TNAG-2814-FCO40-4060-Future-of-Hong-Kong-International-Rights-and-Obligations-(IR-1993 — Page 8

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FM FCO

DESK OFFICER

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INDEX

PA

Action Taker.

pa.

TO IMMEDIATE UKDEL IMF/IBRD WASHINGTON

TELNO 33

OF 18171OZ FEBRUARY 93

INFO IMMEDIATE HONG KONG, PEKING, UKREP JLG HONG KONG INFO IMMEDIATE BTC HONG KONG

(10)

175445

MDHOAN 9022

IMF/IBRD 1997 ANNUAL MEETINGS: HONG KONG'S TELNO 116

1.

WE AGREE WITH TUR. GRATEFUL IF YOU COULD RESPOND TO THE CHINESE DIRECTOR, DRAWING ON THE LINE TO TAKE IN PARA 2.

HURD

YYYY

ΜΑΙΝ

155

MONETARY ERD

NNNN

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155

HKD

FED

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SAVINGRAM

BY BAG

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FM UKDEL IMF/IBRD WASHINGTON

TO FCO SAVINGRAM NO. 34

[102300Z]

OF FEBRUARY 10, 1993

AND INFO.SAVING HONG KONG, MANILA (FOR DAVIS ASDB)

IMF: HONG KONG--1992 ARTICLE IV CONSULTATION

See UKDEL telno 42 of February 3

031/10.

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DETAIL

1. Before the meeting, I circulated BUFF/ED/93/13, and Che (China)

circulated BUFF/ED/93/15 (both faxed to London and Hong Kong). Che was

complimentary of economic performance, stressing that much of this success

reflected strong growth performance in China. He supported the exchange rate

link to the dollar, but was very concerned by the rising projected total

construction costs of the airport. He nonetheless reiterated Chinese continued

commitment to adhere to the Sino-British joint declaration, and to ensure a

smooth transition in 1997. Che made no additional comments during the meeting

itself.

2. Bonzom (France) said that the main problem facing HK was inflation. Core

inflation was still above 10 percent, and there was now a risk that inflationary expectations might start to become entrenched in the economy. This had to be avoided at all costs, especially as HK is a major financial

centre in the region, and because of the delicate transition process currently underway. He welcomed the measures taken on the supply side (labour importation and land sales), and encouraged that these policies be pursued.

He said that if inflation persisted, both Fiscal and Monetary policy should be tightened. In this context, he suggested a 'one shot' revaluation of the exchange rate against the dollar, which he claimed would allow real interest

rates to rise. If this was not done, then fiscal tightening was even more

important. He agreed with the staff's assessment that the current budget projections were likely to lead to strong aggregate demand and so stronger

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inflationary pressure in the medium term. He regretted that planned revenue

raising measures had been dropped in 1992, and urged caution on the level of

public expenditure. Finally, he welcomed the recent measures aimed at

strengthening monetary management and the collection of economic statistics.

3. Tabata (Japan) commented on the remarkable economic performance in

recent years. However, while inflation had slowed, it was still about 10

percent, reflecting demand pressures, supply constraints, and structural rigidities. He thought that the HK authorities should now search for ways of reducing current expenditures. He was also concerned that monetary policy was

too lax. HK needed positive real interest rates. Recent events in the ERM

showed that a fixed exchange rate system was fundamentally flawed and he

advised that the HK dollar should be allowed to float. He welcomed the recent

creation of the HK monetary authority, and agreed with Bonzom on the

importance of labour import measures which would ease conditions in the labour

market. In this context he warned of the dangers of allowing public sector

wages to rise too quickly. Wages had to grow below the growth rate of

productivity.

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4. Abbott (US) agreed that performance was remarkable. Nonetheless he, too,

was concerned that inflation was still 10 percent. This reflected the fixed

exchange rate combined with a build up in excess demand. It was important that

inflation expectations did not become entrenched in the system. If they did,

then the exchange rate link with the US dollar would become unsustainable -

thus demanding a policy response. In his view, therefore, the exchange rate

link, which he supported, effectively placed an upper bound on inflation. The

inability to use monetary policy placed greater pressure on fiscal policy. He

commented that the 5 year fiscal simulations in the staff paper seemed

plausible, and so agreed with the staff that the authorities should be ready

to take revenue and expenditure measures.

STAFF REPLIES

5.

Citrin (staff) emphasized the benefits of the exchange rate link, which

he concluded were greater than the associated costs. Minimising the costs

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