TNAG-2472-FCO40-3599-Confidential-talks-between-the-UK-and-China-regarding-financ-1992 — Page 56

R

Mr Ricketts

Hong Kong Department

FROM: S H Broadbent

DATE : 8 May 1992

cc : Mr Burns

HONG KONG ECONOMY

1.

You asked for comments on Mr Gray's observations. I am glad to see that he has got more or less the right idea: the wonder of a really dynamic economy; the importance of Southern China; and the value of the exchange rate Link.

2. He has also picked up some of the unease we have felt about the consequences of direct elections. But I think he has underestimated this. The change is a much more fundamental one than the modest prod administered by the Select Committees in the UK. The Hong Kong administration is not just a civil service, but has been thrust right into the middle of the political arena itself. The measures it might need to take to control the inflation about which Mr Gray is so concerned may well be frustrated by Legco - importing labour, raising taxes, perhaps running large budget surpluses.

3. I am not quite as worried as Mr Gray about Hong Kong's inflation; it is a symptom of rapid growth and change, arising in large part from the external stimulus of the boom in China. While this continues there may not be a great deal HKG can do about it. But it is obviously right to keep a fairly tight grip on public sector construction demand, which will be difficult whilst the airport is built, and to increase the supply of labour and land. It may also be necessary to tighten fiscal policy, which may mean running surpluses, since the link tends to result in a rather loose monetary policy. (It could, of course, mean the opposite if confidence took a knock.) The worry about uncompetitiveness in the service sector is somewhat overplayed. As Mr Gray himself implies, the demand for services arises from Hong Kong's location and skills, not from competitiveness. Indeed, the rapid rise in wages and hence of certain consumer services may well reflect real productivity growth.

4.

Inflation will, nevertheless, remain something of a worry while the economy booms. But while this happens, it will not be necessary to worry as well about generating adequate financial surpluses. In practice, the projections tend to underestimate the surpluses, and do not take account of new revenue measures. To do otherwise would invite still greater spending pressures.