TNAG-1873-FCO40-2661-Relations-between-Hong-Kong-and-China-1989 — Page 209

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15.

(c) Outward processing activities

Most of the outward processing contracts are

denominated in Hong Kong dollars. Because a given amount

of processing fees in Hong Kong dollar terms can now be converted into much more Renminbi than previously, due

to the unofficial depreciation of the Renminbi, it is

unlikely that labour costs will increase much in Hong

Kong dollar terms as a result of domestic inflation in

China (paragraph 46). However, again there is clearly a

limit to the extent to which this process can provide protection without a devaluation of the official

exchange rate.

16.

(a) Longer-term implications

Given the special relationship between Hong

Kong and China, politico-economic developments in China in relation to inflation have implications for Hong Kong that go well beyond the direct impact on prices in Hong

Kong. In the past ten years or so the economic reform programme in China, with the associated open door policy

and rapid economic growth, have built up confidence in

the future course of China's economy and economic

policy. The current bout of inflation represents a

challenge to that policy. China's response to that challenge is likely to have a major impact on confidence in China's commitment to the reform programme and on confidence in Hong Kong's economic future (paragraph 47).

17.

The best scenario for confidence and for Hong

Kong (and for China?) would be the use of macroeconomic

tools to damp down the excess demand while continuing with price and other reforms to improve the efficiency of the operation of the economy.

This would represent a

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