TNAG-1270-FCO40-1620-Financial-policy-in-Hong-Kong-1983 — Page 191

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look like the thin end of a wedge, and, again, could easily make matters

worse by encouraging preemptive outflows and damaging Hong Kong's attraction as a financial and commercial centre.

(iii) Action on interest rates: As shown by the apparent effects of the 3% increase in prime rates this week, the interest rate weapon (the main one immediately available to the Hong Kong authorities) can clearly

help to hold the situtation for a time, and may well continue to be the

most useful way of dealing temporarily with periods of fluctuating

confidence in future. But as Annex 4 explains, if confidence is really

severely shaken interest rates might have to go very high indeed to prevent

a fall in the currency; and any prolonged period of high interest rates

could cause major economic and financial problems in the local economy (not least in the property sector), which would themselves serve to damage

confidence further.

(iv)

Changes to the tax regime to increase the relative attractiveness

of HK deposits: Annex 5 discusses the possibility of abolishing with-

holding tax on interest on HK deposits, to put them on all fours with

foreign currency deposits. There are arguments for this; but it could not

be expected to have more than a very marginal impact on the exchange rate,

and would entail a substantial loss of revenue.

7.

These options are not necessarily mutually exclusive. Indeed if the first were

judged sensible there would be a case for bolstering such a commitment with action under (i), (iii) and (iv) also. But any course in which HMG were engaged - certainly if it became known we were so engaged would present obvious major difficulties. (Since the notes at Annex were prepared, we have heard from the Governor that he is

not planning to remove the withholding tax, at least at present, or to introduce

exchange control).

Monetary Control

8.

In addition to the immediate pressures relating fundamentally to political uncertainty, some of the loss of confidence in the HK $, which has been building up over a period, may also reflect concern about the inadequacy of monetary long

Kong. To the extent that this is so, action to improve control over the Hong Kong

money supply should also help the HK %, but in the longer run rather than as an

immediate response to the current situation. Annex 6 therefore discusses some of the

possible ways of improving control. These are frankly not very promising.

A key

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