG, primarilyfor regulating the exchange value of the Hong Kong dollar.

2 The key excerpts from the Joint Declaration and the Basic Law are attached as

Annex I of the paper.


Under the Basic Law, there will be an even higher degree of

monetary autonomy. Currently under the Royal Instructions, the

Governor shall not assent to any Bill relating to the currency or

any banking association wi thout having obtained approval f rom the

Secretary of State. However, the Basic Law only requires that

laws enacted must be reported to the Standing Committee of the

National People's Congress for the record, while such reporting

for record wil l not affect the entry into force of these laws.

Furthermore, powers of the Secretary of State have been

localised, so that the authorities over areas such as Exchange

Fund's investment in securities and the borrowing limit for the

Exchange Fund have been brought entirely into Hong Kong.

Hong Kong wil l enjoy an equally high degree of fiscal and financial

autonomy after the change in sovereignty. The legal framework

safeguards that the HKSAR shall use its financial revenues

exclusively for its own purposes, and they shall not be handed

over to the Central People's Government. There are also

provisions stating that the Central People's Government shall not

levy taxes in the HKSAR.

A distinctive feature of the Basic Law is that it specifically lays

down that the HKSARG "shall provide an appropriate economic

and legal environment for the maintenance of the status for Hong

Kong as an international financial centre". It is also the responsibility

of the HKSARG to safeguard the free operation of financial

business and financial markets, and regulate and supervise them in

accordance wi th the law. Under the Basic Law, Hong Kong's

common law framework and courts system wil l be retained. The

existing capitalist system will be retained in Hong Kong, whereas

the mainland socialist system and policies wil l not be practised in

Hong Kong. Moreover, Hong Kong wil l maintain its status of a

free port and a separate customs te r r i to ry wi th free f low of

capital. Such constitutional framework is conducive to maintaining


and enhancing the competitiveness of Hong Kong's financialmarkets.

There are also provisions in the Joint Declaration and the Basic

Law that Hong Kong may, on its own, maintain and develop

relations and conclude and implement agreements with other

countries, regions and international organisations, using the name

of "Hong Kong, China". For example, Hong Kong is a member of

the Asian Development Bank, the Wor ld Trade Organisation, and

Asia Pacific Economic Co-operation (APEC); and the Hong Kong

Monetary Author i ty (HKMA) is a member of the Bank for

International Settlements and a participant of the New

Arrangements to Borrow (NAB). Such provisions help maintain

and promote Hong Kong's international monetary relations and

hence its status as an international financial centre.

HI Principles Governing the Monetary Relations Betweenthe Mainland of China and Hong Kong after 1997

On the basis of the legal framework, there are seven principles

governing the monetary relations between the mainland of China

and Hong Kong after 1997, as enunciated by Mr Chen Yuan,

Deputy Governor of the People's Bank of China3. These principles

cover the full range of monetary and financial affairs and elaborate

the f ramework of "one country, two currencies, two monetary

systems and two mutually independent monetary authorities".

Monetary Autonomy

The first principle states that the Renminbi and the Hong Kong

dollar wil l remain two different currencies, circulating as legal

tender in the mainland of China and Hong Kong respectively. The

3 Speech at a Bank of England seminar held on 10 September 1996 in London.

Hong Kong's Monetary Arrangements Through 1997 gQy

Hong Kong dollar wil l be treated as a foreign currency in the

mainland. Likewise, the Renminbi wil l be treated as any other

foreign currency in Hong Kong.

Corresponding to the " two currencies" wil l be " two monetary

systems". The current note-issuance by three note-issuing banks

in Hong Kong will continue to exist, wi th 100% backing by US

dollars under the linked exchange rate system. The objective of

monetary policy in Hong Kong is currency stability, in terms of the

Hong Kong dollar's link to the US dollar at the fixed exchange

rate of 7.80 to the US dollar. Exchange rate stability and hence

confidence in the currency is crucial to the maintenance of

stability and prosperity in Hong Kong before and after 1997.

The Hong Kong dollar's link with the US dollar follows the

currency board system, which is a strong form of the fixed

exchange rate regime. Since its adoption in 1983, the link has

remained resilient to a number of external shocks. For an open

and highly externally oriented economy, the maintenance of a

stable external value of the currency has proved to be a successful

policy. Over the past ten years, a number of monetary reform

measures have been introduced to strengthen Hong Kong's

monetary system and to put the authorities in a strong position to

ensure exchange rate stability.

The linked exchange rate system has received support f rom both

the United Kingdom and the Chinese Governments, as well as the

international community including, the International Monetary

Fund4 and the Bank for International Settlements5. Indeed, the

People's Bank of China (PBoC) has pledged to support the

4 In the IMF's annual Article IV consultations with Hong Kong.5 The BIS stated that the sheer size of Hong Kong's international reserves "has

given this commitment (to exchange rate link) almost unparalleled credibility"


currency stability of Hong Kong, as the fourth of seven principles

laid down above. In February 1996, the PBoC entered into a

repurchase agreement on US Treasury papers with the HKMA, to

enhance the liquidity of each other's official reserves and to

preserve exchange rate stability. The PBoC has also pledged its

readiness t o use China's foreign reserves to support the Hong

Kong dollar when necessary at the request of the HKMA.

However, i t has been emphasised many times that China will not

draw on or resort to Hong Kong's Exchange Fund or other assets

in any way and for any reasons. China is currently the world's

second largest foreign reserves holder, with reserves of US$105

billion as at the end of 1996.

The second principle relates to the relationship between the two

monetary authorities. W i th two currencies and two monetary

systems, the two monetary authorities will also be mutually

independent, as defined in the third paragraph (p.220). The PBoC

will not take the place of the HKMA and will not set up any

branches in Hong Kong. The HKMA is responsible for monetary

affairs in Hong Kong and it wil l be accountable solely to the Hong

Kong government.

Co-operation in Prudential Supervision

As a major international financial centre, Hong Kong will maintain

its high level of prudential supervision over financial institutions

operating in Hong Kong, and a clear level playing field in

accordance wi th international rules and practices. Hong Kong's

high financial regulatory standards will be maintained in line with

the best international practices and standards. These are illustrated

in the th i rd principle.

In particular, the supervisory standards recommended by the

Basle Committee on Banking Supervision are fully met in Hong


Kong. Indeed, the supervisory framework is clear, transparent and

accountable, w i th the Banking Ordinance clearly defining the

powers and responsibilities of the HKMA as the regulator.

Moreover, the HKMA is transparent on how it interprets and

applies the statutory framework and it maintains a close dialogue

with the banking industry. There is also a clearly defined

mechanism for reaching supervisory decisions and judgments

with in the H K M A for appropriate checks and balances.

Furthermore, the HKMA offers guidance to the banking industry

through statutory guidelines issued under the Banking Ordinance

and a Code of Banking Practice.

The co-operation in licensing procedures and supervision of

financial institutions from the mainland of China and Hong Kong

will fol low these guidelines:-

• Financial institutions from the mainland established in Hong

Kong shall not enjoy any privileges. They shall abide by the

law of Hong Kong and be regulated by the relevant

supervisory authority in Hong Kong.

• Financial institutions based in the mainland and Hong Kong

setting up offices in each other's te r r i to ry shall be approved

on the same basis as foreign financial institutions.

The offices of Hong Kong based financial institutions in the

mainland shall continue to enjoy the same preferential

treatment in the mainland as other foreign financial institutions.

In addition, the HKMA has agreed wi th the PBoC to co-ordinate

the applications for cross-border licences by banks f rom their

respective terr i tor ies. They wil l also allow one another to

conduct examinations of the cross-border operations of banks in

their respective terri tories and t o exchange information on such

operations.

