TNAG-2749-FCO40-3964-Economic-situation-in-Hong-Kong-1993 — Page 78

Mr Whitney

HKD

RESTRICTED

MOODY'S SOVEREIGN CREDIT REPORT

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HKB 090/4

2 SEP 1993

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1.

You asked whether there is any useful advice we might offer to HKG on arguing their case on appeal on Moody's recent rating (attached). I expect HKG have gone over this thoroughly but the following points occur to me.

2.

Moody's make two points which might substantiate their downgrading. The first is a political one that relations between Britain and China have become strained since end 1992 and that as a result China has threatened to oppose major projects thereby increasing economic uncertainty in Hong Kong. This is then used to support the contention that China is likely to intervene more frequently in the affairs of Hong Kong and with less regard for the practices of competitive markets than the UK has been accustomed. The second point is economic, that inflationary expectations have become embodied in nominal wage growth which could be seen to threaten competitiveness and future prosperity.

3. On the first point it is clear that China has always had the potential to meddle in Hong Kong's eonomic affairs, that being one reason for framing the economic sections of the Joint Declaration and the Basic Law. It does not seem tenable to argue that the Chinese propensity to meddle has increased, indeed during the recent political difficulties it has become clear that China has fought with words rather than actions and that none of their threats have had any material effect on the operation of Hong Kong's economy. Chinese interests in Hong Kong's future prosperity are increasing as evidenced by direct investment, by trade and by increasing Chinese involvement in economic management, as evidenced for example by the plans for Bank of China note issuance and various supervisory committees.

4.

Moody's claim that inflationary expectations have become embodied in wage claims is difficult to justify. It is perfectly plausible to argue that wages growth is entirely market determined and related to productivity growth in Hong Kong's most dynamic sectors. There is no evidence that overall unemployment has increased as a result of nominal wage growth, indeed Hong Kong is as close or closer to full employment than any OECD or other similar economy. inflationary expectations were embodied in wages we would also expect to see evidence of generalised inflation in Hong Kong produced goods. Again this is not evident, inflation is confined largely to service sectors. Goods inflation, and particularly exported goods inflation remains remarkably low.

5.

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Finally Moody's sovereign risk ratings across the region do not appear to be entirely fair to Hong Kong. The ratings

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