TNAG-0735-FCO40-939-Policy-objective-for-the-developing-of-Hong-Kong-in-the-1980-1978 — Page 100

CONFIDENTIAL

5. We have of course had some bad luck. The speed-up in the public works and housing programmes after the recession initially failed to achieve their targets for reasons I will not go into. Once these were corrected, a bunching of contracts and consequently of demands on the construction industry resulted. On top of this has come the MTR and its extension to Tsuen Wan. As ill luck would have it this has happened to coincide, against our expectations, with a continuing boom in private sector construction. While even last year we were very much aware of the excessive demands that domestic consumption was making on real resources in comparison to the export sector, we had expected these to level off. The salient features of the present situation are excessive growth in money supply, imbalance between the growth rates of retained imports and domestic exports, erosion of the value of the Hong Kong dollar, a very tight labour market,

and a tendency of domestic demand to draw off the resources from the export sector which would otherwise have corrected the imbalance.

6. All this is a very old story with which you will be all too familiar, both in the United Kingdom and elsewhere. We are lucky in that although wages have risen fast, prices of imports and exports have not, and we are not yet showing all the normal symptoms of inflation. So the situation is certainly not out of hand. The recent substantial and sharp increases in bank rates have had considerable impact and should reduce lending and the money supply, though we have no doubt that the rates will have to go up still further if only in response to upward movements elsewhere.

7. The situation has been complicated by two factors which, though not entirely new in themselves, have recently had a new impact. The issue of bank notes against notes of indebtedness, when the latter were denominated in sterling, was automatically neutral on the money supply. Now that they are demon inated in Hong Kong dollars they are inflationary unless the exchange fund's Hong Kong dollar balances can be switched into foreign currency assets held outside Hong Kong, or in some other way removed from the money supply. Similarly the contractionary effect of the surplus on General Revenue account is greatly reduced unless it too is either sterilised (which would lose interest) or can be switched out of the banking system and into foreign exchange held abroad. Over the last year there has been great difficulty in such switching without disturbing the foreign exchange market and leading to a weaker Hong Kong dollar with all its implications .

CONFIDENTIAL

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