TNAG-0475-FCO40-540-Contributions-of-Hong-Kong-for-costs-on-maintaining-military-1974 — Page 26

C.S. 166

CONFIDENTIAL

XCC(74)41

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(v) the compounded inflation is applied month by month to

the amount assumed to be spent each month.

This produces a total supplement of £2.366 million, which at HK$12 to £1 = HK$28.39 million. At a 2% compound inflation rate the total would be £3. 4 million, say HK$ 40.8 million.

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In recognition of the fact that HMG have already absorbed cost inflation up to 50%, and in order to produce a reasonable supplement to allow the programme to continue, albeit at a much reduced rate, it is suggested that the lower sum thus calculated could be rounded up to $30 million. This is a figure which the UK team regarded as the absolute minimum acceptable, bearing in mind the $50 - $60 million the team had hoped to settle for.

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In the final session of the talks, the UK side put forward an alternative solution for consideration. This was that the slightly complicated formula set out in paragraph 7 above, should be replaced by a straightforward agreement now to supplement the unspent balance by an additional contribution of $35 million. The Hong Kong team, whilst continuing to favour the formula approach (rounded up to $30 million), its professional advisers being fairly confident that the 1.5% inflation rate would not be exceeded, nevertheless agreed to include the alternative proposal in the submission to the Governor in Council. HMG have now confirmed their acceptance of the provisional agreement reached between the two teams but have repeated their preference for the 'lump sum' arrangement.

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Any additional Hong Kong contribution during the next two years is likely to be at the expense of other expenditure already plaaned that is it is likely to necessitate equivalent cuts in the Public Works Programme. It is for consideration, however, which proposal will eventually prove to be in Hong Kong's best interests. The (rounded-up) $30 million minimum - $40.8 million maximum formula should be less expensive if building costs inflation does indeed stay below or fractionally over 1.5% per month compound during the period. The straight additional contribution of $35 million (in effect payable during 1975-76) on the other hand has the attraction of simplicity.

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