0J@ Hong Kong's Monetary Arrangements Through 1997

The fifth principle relates to the treatment of financial business

between the mainland of China and Hong Kong. After I July 1997,

all financial business and even commercial disputes between the

two places wil l be handled according to the rules and practices of

international financial activities. Claims and liabilities between

banks and companies f rom the mainland and those in Hong Kong

will continue to be regarded as external claims and liabilities.

The sixth principle relates to the standing of financial institutions

from the mainland in Hong Kong. The HKMA will continue to

supervise all financial institutions in Hong Kong, including financial

institutions f rom the mainland. The Bank of China group, though

being one of the three note-issuing banks and a leading commercial

bank in Hong Kong, shall not be treated more favourably than

other banks. It shall not carry out activities beyond the role of a

commercial bank.

Hong Kong as an International Financial Centre

Hong Kong's continued autonomy as a financial centre after 1997

requires that it should retain its own links with monetary and

financial authorities abroad and continue to participate in the

activities of international and regional financial institutions, such as

central bank forums and working groups. China has supported

Hong Kong's continued membership of a number of international

bodies. The international financial community also acknowledged

the "mutually independent" relationship between the PBoC and

the HKMA, as demonstrated by separate membership of the two

in the Bank for International Settlements.

To cope wi th the growing financial integration, there should be an

efficient and robust market infrastructure linking the financial

markets. The HKMA and the PBoC have agreed in principle to the

linkage of their high value interbank payment systems. The HKMA


introduced its Real Time Gross Settlement (RTGS) interbankpayment system in December 1996, while the PBoC is expectedto complete its RTGS China National Automated Payment Systemin the near future. Further linkages of payment systems aroundthe region and with other international financial centres wouldenhance both regional and global financial integration.

The seventh principle of Hong Kong's monetary arrangementsthrough 1997 relates to the complementarity between Hong Kongand Shanghai. While Shanghai is currently China's major financialcentre, the governing principle is that Hong Kong and Shanghaiwill have a complementary and mutually reinforcing relationship,developing together with their own unique features and underdifferent comparative advantages. It has been pointed out byseveral senior Chinese officials that in the short run, and at leastbefore the Renminbi becomes fully convertible, it will not bepossible for Shanghai to become an international financial centre.In the longer-term, the role of Hong Kong as an internationalfinancial centre will serve to expedite the development ofShanghai as the main centre for Renminbi business. At the sametime, Shanghai will support Hong Kong's further development asan international financial centre, and gradually become aninternational financial centre itself. Given the size of China'seconomy, there are ample business opportunities for more thanone financial centre.

IV Economic Foundations of the Monetary Relations

The strong economic fundamentals in the mainland of China andHong Kong also argue for a smooth monetary transition through1997. The sound economic fundamentals of Hong Kong,characterised by continued strong growth and moderated inflation,are the bases for continued prosperity and stability. In addition, itsunique advantages, such as openness, strategic geographical


location, excellent communications and financial skills, will notchange as a result of the change in sovereignty. Moreover, theHong Kong government follows strict fiscal discipline thatunderpins its monetary policy and enhances the credibility of itsmonetary stance.

Equally, the continued economic development and financial reformsin the mainland of China have created excellent opportunities forHong Kong. China's economy continues to grow strongly,generating a strong demand for funds. Given the strategic positionof Hong Kong, it will continue to be the major funding centre forthe mainland after 1997, as it has been in the past. Stability in themainland is the very basis for Hong Kong's stability while HongKong's stability will certainly enhance economic reform anddevelopments in China.

As an indication, the market has its vote of confidence on HongKong's monetary arrangements through 1997. The inaugural issueof 10-year Exchange Fund Note in October 1996 was wellreceived, with oversubscription rate of over 13 times. The papercurrently shows a yield with only 40 basis points above USTreasuries, indicating no risk premium associated with 1997 andbeyond.

V Conclusion

With the mutually beneficial relationship between the mainland ofChina and Hong Kong, it is of .China's strategic interest to retainthe present monetary and financial policies that have served bothwell. Nevertheless, there is. also the need for close co-operationbetween the two places to derive the most benefits out of theirclose ties.


The "one country, two currencies, two monetary systems and two

mutually independent monetary authorit ies" principle is both

visionary and pragmatic way of defining the monetary relations

between the mainland of China and Hong Kong after I July 1997.

Indeed, this is well secured by the legal and constitutional

framework, which has been translated into a set of governing

principles publicly announced by the senior Chinese officials. At

the same time, the economic developments in the mainland and

Hong Kong also provide a favourable environment for the legal

provisions to be realistically observed. Through 1997, there will

be the right legal, constitutional and economic framework for a

smooth monetary transition in Hong Kong.


Annex I

T h e J o i n t D e c l a r a t i o n o f

t h e G o v e r n m e n t o f t h e U n i t e d K i n g d o m o f

G r e a t B r i t a i n a n d N o r t h e r n I r e l a n d

a n d t h e G o v e r n m e n t o f

t h e P e o p l e ' s R e p u b l i c o f C h i n a

o n t h e Q u e s t i o n o f H o n g K o n g

(Annex I: Part V and Part VII)

(Signed on 19 December 1984)

Part V . F I N A N C E

Budget

The Hong Kong Special Administrative Region shall deal on its

own wi th financial matters, including disposing of its financial

resources and drawing up its budgets and its final accounts. The

Hong Kong Special Administrative Region shall report its budgets

and final accounts to the Central People's Government for the

record.

Taxation and public expenditure

The Central People's Government shall not levy taxes on theHong Kong Special Administrative Region. The Hong Kong SpecialAdministrative Region shall use its financial revenues exclusivelyfor its own purposes and they shall not be handed over to theCentral People's Government. The systems by which taxation andpublic expenditure must be approved by the legislature, and bywhich there is accountability to the legislature for all publicexpenditure, and the system for auditing public accounts shall bemaintained.


Part VII. MONETARY SYSTEM

Previous monetary and financial systems

The Hong Kong Special Administrative Region shall retain thestatus of an international financial centre. The monetary andfinancial systems previously practised in Hong Kong, including thesystems of regulation and supervision of deposit taking institutionsand financial markets, shall be maintained.

Monetary and financial policies

The Hong Kong Special Administrative Region Government maydecide its monetary and financial policies on its own. It shallsafeguard the free operation of financial business and the free flowof capital within, into and out of the Hong Kong SpecialAdministrative Region. No exchange control policy shall beapplied in the Hong Kong Special Administrative Region. Marketsfor foreign exchange, gold, securities and futures shall continue.

Hong Kong dollar

The Hong Kong dollar, as the local legal tender, shall continue tocirculate and remain freely convertible. The authority to issueHong Kong currency shall be vested in the Hong Kong SpecialAdministrative Region Government. The Hong Kong SpecialAdministrative Region Government may authorise designatedbanks to issue or continue to issue Hong Kong currency understatutory authority, after satisfying itself that any issue of currencywill be soundly based and that the arrangements for such issue areconsistent with the object of maintaining the stability of thecurrency. Hong Kong currency bearing references inappropriateto the status of Hong Kong as a Special Administrative Region ofthe People's Republic of China shall be progressively replaced andwithdrawn from circulation.

ffljj Hong Kong's Monetary Arrangements Through 1997

Exchange Fund

The Exchange Fund shall be managed and controlled by the Hong

Kong Special Administrative Region Government, primarily for

regulating the exchange value of the Hong Kong dollar.


Basic L a w o f t h e H o n g K o n g

S p e c i a l A d m i n i s t r a t i v e R e g i o n o f t h e

P e o p l e ' s R e p u b l i c o f C h i n a

(Article 106 and Articles 109 to 116)

(promulgated on 4 April 1990)

Art ic le 106

The Hong Kong Special Administrative Region shall have

independent finances.

