SOVEREIGN FINANCE - Making Hong Kong count

In 11 years at the helm of the Hong Kong Monetary Authority, Joseph Yam has witnessed massive economic transformation in China and the upheaval of the Asian financial crisis. He argues that Hong Kong must be able to conduct high-value transactions in renminbi to preserve its role as a financial centre, and predicts that the region's foreign exchange reserves will be increasingly invested in Asia.

  • 01 Nov 2004
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AM: What pressing challenges do you face over the next 12 months?

JY: Financial markets around the world seem to be in a rather nervous mood lately. There are two issues of particular concern; the timing and the extent of the upturn in the interest rate cycle in the United States; and the prospects of the necessary macroeconomic adjustments on China's mainland being successful. There are other issues too such as the surge in oil prices, ongoing geopolitical tension, continuing external payment imbalances, the threats of terrorism, and so on. It is an uncertain world and uncertainty affects market sentiment, which pose challenges to the work of the HKMA.

AM: Why should foreign institutional investors buy into your sovereign bond issues?

JY: It is a matter for investors to decide as to whether our sovereign bond issues are worth investing. In general, investors would seek to diversify risks by holding a variety of assets with a view to maintaining a desirable balance between risks and returns for their portfolio. The HKSAR Government successfully launched, issued and listed its first HK$20 billion Global Bond Offering in July 2004. This provided additional choices for investors to diversify their portfolio. The fact that this transaction was well-received by the international as well as the local investors indicates that the international investment community has confidence in the fiscal prudence of the HKSAR government and Hong Kong's economic prospects.

AM: On a scale of 1 to 10, with 1 denoting complete independence and 10 total dependence on other agencies and the government, how would you rank your central bank in terms of independence?

JY: Central banking is far too complicated an activity to be dealt with by rankings like this. No central bank can be totally independent: there has to be accountability and objective setting. But we have a very high degree of independence in our day-to-day operations. Our functions and powers are clearly defined in law and our relationship with the Government is set out in an exchange of letters between the Financial Secretary and myself as Monetary Authority published last year. This clearly states, among other things, that the Financial Secretary sets the monetary policy objective and the Monetary Authority on his own determines the strategy, investment and operational means for achieving it and for maintaining the stability and integrity of the monetary system of Hong Kong. We could not ask for it to be clearer than that. Nor could any central banking institution reasonably expect to have greater independence than this.

AM: Can you explain the main powers that you now have that your predecessors didn't?

JY: Central banks and monetary authorities, particularly in the smaller, more open economies, face greater challenges now than they ever did. I have no predecessors as Monetary Authority in Hong Kong, since the HKMA was only established just over a decade ago. Before then, our functions were spread out within the government and in the banking system. In Hong Kong we made a late start in the development of our central banking arrangements. But we adopted a cautious, step-by-step approach in this important area. This has enabled us to consider technical issues thoroughly and we have been able to learn from the experience of others and develop a system best suited to our needs. But with experience we have become much more ready to build for future rather than current needs. This is particularly so with our infrastructural projects, where we are building clearing systems and linkages in anticipation of future business. This keeps Hong Kong one-step ahead, which is necessary if we are to maintain our edge as an international financial centre. Hong Kong has transformed itself rapidly into a centre for financial and other services, against the background of, and in association with, rapid economic liberalisation in China, in a region that promises to be the fastest growing area in the world, probably in the next twenty or thirty years. Hong Kong faces challenges very different from those of other economies.

Hong Kong therefore needs a monetary system and a mechanism for monetary management that are adequately robust to enable us to meet the challenges with confidence and to maximise the economic benefits that we can derive from the massive changes that are taking place across the border. The growing importance of Hong Kong as an international financial centre has placed added emphasis on monetary stability, the soundness and integrity of the financial system, and the efficiency and robustness of the market infrastructure. The development of the central banking role of the HKMA made it desirable to ensure that the Government's various activities in the monetary and banking fields are co-ordinated and performed with a high degree of professionalism and continuity.

To this end, the Exchange Fund Ordinance was amended in December 1992 to provide for the appointment of a Monetary Authority, whose duties combine those of the Office of the Exchange Fund with those of the Commissioner of Banking, and to empower the Financial Secretary to use the Exchange Fund to maintain the stability and integrity of the monetary and financial systems of Hong Kong, in addition to its primary use which remains regulating the exchange rate. The Exchange Fund (Amendment) Ordinance came into operation on 1 April 1993, and on that date the Hong Kong Monetary Authority was established.

I took up the position of the Chief Executive on the establishment of the HKMA on 1 April 1993 and the HKMA marked its 10th anniversary last year. The decade between 1993 and 2003 was a period of political transition, culminating in Hong Kong's establishment as a Special Administrative Region of the People's Republic of China on 1 July 1997. This was also a decade of economic change and stress. Hong Kong's economy became more closely integrated with that of the mainland China. Following the Asian financial crisis in 1997, Hong Kong also experienced a period of prolonged economic difficulty. Having a separate central banking institution, with a distinct identity and clearly defined responsibilities helped Hong Kong deal with all of these challenges.

