inflows of capital to 1 long kong
a siiu- ation that has tended to incrasso geea! values. Hong Kong's monetary role in the southern China region has also become more significant. Chinese residents, both individuals and banks, hold ever greater amounts of Hong Kong dollars, and ex- panding currency demand entails some costs and benefits for Hong Kong. First, the part hald as cash represents seigniorage for the government and for the banks that issue notes. Second, it tends to reduce interest rates at given exchange rates or to appreciate the currency for given interest rates. However, it reduces control over mone- tary aggregates. With strong capital in- thue and a fived-ovchange-rato rogimo, the only way for a currency to appreciate is through an increase in prices.
Capital markets are, however, sensi- tive to political events. Since the end of 1992, relations between China and Britain have become strained. Hong Kong's governor, Chris Patten, has pro- posed a slight increase in the share of representatives to Hong Kong's
Medium- and Long-Term Outlook
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Our A3 long-term credit rating of Hong Kong reflects Hong Kong's mounting economic integration with southern China and its ultimate political absorption into China. Our view, however, is that Hong Kong should benefit from the framework of the Basic Law enacted by China's National People's Congress. According in the law, Hong Kong will romain an au- tonomous region with its own monetary and fiscal powers. It will also largely maintain its legal system. The evolution of China's own political priorities will of course affect how much autonomy Hong Kong.ultimately enjoys and China could in the future push toward more centralized government. Also, a political crisis in China (as in 1989) could lead to a confrontation between Hong Kong and the Chinose government. The Hong Kong population, however, is likely to put economic stability anead desires for point- ical autonomy. Thus, as long as its sov DTONINY Hong Kong and its allaita is not disputed, China is likely to implement the tenots of Basic Law.
A smooth incorporation of Hong Kong, without drastic changes in the sta. tus quo, should spur China's own eco- nomio development. Such a smooth as- similation will also be seen as a positive model for the mainland' future relations with Taiwan, China's deepening integra-
4 Hong Kong
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Legislative Council (Legco) chosen (vir.
by direct vote in the next elections. China has loudly opposed that change, and it has named a group of advisers who could be seen as a shadow assem- bly. By opening Legco to more direct rep. resentation, Mr Patten intends to strengthen the Legco's standing once Hong Kong becomes a Special Region of China, but the effect may be different. China has threatened to oppose pending major projects in Hong Kong, thus per- haps delaying the projects and increas. ing economic uncertainty in the territory
thereby mobilizing public opinion against governor Patten. With the sem- blance of a shadow council in place, Chiffa in effect Couki also set up a mech. anism under its control and ready to head the territory's government at any moment. Finally, this row has underlined China'e accortion of envereignty ov ahead of 1997. The current strains may actually accelerate the de facto transition to 1997.
ALAA
tion into the world economy makes its commitment to the future of Hong Kong gradually more credible. Hong Kong is likely therefore to retain a degree of au- tonomy and insulation from the mainland and to keep significant control over the main instruments of macroeconomic poli- cy. Given the territory's strong record of cconomic management, iliose reasons suggest, for now, a slightly higher rating for Hong Kong than for China.
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There are broadly three basic sce- narios for the future of Hong Kong. In the first, China could maintain a truly hands- off appesch with Hong Kong -— essen-
withKLAR tially allowing the present situation to continue, but under a different ruler. In this scenario, China would be tolerant of Hong Kong's institutions, whose continu- ity would allow Hong Kong to develop further as business and financial center. The chances for such a scenario would he strengthened if China's development were accompanied by increasing poinica stability. However, China's political cul- ture is inore interventionist ihan Britain's, and less tolerant of unrestricted political freedom. In addition, China is likely to subordinate Hong Kong's Interests to its broader priorities.
For these reasons, a second sce- nario is perhaps more likely. In this sce- nario, China is likely to broadly respect
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