The Hong Kong Special Administrative Region shall use its

financial revenues exclusively for its own purposes, and they shall

not be handed over to the Central People's Government.

The Central People's Government shall not levy taxes in the Hong

Kong Special Administrative Region.

Article 109

The Government of the Hong Kong Special Administrative Region

shall provide an appropriate economic and legal environment for

the maintenance of the status of Hong Kong as an international

financial centre.

Art ic le 110

The monetary and financial systems of the Hong Kong Special

Administrative Region shall be prescribed by law.


shall, on its own, formulate monetary and financial policies,

safeguard the free operation of financial business and financial

markets, and regulate and supervise them in accordance with law.

|j2 Hong Kong's Monetary Arrangements Through 1997

Article I I I

The Hong Kong dollar, as the legal tender in the Hong Kong

Special Administrative Region, shall continue to circulate.

The authority to issue Hong Kong currency shall be vested in the

Government of the Hong Kong Special Administrative Region. The

issue of Hong Kong currency must be backed by a 100 per cent

reserve fund. The system regarding the issue of Hong Kong

currency and the reserve fund system shall be prescribed by law.


may authorize designated banks to issue or continue to issue

Hong Kong currency under statutory authority, after satisfying

itself that any issue of currency wil l be soundly based and that the

arrangements for such issue are consistent with the object of

maintaining the stability of the currency.

Art ic le 112

No foreign exchange control policies shall be applied in the Hong

Kong Special Administrative Region. The Hong Kong dollar shall

be freely convertible. Markets for foreign exchange, gold, securities,

futures and the like shall continue.


shall safeguard the free f low of capital within, into and out of the

Region.

Art ic le 113

The Exchange Fund of the Hong Kong Special Administrative

Region shall be managed and controlled by the Government of the


Region, primarily for regulating the exchange value of the Hong

Kong dollar.

Art ic le 114

The Hong Kong Special Administrative Region shall maintain the

status of a free port and shall not impose any tariff unless

otherwise prescribed by law.

Art ic le 115

The Hong Kong Special Administrative Region shall pursue the

policy of free trade and safeguard the free movement of goods,

intangible assets and capital.

Art ic le 116

The Hong Kong Special Administrative Region shall be a separate

customs territory.

The Hong Kong Special Administrative Region may, using the

name "Hong Kong, China", participate in relevant international

organizations and international trade agreements (including

preferential trade arrangements), such as the General Agreement

on Tariffs and Trade and arrangements regarding international

trade in textiles.

Export quotas, tariff preferences and other similar arrangements,

which are obtained or made by the Hong Kong Special

Administrative Region or which were obtained or made and

remain valid, shall be enjoyed exclusively by the Region.

Hong Kong's Monetary Arrangements Through J 997

T H E I M P O R T A N C E O F F I N A N C I A L I N F R A S T R U C T U R E I N

F I N A N C I A L I N T E G R A T I O N 1

Hong Kong Monetary Authority staff

Overview

During 1990-95, one-third of total capital flows to developing

countries came to Asia, about half of this in the form of foreign

direct investment This is in stark contrast to the situation in Latin

America, Africa, and the Middle East, where portfolio flows

represent the bulk of capital flows. Despite the region's healthy

growth - Asia's share of world output jumped from 16 percent in

1985 to 24 percent in 1995 - there is the question of why Asia

has not been able to benefit more from the global increases in

portfolio flows. Asia has high saving rates and has undertaken

significant deregulation of its financial markets. Nevertheless, the

development of Asian financial markets has been uneven.

To maintain stable growth with low inflation, Asian investment

requirements, particularly in infrastructure, will be huge. Deep

debt markets must be developed to intermediate long-term

savings to finance long-term investments, both regionally and

abroad. At present, much of Asia's high savings is intermediated

through OECD markets. Since the degree of foreign funding of

domestic investments is subject to balance of payments constraints,

there is no alternative to developing domestic market

intermediation. An obvious starting point is the improvement of

financial infrastructure. In this respect, the lessons of Hong

This paper was prepared by the Hong Kong Monetary Authority staff for theConference on Financial Integration in Asia and the Role of Hong Kong, held inHong Kong on 7 March 1997.

The Importance of Financial Infrastructure in Financial Integration

Kong's experience in developing financial infrastructure to deepen

financial integration are useful.

Through its strategic geographical location, good communications,and low-tax and free-port status, Hong Kong has played animportant role as a regional financial centre for loan syndicationand equity investment Eighty of the top 100 international banksoperate in Hong Kong. The equity market has a marketcapitalisation over two and a half times Hong Kong's GDP; itserves not only Hong Kong, but in recent years has also been animportant source of funding for companies investing in the Asianregion, particularly in China. The size of Hong Kong's debtmarket has increased from almost zero in 1990 to 23 percent ofGDP in 1996. In December 1996, Hong Kong upgraded itsinterbank payment system, which is fully integrated with the debtsecurities clearing system, thus adding to the liquidity of the debtmarket and reducing payment and settlement risks.

As global markets become more interrelated through trade andinvestments, there are increasing benefits in enhancing financialmarket infrastructure to minimise risks, including the contagionrisks arising from capital flows. Adopting international standardsand practices and creating an efficient and robust regionalinfrastructure will help to strengthen domestic financial marketsand improve risk management. The Hong Kong MonetaryAuthority has initiated discussions in Asia to promote cross-borderlinkage of domestic central securities depositories - through theAsiaClear network concept - and, separately, to establish linkagesbetween payment systems, when ready, to further reduce cross-border transaction risks. These and similar steps to upgradeAsian financial infrastructure will help to ensure that financialintermediation and integration, in the Asian region and globally,will progress in a sound and stable manner, in line with Asia'sgrowth in the twenty-first century.


I Introduction

Over the past two decades, Asian economies have substantiallyincreased their share of world trade and income and access tointernational capital markets. To sustain this strong performance,substantial investments will have to be made to upgrade social andphysical infrastructure. Financial integration, both regionally andglobally, can help effectively mobilise and improve resourceallocation for these investments.

In recent years, greater cross-border trade, direct and portfolioinvestments arose because of greater financial sector liberalisationin many markets, the emergence of institutional investors, andgrowing financial innovation and product development. Directinvestment in Asia was led by the prospects of stable and highergrowth, attractive rates of return, low cost of production andrising purchasing power.

Financial integration carries both opportunities and risks. Greaterfinancial integration implies greater access to foreign skills andcapital resources, but the rapid reversal could disrupt currencyand capital markets, forcing painful adjustments to the emergingmarkets. Lessons since the Mexican crisis of 1994 have inducedboth the private and public sectors to review their ability tomanage the risks associated with capital flows.

As regional investors participate in each other's markets - theprocess of financial integration - the financial markets mustfunction efficiently and smoothly to accommodate such flows. Thecontinuing globalisation of markets means that domestic marketscannot be considered in isolation by both the private investorsnor the regulators. Shocks can be rapidly transmitted from withinand without Since the degree of foreign funding of domesticinvestments is subject to balance of payments constraints, there is


no alternative t o the development of domestic market

intermediation. This paper suggests that an obvious starting point

is the improvement in the financial infrastructure.

As an international financial centre in the region, Hong Kong has

played a significant role in facilitating the international f low of

funds that has assisted economic development in Asia. The lessons

of Hong Kong's experience in developing financial infrastructure

to deepen financial integration may be instructive.

II Growing Financial Integration

Asia2 is the fastest growing region in the world. Since I960, theregion has grown at an average annual rate of 5.7%, which was I ]/itimes the global average. Fast economic growth in Asia is alsoreflected in its rising share of world output, which jumped from16% in 1985 to 24% in 1995. A major contributor to Asia'sremarkable economic growth has been the expansion of externaltrade, in particular intra-regional trade. While trade between Asiaand the rest of the world increased by 280% in the past decade,intra-Asian trade grew sixfold.

