ENG-1983 — Page 74

THE ECONOMY

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This important change in Hong Kong's monetary framework means that the exchange rate is in effect no longer a variable element in the economy's adjustment process. Factors such as interest rates, money supply and the level of economic activity, rather than the exchange rate, now adjust automatically to balance of payments pressures, without government intervention being necessary. The role of interest rates as an instrument of monetary policy has therefore also altered. They now assume a more passive role, changing, more frequently perhaps, in response to balance of payments inflows and outflows. Nevertheless, the mechanisms whereby the government can influence interest rates through the Hong Kong Association of Banks or the money market remain in place.

Thus, the Hong Kong Association of Banks, which sets the maximum rates of interest payable on deposits with licensed banks, still has the statutory obligation to consult the government on these interest rates. This procedure was designed to ensure that the association took account of the wider public interest in its decisions, including of course their effect on the exchange rate. Under the new exchange rate regime, however, it is neither so necessary nor so desirable for the government to play an active role in this process.

Also, through its bankers, the Exchange Fund has operated a scheme which enables it to draw funds out of the local interbank market and to ensure that these funds are not directly recycled into that market. This arrangement is capable of tightening up the money market and putting upward pressure on market interest rates in the short term. Under the floating exchange rate system prior to October 17, operations under this scheme were at times useful in stabilising the exchange rate, but under the new system there is less need for such direct intervention over interest rates.

Public Sector and Public Finances

For the purpose of formulating annual budgetary policies, the public sector is defined in terms of the deployment of funds under the government's control. Thus public sector expenditure is conventionally taken to include expenditure on the General Revenue Account, expenditure by the Urban Council and the Housing Authority, expenditure financed from certain statutory funds, and expenditure on public works projects financed with loans from the Asian Development Bank. Expenditure by institutions in the private or quasi-private sector is included to the extent that it is met by government subventions but not included is expenditure by those organisations in which the government has only an equity position, such as the Mass Transit Railway Corporation.

As an indication of the size of public sector spending, expenditure on the Consolidated Account rose from $5,061 million in 1973-4 to an estimated $42,504 million in 1983-4. The average annual growth rate for these years taken together was 23.7 per cent in value terms. Over this period, the relative size of the public sector (defined as the ratio of expenditure on the Consolidated Account to the GDP at current prices) rose from 13 per cent to more than 19 per cent.

Several principles are observed in formulating the government's budgetary policy. The first is that the growth rate of public sector expenditure should have regard to the growth rate of the economy, so that the government does not pre-empt resources which would otherwise be used more efficiently by the private sector. The second principle is that the pattern of public sector expenditure should reflect the government's conscious view as to priorities. For example, over the 10-year period 1973-4 to 1983-4, public sector expenditure on social services rose from $1,965 million to an estimated $16,603 million, reflecting a significant government effort in improving the social well-being of the population. The third principle is that a certain balance should prevail between direct and