AM: Which international economist do you respect?

JY: There are many economists that I respect for a variety of reasons. As far as the financial sector is concerned, I think Alan Greenspan is an outstanding one. In the past few years, the international financial sector has experienced one of the greatest changes in history. New technologies have quickened the pace of capital flow and changed many rules of the game. It is very difficult to adapt to these changes, particularly for supervisors. Alan Greenspan has always been encouraging others to identify risks and manage them so as to stabilize the financial and monetary system.

AM: Could Asia's combined foreign exchange reserves ever be used to help with the region's political standing in the world?

JY: Whether foreign exchange reserves should be used for political reasons is not something that particularly interests me. But they can certainly be used to help strengthen the region's financial stability and this is something that interests me greatly. Over the years, Asia's central banks have accumulated large amounts of foreign exchange reserves, amounting to over US$2 trillion as of the end of August 2004. Much of these reserves are invested outside Asia, while the region itself is one of the largest recipients of foreign investment. To address the risks associated with volatile capital flows, central banks and monetary authorities in the region have been working together to use their foreign reserves to strengthen financial stability in the region.

AM: How long will Asia continue to fund the US' deficits?

JY: A key concern for the global economy is the size of the US current account deficit and its implications for the future value of the US dollar. The US current account deficit has increased sharply since the early 1990s, and rose to a high of 5.7% of GDP (annualised) in 2004 Q2. The stock counterpart to this is a growing level of net indebtedness of US citizens to the rest of the world, which stood at 24% of GDP at the end of 2003.

The US, with its deep and liquid financial markets and reserve currency status, is perhaps better placed to fund a large current account deficit, and for longer, than most other economies. Nevertheless, history tells us that a high and rising current account deficit is ultimately unsustainable. The key question is how and when the correction will occur. At the root of the problem is a shortfall of US net national savings relative to US investment net of depreciation, and especially of public savings. It follows that any correction must entail a rise in US savings relative to investment, thereby leading to slower US and, likely, global growth, and possibly a lower value for the US dollar. Although an orderly adjustment is possible, there is a risk of an abrupt and sharp decline in the US dollar, accompanied by hikes in US interest rates to curb the inflationary consequences. That would be much more damaging to the global economy, including Hong Kong.

AM: Is the Asia Bond Fund a good idea? Why? Where should it be located?

JY: Yes, definitely. It will help strengthen regional financial stability and will serve as a platform for addressing regulatory and other hurdles in bond market development. Individual EMEAP economies can leverage on the interest and momentum generated from the collective investment in ABF2 to further develop their domestic bond markets, for instance, through working with relevant authorities to identify and minimise the legal, regulatory, and tax hurdles in their markets.

With regard to the location of ABF2 funds, the EMEAP is currently studying various possibilities.

AM: Within five years should Asian currencies be totally convertible?

JY: Greater capital mobility and currency convertibility increase the potential funds available for domestic investment and the choice of assets for domestic savings, thereby raising the efficiency with which global savings are matched with global investment opportunities. However, greater openness also carries risks to macroeconomic and financial stability. For many Asian economies, the experience of the 1997-98 financial crisis illustrated the damaging effects that free and potentially volatile capital flows can wreak on an economy, or group of economies through contagion. This has underscored the importance of careful sequencing in liberalising capital accounts in emerging Asian economies along the road to full convertibility.

The speed at which this is done will likely vary between economies, depending on the stage of economic and financial market development, and the soundness of the banking system. In Mainland China, in particular, underdeveloped capital markets, the size of non-performing loans in the banking systems, and the need to tighten the micro-incentives for State-owned enterprise to borrow and invest, all suggest that full currency convertibility will take some time to achieve.

AM: What can you do as a central bank to encourage foreign direct investment in your country?

JY: Encouraging foreign direct investment is not a direct mandate of the HKMA. However, we are entrusted with maintaining macroeconomic and financial stability in Hong Kong, which provides a strong foundation for attracting financial inflows. Hong Kong does not have a large manufacturing base, so foreign direct investment has been mainly in services and upstream industries.

We will continue to strengthen Hong Kong's status as an international financial centre by improving the financial infrastructure. In particular, a leading financial centre should have in existence a platform for financial transactions to be conducted in any major foreign currency as well as in the domestic currency. The platform for the conduct of financial transactions in foreign currencies has to be supported by robust payment, clearing and settlement systems.

These systems should be structured in a manner that minimises the risks of failure in the settlement of financial transactions. The HKMA has already made significant progress in building such a financial infrastructure. We are clearly ahead of other financial centres in this, with operating RTGS systems for the US dollar, the euro and the Hong Kong dollar, and these systems are all linked to provide PVP. We intend to include the renminbi in this infrastructure as soon as circumstances permit, which will cement our position as the international financial centre of China. am

  • 01 Nov 2004

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