Accompanying this rapid growth has been an increasing trend offinancial integration, both globally and regionally. Financialintegration, in a broad sense, implies growing linkages betweenfinancial markets through cross-border trade and direct andportfolio investment flows. The phenomenal increase in tradeflows has spurred greater cross-border payments. As developedcountries shifted their production bases to Asia, where costs arelower, foreign capital and foreign financial institutions followed.Financial integration has also been underpinned by the liberalisationand deepening of financial markets in Asia. Greater openness of

2 Developing Asia, excluding Japan, Australia and New Zealand.


these emerging markets has allowed fund managers of developed

markets to broaden their portfolios, benefiting not only f rom the

higher rates of return in Asia, but reducing risks through

diversification.

Between 1990-95, 43% of net private capital flows to developing

countries came to Asia, and about half of such flows were in the

form of foreign direct investment (FDI). This is in stark contrast

to the situation in Latin America, Africa and the Middle East,

where port fo l io flows represent the bulk of capital flows.

Reflecting growing intra-regional trade was the remarkable growth

in intra-regional direct investment flows. For example, direct

investment f rom newly industrialising economies (NIEs)3 accounted

for 30% of the total value of FDI in East Asia in 1993, compared

to less than 10% in 1982, and they overtook the US and Europe to

become the major source of FDI in the region. Available statistics

showed that this trend has continued. Investment by the NIEs in

four ASEAN4 countries totalled about US$27 bn during 1993-95,

significantly higher than investment from Japan and the US

combined. Hong Kong and Taiwan have invested particularly

heavily in China. It is estimated that the NIEs made US$196 bn

wor th of contractual direct investment in the Mainland of China

during 1993-95 (Table I).

Notwithstanding the healthy growth in FDI, Asia has not been able

to benefit t o the same extent from the global increases in

portfol io f lows as other regions, such as Latin America. Whi le net

foreign direct investment flows to Asia rose by an average annual

rate of 41 % during 1991 -95, foreign portfolio and other investments

in the region grew more slowly by 30% (Table 2). Although Asia

3 Hong Kong, Korea, Singapore and Taiwan.

4 Including Indonesia, Malaysia, the Philippines and Thailand.


Table I :

Intra-Asian Foreign Direct Investment , 1993-95

(USSbn)

From/To China1 Indonesia2 Malaysia3 Thailand4 Philippines5 ASEAN 46

NIEs

Hong Kong

Taiwan

South Korea

Singapore

USA

japan

196.4

156.8

21.3

5.2

13.1

18.2

14.0

19.1

8.9

3.1

3.2

3.9

4.1

6.1

1.4

0.2

0.8

0.1

0.4

0.6

0.8

5.5

0.3

1.9

1.7

1.6

2.7

8.2

0.8

0.3

0.3

0.06

0.1

1.4

0.3

26.8

9.7

6.1

5.1

5.9

8.7

15.4

World 268.4 67.6 3.8 17.4 4.7 93.5

1 Foreign direct investment approved.2 Non-oil and gas foreign direct investment approved.3 Foreign investment (including equity and loan) approved by Malaysian Industrial

Development Authority.4 Total foreign investment receiving BOI (Board of Investment) promotion.5 Foreign equity investment approved by the Board of Investment.6 Including Indonesia, Malaysia, Thailand and the Philippines.

Source: Merrill Lynch, Asia Economic Outlook, various issues.

has high saving rates of well over 30% of GDP, and economies in

the region have undertaken significant financial liberalisation, the

development of Asian financial markets has been uneven (Table 3).

Regional financial integration has been constrained by market

segmentation, imbalances in the development of different markets

and the lack, until recently, of an efficient and robust financial

infrastructure.


Table 2:

Private Capital Flows to Asia, 1990-95

Net capital flows' to

AsiaNet foreign direct investmentNet portfolio investmentOther2

Total

All developing countriesNet foreign direct investmentNet portfolio investmentOther2

Total

Asia's share of totalnet capital flows (%)

1990

9.4-0.914.623.1

18.618.36.6

43.5

53

1991

14.32.9

32.649.8

28.436.989.6

154.9

32

(US$bn)1992

14.49.87.9

32.1

31.647.251.3

130.1

25

1993

32.723.814.070.5

48.989.634.5

172.9

41

1994

41.916.023.181.1

61.350.439.8

151.6

53

1995

52.418.533.2104.1

71.737.085.1193.7

54

1 Not including reserve assets.2 Short- and long-term trade credits; loans (including use of IMF credit); currency

and deposits; and other accounts receivable and payable.

Source: International Monetary Fund, World Economic Outlook database.

Asia is expected to continue its rapid pace of growth over thenext decade5. Financing this growth will require massive investment,particularly in infrastructure. The World Bank has estimated thatthe investment needs of East Asia alone amount to US$8 trillionin the decade to 20046. The financing of infrastructure investments

5 For the coming decade, the World Bank projects that East Asia will continue togrow rapidly at an average annual rate of 7.7% (World Bank, The Emerging AsianBond Market, June 95).

6 World Bank, The Emerging Asian Bond Market, June 1995.

The Importance of Financial Infrastructure in Financial Integration wSm

Table 3:

Asia-Pacific Countries - Selected Indicators

China

Hong Kong

Singapore

Thailand

S. Korea

Malaysia

Indonesia

Philippines

East Asia (excl. Japan)

Australia

Japan

USA

Germany

UK

Foreign Reserves(1996)

(US$bn)

105

64

75

38

33

27

16

10

480

15

218

77

88

42

Savings Ratio

(1995)

(%)

42

31

56

34

37

37

36

15

33

20

30

16

23

15

Sources: International Financial Statistics, IMF; Asian Development Outlook 1996 and1997; World Economic Outlook 1996, IMF.

and housing would require long-term funds. Whi le the commercial

banking system has long played a vital role in financing public and

private enterprises, its capacity to syndicate long-term credit for

new investment is constrained by their capital adequacy

requirements and the need to balance asset-liability maturity

mismatches. Moreover, despite the robust growth of several

emerging equity markets in Asia, their capacity to fund long-term


infrastructure projects remains limited. Deep debt markets must

be developed to intermediate long-term savings to finance long-

term investments, both intra-regionally and internationally. The

Wor ld Bank projects that in the next decade, the size of the East

Asian bond market could grow to over US$1 tril l ion (Table 4).

In relative terms, the Asian debt markets are still under-developed

by OECD market standards. The Wor ld Bank estimated that East

Asian bond markets (excluding Japan) averaged only 22% of GDP,

compared wi th 74% in Japan and I 10% in the US (Table 5).

A t present, a significant part of Asia's savings is intermediated

through markets in the US and Europe, which are generally

deeper, more efficient, robust and liquid. Asian foreign exchange

reserves are largely invested in these markets. Asian governments

and credi t -worthy corporations tend to issue their debt there,

clearing the i r paper through European central securities

depositories, such as Euroclear and Cedel in European time.

These are vivid examples of the shortfalls in Asian financial market

intermediation.

Given the increase in incomes and population ageing in Asia, there

will be an increasing role for retirement funds. There is thus an

obvious need to enhance financial integration within the region so

as to facilitate the mobilisation of regional savings into investments.

This can be accomplished through fostering a stable macroeconomic

environment, a well-conceived and enforced legal and regulatory

framework, deeper domestic financial markets and a more

effective financial infrastructure.


