CONT
six month paper on a rolling basis, the proceeds of which would be converted into US dollars. In the event that the Hong Kong dollar interest rate on the borrowings exceeded the US dollar yield on the investments by more than an agreed margin (eg 4%), the Hong Kong Government could guarantee to absorb the excess cost of the borrowing. It might be possible to hedge the risk involved in the currency or interest rate markets.
7.3.2 This raises the question of whether such a guarantee should be subscribed no matter how large the gap, or whether the guarantee should be capped. A cap would make the scheme less effective in convincing officers that their entitlements were protected As an alternative, it might be possible to suspend borrowings while the gap exceeded a pre-agreed level, and resume them when the gap had fallen below that level. Historically, abnormally high (or abnormally low) interest rates only last for short periods. [Graphical evidence to be supplied). If the gap were to remain at unacceptably high levels for a sustained period, the scheme could be liquidated; the investment funds would be used to repay the loans/redeem the bonds, and any surpius re-invested, and paid to participating officers as a supplement to their entitlements on retirement. (Given the risks that participating officers are accepting - see section 2.5 above - it would be inequitable for them to be denied the benefit of any surplus which might have accumulated.)
7.3.2 As the debt market matured, and there appeared to be sufficient potential liquidity in the market for longer term instruments, the maturities of the securities issued could gradually be extended, thereby reducing progressively the demand for the interest rate guarantee.
7.4
The pricing of China sovereign risk. The ultimate guarantee against default for funds providers comes from the Chinese Government's commitment in the Joint Declaration that the future SAR Government will pay Civil Service pensions. In practice, funds providers will also wish to make their own assessment of the likely future strength of the Hong Kong Government's cash flows, since it is these cash flows which will have to fund the pension obligations.
7.4.1 The two major debt rating agencies, Moody's and Standard & Poors (both of the United States) are the major influence on the pricing of debt securities. The 1997 issue has proved to be a significant practical and intellectual block to the provision of long term debt ratings to actual and potential Hong Kong issuers by the two agencies. The political unpopularity of China, particularly in the United States will not improve matters. Many fund managers responsible for conservatively managed long term portfolios are restricted to OECD countries when it comes to sovereign debt or to AAA rated corporate debt. It is unlikely that the corporation in which the future entitlements would be vested under the scheme would achieve AAA rating, and China is not an OECD country.
7.4.2. The current price for lending to China against Bank of China guarantee is 1% to 1.5% above HIBOR, but these rates apply to loans of relatively short duration. The indications are that for maturities of 5 years or more, a rate of 2% to 2.5% above HIBOR would be demanded.