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increasingly severe competition from Taiwan and South Korea (both of which had devalued their currencies) declined in quantity terms (by 5% in 1973). It should be emphasised here that the government broadly aimed to maintain the external value of the Hong Kong dollar (that is, its value in relation to a trade-weighted average of other currencies), this being partly in order to stabilise the import bill for foodstuffs from China. The government held to the view that its external competitive position would be restored through the ability of the internal cost/price structure to adjust to the new exchange rate pattern, largely through the wage mechanism. And that, in any event, of far greater concern was discrimination against Hong Kong from abroad in favour of Taiwan and South Korea, rather than increased
competition from low-cost countries as such.
Erosion and Depletion of the Reserves
19.
These exchange rate movements, and in particular the depreciation of sterling following its flotation, resulted in heavy exchange losses for the government both on its fiscal reserves (held largely in London) and on the (largely sterling) assets of the Exchange Fund which, for the first time since its inception in 1935, moved into deficit. This deficit was also partly the result of compensation payments to the bank for exchange losses under the Exchange Fund Guarantee Scheme bcing greater than the compensation payments received by the government from the United Kingdom under the Sterling Guarantee Agreement. At the end of 1974, the deficit stood at approximately HK 650 million, and represented a substantial prior charge on the fiscal reserves which themselves stood at only HK$2500 million (representing just 3 months' government spending at 1975/76 expenditure rates).
20. The low reserves level by the end of 1974 was not, however, solely a consequence of exchange losses. The increased rate of government expenditure was also straining the government's finances. In 1974/75, the General Revenue Account produced a deficit of HK$470 million, the first since 1966/67, and this was in spite of the fact that much of the 1974/75 revenue was derived from income arising in the boom year of 1973. It is possible that these financial strains would have become clearly visible even earlier, that is in 1972/73 and 1973/74, taking into account also that 1971 was a year of relatively
/slow
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