Table 4:

East Asia- Indicative Financing of Gross DomesticFixed Investment

Total PrivateGross DomesticFixed Investment

FinancingInternally Generated Funds

New Equity

Bank Borrowing

1994

(Actual)

US$bn %

309 100

124 40

31 10

124 40

1995-99

(Projected)

US$bn %

2,007

702

201

702

100

35

10

35

2000-2004(Projected)US$bn %

2,946

884

295

884

100

30

10

30

Sub-total 279 90 1,605 80 2,063 70

Remaining GapBondsForeign Financing

31283

1091

40234161

20173

884766118

30264

Source: World Bank, The Emerging Asian Bond Market, June 1995.

ill Importance of Market Infrastructure to SupportFinancial Integration

Increasingly, market participants realise that growing financialintegration require international standards of prudential supervision,and the ability of financial institutions in these markets to managetheir risks. Upgrading the quality of prudential supervision,


Table 5:

East Asia - Financial Market Size (% as of GDP, 1994)

Equity Bank Assets Bond

ChinaHong KongMalaysiaSingaporeS. Korea

East Asia (excl. Japan)JapanU.S.A.

* 1995 figures

920528321751

718075

7671910018675

13715254

717*567243

2274

110

Sources: World Bank, The Emerging Asian Bond Market, June 1995; Hong KongMonetary Authority.

including raising the quality of transparency of market transactionsand issuers to international standards will necessarily take time.As the macroeconomic framework improves, and domestic issuersimprove their accounting and reporting standards, credit risksbecome better managed. However, operational risks, includingpayment and settlement risks remain high, so long as an efficientand robust market infrastructure does not exist. The danger offraud and systemic shocks escalates with the operational inefficiencyof securities clearing and payment systems. These include theequity, debt and futures securities clearing and settlement systems,as well as the high value inter-bank payment systems. The failureof one system is likely to spread to another system, leadingpossibly to gridlock or gross uncertainties that increase volatilityin financial markets.


There are several reasons why improving financial market

infrastructure can enhance market efficiency and simultaneously

reduce risks. Firstly, Asian financial markets are latecomers in

development, with many payment and settlement systems still

largely paper-based. By adopting the latest technology in payment

and debt clearing systems, they can rapidly leapfrog developments

in many markets and attain international standards much quicker

than expected.

Secondly, the process of building financial infrastructure requires

sound project planning and close co-operation between the

regulatory authorities and the market participants, particularly the

securities and banking community. Co-operation in standards,

market practices and regulatory requirements can rapidly raise the

level of awareness of risks in existing systems, and improve

market management of such risks. The process of building one

system rapidly requires reform in another, so that smooth

linkages are achieved domestically and eventually, internationally.

Thirdly, co-operation between different systems in the same

region enables the adoption of common standards, which facilitates

transactions and reduces costs. For example, the European Union

has imposed uniform high value inter-bank payment systems

standards throughout the Union through the common system

TARGET These in effect impose standards on other systems

outside the Union which seek compatibility wi th TARGET

Similarly, the G-30 recommended the best practice on market

infrastructure in 1989, which was widely adopted. In 1995, the

International Society of Securities Administrators (ISSA) made

recommendations to update the G-30 guidelines, taking into

account improved technological capabilities and evolving market

best practices (Annex I). Financial markets in Asia will have to

meet the G-30/ISSA standards in order t o continue attracting

foreign portfolio investment.


Investors, particularly institutional investors, favour markets which

deliver market transparency and also robustness in achieving

Delivery versus Payment (DvP) or Payment versus Payment (PvP),

with minimal lags and payment and settlement risks. In Asia, Hong

Kong, Japan, South Korea and Thailand have already implemented

Real Time Gross Settlement (RTGS) interbank payment systems.

Increasing financial integration also calls for the networking of

financial infrastructure, between domestic markets and also cross-

border. Such linkages can be facilitated, if different systems with

different operating times use similar standards or internationally

accepted protocols and practices. This will allow PvP for foreign

exchange transactions and DvP for securities trading, thus

reducing cross-border payment and settlement risks and increasing

market liquidity. Institutional fund managers are increasingly

managing their portfol io on a global basis, and will allocate funds

to those markets that offer such facilities.

IV T h e H o n g Kong Experience

Through its strategic geographical location, good communications

and low-tax and free port status, Hong Kong has developed over

the past three decades as a fully-fledged regional and international

financial centre. It offers to local and international customers an

integrated network of financial institutions and markets that

provide a wide range of products and services. Financial services

contributed one-tenth of Hong Kong's GDP in 1994. Exports of

financial services have recorded an average annual real growth

rate of 10% over the past decade, reflecting both Hong Kong's

rapidly expanding financial links with economies in the region and

beyond, and its growing importance as an international financial

centre.


The stability of the financial markets in Hong Kong is ensured by a

regulatory regime which meets international standards and strikes

a careful balance between the need for prudential supervision and

allowing market initiatives to develop. This is reinforced by a

stable currency, which is fully convertible and remittable with no

restrictions. The Government also promotes regulatory standards

at least equal to the highest international standards, and also

encourages good code of conduct for market participants.

Hong Kong's soft financial infrastructure includes English common

law, which is widely practised in international trade, commerce

and banking. Having laws and regulation which are clear, fair,

transparent and consistent are crucial to sustaining the confidence

of local and international participants in Hong Kong's financial

services. The legal framework is supported by an independent

judiciary and one of the highest concentrations of international

firms of lawyers, accountants, and other financial services supporting

industries in the region.

In particular, Hong Kong has played an important role as a

regional financial centre for loan syndication and equity investment

Hong Kong's banking sector is the world's fifth largest in terms of

external assets. Eighty of the top 100 international banks are

operating in Hong Kong. In 1996, syndicated loans of over US$30

bn were arranged in Hong Kong. The banking sector of Hong

Kong is highly integrated with those in the region. Banks and non-

bank clients in the region currently account for more than 80% of

the external claims, of Hong Kong's banking system. A t the same

time, about 70% of the external liabilities of banks in Hong Kong

reflects deposits and inter-bank placements f rom the region.

Hong Kong has been an important saver and capital exporter in

the region. It is the largest external investor in the mainland of


China and Indonesia. Cumulative FDI amounting to over US$90

bn7 was invested in the mainland from 1979 to September 1996

and US$9 bn8 was invested in Indonesia during 1993 to 1995. In

addition, Hong Kong is amongst the top foreign investors

Malaysia, the Philippines and India.in

The equity market in Hong Kong is the largest in non-Japan Asia,

with a market capitalisation over 272 times of GDP. The stock

market serves not only Hong Kong, but also acts as an important

source of funding for companies investing in the Asian region,

particularly in China in recent years. Presently, there are 24 H-

shares listed on the Stock Exchange of Hong Kong, raising HK$2I

bn for enterprises operating in China.

Whi le Hong Kong has a well developed banking system and an

efficient equity market, its bond market is relatively nascent, as is

the case in other Asian economies (Table 5). In order to deepen

the debt market, the Hong Kong Monetary Authori ty (HKMA)

initiated the issue of its own debt paper in 1990 to serve as a

benchmark for Hong Kong dollar debt paper, despite the fact that

the government runs budget surpluses in most years. The Hong

Kong dollar yield curve has been gradually extended through the

introduction of longer term Exchange Fund Notes. It is currently

established up to 10 years.

To facilitate secondary market trading, a computerised debt

securities clearing system was developed. This robust and efficient

system, known as the Central Moneymarkets Unit (CMU), is

operated by the HKMA and serves as the central clearing and

settlement system for Hong Kong dollar debt securities. It was set

up in March 1990 to clear the Exchange Fund Bills. Encouraged by

the highly successful Exchange Fund Bills and Notes programme,

7 Actual direct investment.8 Approved direct investment.


the CMU has extended its clearing facilities and services to private

sector debt securities since the beginning of 1994. This CMU

Service has grown very rapidly since then and most of the financial

institutions in Hong Kong participate as CMU members. By end-

1996, the total value of debt securities lodged with the CMU,

including Exchange Fund Bills and Notes, stood at HK$225 bn

(US$29.1 bn).

