E.
CONFIDENTIAL
4 -
rates have supported the buoyancy of private investment and consumET
spending and have thereby intensified inflationary pressures.
Thus, while
the objective of maintaining financial stability continues to justify the
commitment Lo the exchange rate anchor, eschewing the use of monetary and
exchange rate policy inevitably imposes a greater burden on other policy
instruments in containing demand pressures. We would note that persistent
high inflation rates in an environment of low global inflation would lead to
a deterioration in the competitiveness of Hong Kong's manufacturing and
externally-oriented service industries, and could eventually undermine the
credibility of the exchange rate anchor, particularly in the event of an
unfavorable external shock.
We continue to believe that fiscal policy should play a key role in
containing domestic demand, A prudent fiscal policy in past years has
resulted in the accumulation of large fiscal reserves, These reserves are
essential for maintaining confidence, given Hong Kong's vulnerability to
external shocks and the commitment to the exchange rate anchor. Notwith-
standing the relatively small size of Government in Hong Kong, sharp changes
in the net savings-investment balance of the public sector would translate
into excessive claims on resources available to the economy.
small and
open economy as Hong Kong's, part of the change in the Government's demand
for resources will be met through higher imports. However, part of it will
also be reflected in a change in overall demand for limited domestic
resources which, in the context of full employment, will intensify price
pressures. Indeed, the marked reduction in the budget surplus from 1988/89
In a