TNAG-1347-FCO40-1777-Financial-policy-in-Hong-Kong-1984 — Page 28

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fund Given an initial stock. A of assets that are potentially available to redeem Hong Kong currency in terms of foreign exchange, the managers of the mutual fund face a variety of feasible payout policies. The policy that is adopted determines the net worth left to the managers of the fund. For example. among fixed ex- change rate policies, the lower is the value of Hong Kong currency, the higher is the net worth.

The Exchange Fund is likely to be managed by the British government until 1997 and by the Chinese government thereafter. In this situation. the Chinese government cares about how the Exchange Fund is administered before 1997, for this will influence the net worth of the fund at the time that the Chinese take over. To see this, suppose. for example. that the British managers of the Exchange Fund were to peg the Hong Kong dollar at the upper bound of the feasible range which we have delineated. namely, fh Suppose further that holders of Hong Kong dollars (the fund's share- holders) were uncertain about how the new Chinese managers of the fund would manage it. Inevitably, a run on Hong Kong dollars would occur before 1997, a run which the Exchange Fund could meet by drawing down ! to zero the foreign exchange backing. Then, the Hong Kong dollar would simply disappear too as the Exchange Fund paid out the backing to the owners of Hong Kong dollars. A fixed rate policy such as this. that values the Hong Kong dollar at or near the upper bound fh, could easily be viewed as unfriendly by the current Chinese government. Concern by the current govemment of Hong Kong to avoid such unfriendly acts could thus constrain the way the Exchange Fund is now managed.

Additional doubts about the likely management of the Exchange Fund between now and 1997 stem from what threaten to be new and growing departures from Hong Kong's traditionally conservative fiscal policy. These departures are partly induced by the fall in value of land and other assets in Hong Kong. the sale and taxing of which the government depends on for revenues.

During the 1970s. the Hong Kong government had budget surpluses totaling 8.6 billion Hong Kong dollars (usually expressed HKS 8.6 billion). Government in- vestment was financed largely by current revenues and the proceeds of public land sales. As a result, even now Hong Kong's public sector nas large net claims or the pomestic banking system and or the rest of the world However recent declines in government revenues nave outpaces alempas in curt public expenditures, with the

result that, in 1982-83 and 1983-84, the Hong Kong government had budget defons for the first time in nearly a decade These deficits are estimated at HKS 3.9 bilbon and HKS 3.2 billion, respectively.

By themselves, two consecutive annual deficits of such magnitude do not threaten responsible management of the Exchange Fund. because the government has accumu- lated substantial fiscal resen es. At the start of the 1983- 84 financial year, fiscal reserves amounted to HKS 18.7 billion. of which HK$ 11.5 billion constituted free reserves, that is. reserves left after HK$ 7.2 billion were allocated to cover possible losses on capital projects. Deficits of the current magnitude would not wipe out these free reserves for about three years.

However, continued deficits- and devaluations-may be seen as the only politically feasible ways for the British government to deal with the govemment's capital losses resulting from the 1997 change in management. The 1997 situation creates special problems with regard to the pricing of services of long-lived, publicly owned capital- like the roads. the subway system, and the public housing. After 1997. the public capital of Hong Kong is likely to belong to the government of China. so that the tail of the stream of taxes and tolls from long-lived capital currently in place or under construction may not be available as backing for debt of the current government. To deal with this situation. the current government could increase charges on existing projects so that the revenue stream collected through 1997 would be sufficient to balance the budget in a present value sense, and it could undenake only those new public investment projects that would pay for themselves by 1997. Such policies would be drastic and amount to managing the economy as though it were going to end in 199", a stance that could be expected to be opposed both by some current residents of Hong Kong

⚫Consider a mutual fund with shares outstanding and with maia, esser worth invested in foreign exchange. There are at least two ieasible way that the mutual func could operate. First, the mutual fund could close, with no new share to be issued. On the understanding that shareholders are entitied K L on ras share of the assets, the marke: could be permitted to determine & price of share. I the mutual fund. Abstracting from fees, the equilibnum price would be for me. the mutua. runs would be priced as though it were operating 2 warenos foreign securitie: Second the mutugi func could remain open d. oflenna wese new share, ɔrredeeme›istifa One: 2 ani the price between zero and esther the manual tunc coeis in as sunday of outstanding share, rar... REDMETY price them I LOLS at. e thate, price at whitit Mou? is ut new Maren and invest she proceed. movevet, & policy agre Trollem 15% share 3. 2 pc li me ne bi the market with LA irvesico ate bidiladi *** Teluśmin, share whuc no, nit, ofwho en

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