Since its establishment, the CMU Service has been further

enhanced to become more comprehensive and user friendly.

Starting f rom I October 1994, the CMU offers a paying agent

function for private sector debt issues as an optional service

available to CMU Members. In December 1994, the CMU

established linkages with both Euroclear and Cedel, the two

largest international securities clearing systems in the wor ld.

These links, the first of their kind in East Asia, enable overseas

investors and traders easy access to the Hong Kong dollar debt

market. From December 1996, the CMU has further enhanced its

services by introducing real time and end-of-day DvP facility for all

instruments (both government and private sector papers) lodged

with and cleared by the CMU through the seamless interface with

the RTGS system.

A number of measures were implemented to encourage the

supply of high quality paper in Hong Kong. First, profits tax

exemption is offered to supranational for their Hong Kong dollar

debt issues. Second, the HKMA has acted as the arranger for

MTRCs HK$ I0 bn Notes Programme and will offer similar

services to the A i rpor t Authority. Third, a 50% profits tax

concession is offered for certain long-term debt securities issued

in Hong Kong. Fourth, with the impending implementation of a

Mandatory Provident Fund scheme to provide retirement benefits

for an ageing population, the introduction of a secondary

mortgage corporation which will issue mortgage-backed securities


would intermediate long-term savings to match the demand forlong-term mortgages.

The enhancement of financial infrastructure has facilitated the

development in the bond market. The size of Hong Kong dollar

debt market has since increased from almost zero in 1990 to 23%

of GDP in 1996. In 1996, the average daily turnover of Exchange

Fund Bills and Notes amounted to HK$I6 bn, or 25% of the total

value outstanding. The Exchange Fund Bills and Notes market

remains one of the most actively traded and liquid government

debt securities market in the wor ld.

To meet international standards and minimise settlement risks,

Hong Kong upgraded its large value interbank payment system to

a modern and streamlined Real Time Gross Settlement system in

December 1996. The RTGS system is fully integrated wi th the

CMU, so that debt trading can be cleared and settled on real-time

or end-of-day DvP basis. This has added to the liquidity of the

debt market and reduced payment and settlement risks. The

RTGS system also provides the building block for extending the

DvP services to other financial product markets in Hong Kong and

for establishing PvP linkages with other major financial centres.

As global markets become more inter-related through trade and

investments, there are increasing benefits to be gained by

enhancing financial market infrastructure to minimise risks, including

the contagion risks arising from capital flows. By adopting

international standards and practices, the creation of a regional

efficient and robust infrastructure will help strengthen domestic

financial markets and allow market participants to manage their

risks better. The HKMA has initiated discussions in Asia to

promote cross-border linkage of domestic central securities

depositories, through the AsiaClear concept of a network of such

depositories. Such discussions, including technical exchange of


experience, would lead to greater harmonisation of practices and

standards of compliance with international banking practice,

leading to overall improvement in efficiency with lower risks.

When fully developed, AsiaClear will facilitate domestic participants

in the trading, holding and settlement of Asian and Euro bonds in

Asian t ime and it wil l enable cross-border DvP transactions.

Separately, discussions are ongoing to establish linkages between

payment systems, when they are ready, to further reduce cross-

border transaction risks. The HKMA has reached agreement in

principle wi th the People's Bank of China to develop a PvP link

between the Hong Kong dollar payment system when the latter

has also gone live on RTGS. There are also intended links with

payment systems in other countries wi th which Hong Kong has

developed a high degree of trade and investment integration.

V Conclusion

Financial integration in Asia brings about benefits as well as

challenges. The future success of Asian financial markets depends

crucially on whether they can adjust efficiently to the changes

arising from financial integration and whether associated risks are

managed well. The upgrading and networking of Asian financial

infrastructure will help significantly to ensure that financial

intermediation and integration, in the Asian region and globally,

would progress in a sound and stable manner, in line wi th Asian

growth in the twenty-first century. Enhancement of financial

integration will in turn feed back to stronger growth in the

economies concerned. Trade integration, investment integration

and financial integration are all pre-conditions for strong and

stable domestic, regional and global growth.


A n n e x I

G-30 Recommendations onInternational Securities Market Compliance Standards and

International Society ofSecurities Administrators ( ISSA) Revisions

Recommendation I

Recommendation 2

All comparisons of trades between direct

market participants (i.e. brokers, broker/

dealers, and other exchange members)

should be accomplished by T+0. Matched

trade details should be linked to the

settlement system.

Indirect market participants (such as

institutional investors and other indirect

trading counterparties) should achieve

positive affirmation of trade details on

T + l .

Recommendation 3 Each country should have in place an

effective and fully developed central

securities depository, organised and

managed to encourage the broadest

possible direct and indirect industry

participation. The range of depository

eligible instruments should be as wide as

possible. Immobilisation or dematerialisation

of financial instruments should be achieved

to the utmost extent possible.


Recommendation 4

Recommendation 5

If several CSDs exist in the same market,

they should operate under compatible

rules and practices, wi th the aim of

reducing settlement risk and enabling

efficient use of funds and available cross-

collateral.

Each market is encouraged to reduce

settlement risk by introducing either Real

Time Gross Settlement or a trade netting

system that fully meets the "Lamfalussy-

Recommendations"

Delivery versus payment (DvP) should be

employed as the method of settling all

securities transactions. DvP is defined as

follows:

Recommendation 6

Recommendation 7

Simultaneous, f inal, i r revocable and

immediate ly avai lable exchange of

securities and cash on a continuous basis

throughout the day.

Payments associated wi th the settlement

of securities transactions and the servicing

of securities portfol ios should be made

consistent across all instruments and

markets by adopting the "same day"

funds convention.

A rolling settlement system should be

adopted by all markets. Final settlement

for all trades should occur no later than

T+3.


Recommendation 8

Recommendation 9

Securities lending and borrowing should

be encouraged as a method of expediting

the settlement of securities transactions.

Existing regulatory and taxation barriers

that inhibit the practice of lending and

borrowing securities should be removed.

Each country should adopt the standard

for securities messages developed by the

International Organisation of Standardisation

(ISO Standard 7775). In particular,

coun t r ies should adopt the ISIN

numbering system for securities issues as

defined in the ISO Standard 6166.

Source: International Economics Department, the World Bank.


B I O G R A P H Y O F S P E A K E R S

Anwar bin IbrahimDeputy Prime Minister and Minister of Finance, Malaysia

Mr Anwar bin Ibrahim was appointed Minister of Finance in 1991

and Deputy Prime Minister in 1993. In 1972, he was appointed a

member of the Ad Hoc Advisory Group to the United Nations

Secretary General regarding youth affairs. He was also formerly

the Executive Board Member of UNESCO f rom 1987 t o 1989 and

served as President of the UNESCO General Conference from

1989 to 1991. Mr Anwar bin Ibrahim began his career in

Government as the Deputy Minister for Religious Affairs in the

Prime Minister's Department. Before becoming Finance Minister,

he held several other Cabinet portfol ios including that of Culture,

Youth and Sports from 1983 to 1984; Agriculture f rom 1984 to

1986; and Education from 1986 to 1991. Mr Anwar bin Ibrahim

obtained his Bachelor degree in Malay Studies f rom University

Malaya Kuala Lumpur, Malaysia in 1970.

David W Borthwick

Deputy Secretary, Department of the Treasury, Australia

Mr Borthwick is responsible for international economic issues,

structural policy including competit ion policy, foreign investment

policy and Commonwealth debt management. His previous senior

experience in the Treasury includes overseeing the financial

system, formulating fiscal, monetary and taxation policy, as well as

economic forecasting. Mr Borthwick was Australia's Ambassador

to the OECD from 1991 to 1993.

Biography of Speakers

Michel Camdessus

Managing Director, International Monetary Fund

Mr Camdessus assumed office as Managing Director and Chairman

of the Executive Board of the International Monetary Fund in

1987. He joined the Treasury in the Ministry of Finance and

Economic Policies of France in I960. After serving as Financial

Attache to the French delegation at the European Economic

Community in Brussels from 1966 to 1968, he returned to the

Treasury and went on to become Assistant Director in 1971,

Deputy Director in 1974 and Director in 1982. He was appointed

Deputy Governor and then Governor of the Bank of France, both

in 1984. He was also Chairman of the Paris Club from 1978 to

1984, and Chairman of the Monetary Committee of the European

Economic Community from 1982 to 1984. Mr Camdessus earned

his postgraduate degrees in economics at the Institute of Political

Studies of Paris and the National School of Administration.

Chen Yuan

Deputy Governor, People's Bank of China

Mr Chen was appointed Deputy Governor of the People's Bank of

China in 1988. Since his graduation at Qing Hua University in

1970, he has worked in the Ministry of Mechanic Industry, the

Chinese Academy of Social Science, the State Planning Commission

of China and the Committee of the Communist Party of China,

West City Distr ict of Beijing. From 1984 to 1988, he was a

member of the Standing Committee of Beijing Committee of the

Communist Party and the Director of Commercial and Trade

Department of Beijing Municipal Government. Mr Chen received

his Master of Arts in Economics at the Chinese Academy of Social

Science, Beijing, China in 1981.


Kenneth ClarkeFormer Chancellor of the Exchequer, the United Kingdom

Mr Clarke was appointed Chancellor of the Exchequer in 1993

having previously held the position of Secretary of State at the

Home Office f rom 1992. He was Parliamentary Private Secretary

to the Solicitor General f rom 1971 to 1972 and Assistant

Government Whip from 1972 to 1974. From 1973 to 1974, he

served as a Member of the Parliamentary Delegation to the

Council of Europe and the Western European Union. Mr Clarke

was Opposition spokesman on social services f rom 1974 to 1976

and on industry from 1976 to 1979. After the 1979 General

Election, Mr Clarke was appointed Parliamentary Secretary,

Department of Transport; and then Parliamentary Under Secretary

of State for Transport from 1981 to 1982. He also served as

Minister for Health from 1982 to 1985; Paymaster General and

Employment Minister from 1985 to 1987; Minister of Trade and

Industry f rom 1987 to 1988; Secretary of State for Health from

1988 to 1990; and Secretary of State for Education and Science

from 1990 to 1992. Mr Clarke was educated at Cambridge

University, UK.

£ Gerald Corrigan

Managing Director, Goldman, Sachs & Co

Mr Corrigan was named Managing Director at Goldman, Sachs &

Co in 1996. He started his career as an Economist of the New

York Fed in 1968, then rose to the position of Vice President in

1976; and Senior Vice President in 1979 while serving as special

assistant to the Federal Reserve Board Chairman. In 1980, he

became President of the Federal Reserve Bank of Minneapolis. Mr

Corrigan became the Chief Executive Officer of the New York Fed

in 1985 and in that capacity, he was a permanent voting member

of the Federal Open Market Committee. He was also named Vice


Chairman of such Committee, a position traditionally held by the

President of the New York Fed. In 1991, Mr Corrigan was the first

American to serve as Chairman of the Basle Committee on

Banking Supervision. After leaving the New York Fed in 1993, he

joined Goldman Sachs in 1994 as Chairman of International

Advisors and Senior Advisor to the Executive Committee. Mr

Corrigan received his PhD in economics from Fordham University

in New York City, USA in 1971.

Dai Xianglong

Governor, People's Bank of China

Mr Dai was appointed Governor of the People's Bank of China in

1995 after serving as Deputy Governor for 2 years. Before taking

up the position of Deputy President of the Jiangsu Branch of the

Agricultural Bank of China in 1983, he held several senior

positions in Jiangsu Branches of the People's Bank of China and

the Agricultural Bank of China since 1978. In 1985, he became the

Deputy President of the Agricultural Bank of China. From 1989 to

1993, he was General Manager and Deputy Chairman of the Board

of the Bank of Communications and Chairman of the Board of the

Pacific Insurance Company. Mr Dai received his Bachelor of Arts

in Accounting at the Central Institute of Finance and Banking,

Beijing, China in 1967.

David Goldsbrough

Senior Advisor, Asia and Pacific Department


Mr Goldsbrough is currently Senior Advisor in the Asia and Pacific

Department. From 1973 to 1975, he was an Economist of the

Swaziland Ministry of Finance and Economic Planning. He joined

the International Monetary Fund in 1978 and has worked in the

African, Research, Policy Development and Review and Asian


Departments. After joining the Asian Department in 1986, Mr

Goldsbrough has worked on a wide range of Asian economies,

and rose to the position of Division Chief in 1989. Mr

Goldsbrough received his PhD in Economics at Harvard University,

USA in 1978.

Rafael Hui Si-yan

Secretary for Financial Services, Hong Kong Government

Mr Hui was appointed Secretary for Financial Services of the Hong

Kong Government in 1995. He joined the Hong Kong Civil Service

in 1970 and was subsequently appointed Administrative Officer in

1971. He then held a number of appointments in the Government

and was seconded to the Independent Commission Against

Corruption from 1977 to 1979. He was Deputy Secretary-General

in the former Office of the Unofficial Members of the Executive

and Legislative Council from 1985 to 1986, Deputy Secretary for

Economic Services from 1986 to 1990, Deputy Secretary for

Works from 1990 to 1991, when he was also appointed Director

of the New Ai rpor t Projects Co-ordination Office. He took up

the post of Commissioner for Transport in 1992.

Khor Hoe-Ee

Director, Economics Department,

Monetary Authority of Singapore

Mr Khor was appointed Director of the Economics Department of

the Monetary Authori ty of Singapore (MAS) in 1997. Before

joining the MAS in 1996 as the Deputy Director/Advisor of the

Economics Department, he has worked wi th the International

Monetary Fund (IMF) for many years, starting as an Economist in

the Treasurer's Department in 1981. Mr Khor then rose to the

position of Senior Economist and became the Deputy Resident


Representative of the IMF to China from 1991 to 1993. In 1994,

he was promoted to the rank of Deputy Division Chief and served

in the Central Asia Department from 1994 to 1995, then in the

Southeast Asia and the Pacific Department from 1995 to 1996.

Kyung Shik Lee

Governor, Bank of Korea

Mr Lee was appointed Governor of the Bank of Korea in 1995. He

started his career as an Economist at the Bank of Korea in 1957 and

became an officer in the Ecomomic Planning Board in 1961. Mr Lee

was appointed Economic Attache to the Embassy of the Republic of

Korea in Vietnam in 1969 and subsequently returned to the

Economic Planning Board in 1971 as the Director General of

Economic Planning. In the following years, Mr Lee worked as the

Senior Secretary to the President for Economic Affairs and the Vice

Minister of Ministry of Communication. He became member of the

Monetary Board of the Bank of Korea in 1989, Deputy Prime

Minister and Minister of Economic Planning Board in 1993, and

Advisor of the Korea Foreign Trade Association in 1994. Mr Lee

received his BA in Economics at Korea University in 1957.

Hubert Neiss

Director, Asia and Pacific Department


Mr Neiss took up his present position in January 1997. He started

his career in the International Monetary Fund in 1967 as an

Economist of its European Department. He rose to the position of

Senior Economist in 1970 and was appointed Assistant Division

Chief in 1971. He was transferred to the Asian Department in

1973 when he was promoted to Division Chief of the South

Pacific Division. From 1973 to 1991, he took up several positions

in the Asian Department and rose to Deputy Director in 1980. In


1991 he was transferred to the Central Asia Department and was

appointed Director in 1996. Mr Neiss obtained his Doctorate in

Economics and Business at Hochschule fur Welthandel, Vienna,

Austria in I960.

Christopher Patten

Governor of Hong Kong

Mr Patten was appointed Governor of Hong Kong in 1992. He

joined the Conservative Research Department in 1966 and was

seconded to the Cabinet Office in 1970. In 1972, he joined the

Home Office and was personal assistant and political secretary to

the Chairman of the Party until 1974 when he was appointed

Director of the Conservative Research Department. He was

elected Member of the Parliament f rom 1979 to 1992. Between

1979 and 1981, Mr Patten was Parliamentary Private Secretary to

the Chancellor of the Duchy of Lancaster, Leader of the House of

Commons and Minister for the Arts, and in 1981 Secretary of

State for Social Services. He was appointed Parliamentary Under

Secretary of State, Northern Ireland Office in 1983, Minister of

State at the Department of Education and Science in 1985 and

Minister for Overseas Deve lopment at the Foreign &

Commonwealth Office in 1986. In 1989, he was appointed

Secretary of State for the Environment. In 1990, he became

Chancellor of the Duchy of Lancaster and Chairman of the

Conservative Party. Mr Patten obtained his Master of Ar ts in

Modern History at Balliol College of Oxford University, UK.

Kunio Saito

Director, Regional Office for Asia and the Pacific


Mr Saito assumed his present office in January 1997. He was an

Officer in the International Finance and Securities Bureaus of the


Ministry of Finance of Japan from 1964 to 1968. He joined the

International Monetary Fund as an Economist in 1969 and rose to

the rank of Division Chief and subsequently Assistant Director

before joining the Asian Development Bank as Chief of

Development Policy Office in 1987. He re-joined the Fund in 1989

as the Deputy Director of the Asian Department. From 1991 to

1996, he was the Director of Southeast Asia and Pacific

Department. Mr Saito graduated from the Hitotsubashi University

in Japan and the Edinburgh University in the UK.

Gabriel C Singson

Governor, Bangko Sentral ng Pilipinas

Mr Singson was appointed the first Governor of the Bangko

Sentral ng Pilipinas (Central Bank of the Philippines) and the

Chairman of its Monetary Board in 1993. He joined the Bangko

Sentral ng Pilipinas in 1955 and became Deputy Governor in 1975

and Senior Deputy Governor in 1980. From 1967 to 1968, he

served as Counsel of the Asian Development Bank. He left the

Bangko Sentral ng Pilipinas and became the President of the

Philippine National Bank in 1992. After re-joining the central bank,

Mr Singson served as Chairman of the South East Asian Central

Banks Board of Governors in 1995. Mr Singson obtained his

Master of Laws from the University of Michigan Law School, USA

in I960.

] Soedradjad Djiwandono

Governor, Bank Indonesia

Mr Djiwandono was appointed Governor of Bank Indonesia in

1993. He started his career as a Researcher in 1963 at the

National Institute of Economics and Social Research and was

promoted to the Head of Economics Division in 1968. In 1969, he

was the Special Assistant to the Minister of Trade. From 1972 to


1988, he served as Head of the Bureau of Monetary and State

Finance, National Development and Planning Agency, while

concurrently serving as the Assistant Minister Co-ordinator for

Economics, Finance and Industry Affairs for the period 1984-88.

He was appointed as Junior Minister of Trade for the period 1988-

93. Mr Djiwandono received his PhD in Economics at Boston

University, USA in 1980.

Donald Tsang Yam-kuen

Financial Secretary, Hong Kong Government

Mr Tsang was appointed the Financial Secretary of the Hong Kong

Government in 1995, being the f irst Chinese to assume that

position. He is concurrently serving as the Chairman of a number

of committees and organisations, including the Economic Advisory

Committee, the Exchange Fund Advisory Committee and the

Banking Advisory Committee. He joined the Hong Kong

Government in 1967. Since then, he has held many important

positions in the Administration dealing wi th finance, trade and

issues relating to the future of Hong Kong. He was the Deputy

Secretary of General Duties Branch f rom 1985 to 1989. Following

his appointment as Director of Administration, Mr Tsang became

the Director-General of Trade f rom 1991 to 1993. In 1993, he

was promoted as Secretary for the Treasury. Mr Tsang obtained

his Master degree in Public Administration at Harvard University,

USA.

Tung Chee-hwa

Chief Executive, Hong Kong Special Administrative Region

Mr Tung was appointed the Chief Executive of the First Hong Kong

Special Administrative Region (HKSAR) Government in December

1996. Concurrently, he is serving as Vice-Chairman of the


Preparatory Committee of the HKSAR, a Hong Kong AffairsAdvisor and Committee member of the Eighth Chinese People'sPolitical Consultative Committee. Mr Tung is committed to publicand economic affairs of the society. He has previously served as amember of the Executive Council, a member of the ConsultativeCommittee for the Basic Law, the Honorary Consul of Monaco inHong Kong, Chairman of Council of City University of Hong Kong,Chairman of the Hong Kong/United States Economic Co-operationCommittee and a member of the Hong Kong/Japan Business Co-operation Committee. Internationally, Mr Tung has served as anInternational Councillor of the Centre for Strategic and InternationalStudies, member of the Advisory Council of the Institute forInternational Studies of Stanford University and member of theInternational Advisory Board of the Council on Foreign Relations inNew York. He was also in the Board of Overseers of the HooverInstitute on War, Revolution and Peace, a research institute basedin Stanford, California.

Joseph Yam Chi~kwongChief Executive, Hong Kong Monetary Authority

Mr Yam was appointed Chief Executive of the Hong KongMonetary Authority (HKMA) since its establishment in April 1993.He started his civil service career in Hong Kong as a statistician in1971. In 1976, he was transferred to the position of an Economist.From 1982 to 1990, he worked in the Monetary Affairs Branch ofthe Hong Kong Government Secretariat first as a PrincipalAssistant Secretary and subsequently as Deputy Secretary forMonetary Affairs. In 1991, he was appointed Director of theOffice of the Exchange Fund. Mr Yam received his first classhonours degree in Economics and Statistics at the University ofHong Kong irf 1970.


Yukio YoshimuraExecutive Director for Japan, International Monetary Fund(Former Deputy Director-General, International Finance Bureau,Ministry of Finance, Japan)

Mr Yoshimura was appointed Executive Director for Japan in theInternational Monetary Fund in 1997. He joined the Ministry ofFinance (MoF) of Japan in 1970 and rose to the position of SectionChief in 1973, then as Deputy Director in 1976. Beforetransferring to the International Finance Bureau (IFB) of the MoFin 1982, he served for four years in the Ministry of Foreign Affairsof Japan; first as the Second Secretary of Embassy of Japan inCairo in 1978 and then as the First Secretary of Embassy of Japanin London in 1980. From 1988 to 1991, he acted as the AlternateExecutive Director of the World Bank. He returned to MoF androse to the position of Director in the IFB in 1991. From 1995 to1996, he was the Councillor of the Minister's Secretariat. He waspromoted to Deputy Director-General of the IFB in 1996. MrYoshimura obtained his Bachelor of Arts degree in Economics atthe Tokyo University, Japan in 1970.

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Documents

FINANCIAL INTEGRATION IN ASIA ANDebook.lib.hku.hk/HKG/B35840092.pdf · FINANCIAL INTEGRATION IN ASIA AND THE ROLE OF HONG KONG Contents Page ... Mahmood Pradhan, International Monetary