Asiaweek, October 23, 1998
DONALD TSANG'S GLASSES ONCE had a rose-colored tint. "I believed Hong Kong had behaved impeccably," says the territory's financial secretary. "I had a romantic idea we were invincible." Until August. Speculative hedge funds - "crocodiles," Tsang calls them - had attacked the Hong Kong dollar's peg to the U.S. greenback several times since the start of the Asian Financial Crisis. Hong Kong, with its hefty reserves, surplus budget and strong financial system, beat them off. The cost was rocketing interest rates, plunging asset prices, slowing business activity and rising unemployment.But the big-time speculators returned in August. They hurled $2 billion against the peg in the first week of the month and $4 billion the next. At the same time, they were shorting stocks and futures - selling borrowed shares and index contracts which they could buy back more cheaply. Tsang faced a dilemma. He could defend the peg, but that would again drive up interest rates, pull down stock prices and squeeze the economy in a deathgrip. It would also make the crocodiles' short positions highly profitable, giving them more money to attack the currency. There seemed little Tsang could do.
Two key colleagues thought otherwise. Joseph Yam, chief executive of the Hong Kong Monetary Authority, and Rafael Hui, secretary for financial services, wanted to fight the predators in the equities market. But such blatant government intrusion seemed contrary to everything Hong Kong stood for. Tsang agonized for 10 days. "I could do nothing and thus uphold the free-market principle - and probably die with the economy," Tsang told Asiaweek. Intervention, though, was bound to cause outrage. "But we knew that if we were not able to remove the incentives in the securities market, it would be futile to fight the speculators off just in the currency market." Finally, at an overnight meeting with Hong Kong Chief Executive Tung Chee-hwa on Aug. 13, Tsang and his team decided to act. In the next 10 trading days, they poured billions of dollars from Hong Kong's reserves into stocks. That shored up the market and wiped out short-selling profits. Tsang fought the hedge funds to a standstill.
The battle was won, but what about the war? Hong Kong is a global icon of laissez-faire capitalism. Its faith in free trade produced one of Asia's first economic success stories. Its attention to the rule of law and good business practices created a largely corruption-free environment and a financial system among the region's soundest and best-regulated. And its prudent habits resulted in perennial budget surpluses and huge foreign reserves. The government promises businesses support but no interference - a policy of "positive non-interventionism" vital to its role as a financial and trading center. But now Tsang has propped up share prices, targeted the profits of market players, and built up huge government holdings in listed companies. "In international circles," wrote Salomon Smith Barney analyst Anil Daswani shortly after the intervention, "Hong Kong's reputation as one of the world's leading free markets has been shattered."
The intervention was only part of the story. The Monetary Authority's Yam revised interbank trading rules to boost liquidity in the banking system, making it harder to manipulate local-dollar interest rates. Tsang ordered stock brokers to report all short-selling trades to market regulators and ensure short sellers had stock on hand to cover their positions, with stiff penalties for non-compliance. The loose rule requiring settlement of stock transactions within two days after trading would now be tightly enforced. Futures brokers were required to disclose the holders of large positions to regulators in real time, and to strictly observe margin limits. And Tsang proposed that Tung be authorized, when the public interest was under threat, to direct not only the Securities and Futures Commission, the government's market watchdog, but also the stock and futures exchanges and the stock clearing corporation, which are ostensibly private-sector bodies.
The moves were designed to make things difficult for the crocodiles, but many market players complain some of the changes hurt them as well. Rumors circulated that two U.S. brokerages were contemplating relocating their Asia-Pacific headquarters to Singapore. David Friedland of Timberhill Securities says such talk is not surprising: "No investor will want to trade in the Hong Kong market if they are required to disclose all their open positions." The chief executive of the futures exchange, Geoffrey Ye, warns that some activities could simply move elsewhere. Futures products based on Hong Kong stocks can be launched by any exchange that sees a demand. Singapore, for example, is the center for trade in Japanese stock index futures, and it once tried - but failed - to launch a Hong Kong-derived product. "If we control too much, Singapore might launch it again," Ye says. "Then it will go entirely beyond the reach of our government."
BUT WAS THE INTERVENTION so bad? Not everyone thinks so. "I'm okay with that," says Enzio von Pfeil, director of economic research at Clarion Securities in Hong Kong. "Capitalism is not about unregulated, unruly markets." Hong Kong's problem was not so much an over-valued currency ripe to fall, but the easy "double-play" that allowed speculators to drive up interest rates, push down stock prices and profit from short-stock positions.
Tsang has been at pains to distinguish between run-of-the-mill speculators who may have a legitimate role in the market, and manipulators who abused the double-play. And while he vowed renewed retaliation if the crocodiles bit again, he promised to stay out of the market in the absence of such activity. In the past two weeks, Tsang has toured financial centers in Europe and the U.S., explaining his intervention. Noting that some misconceptions about Hong Kong were about as factual as the movie monster Godzilla destroying New York, he said wanted to dispel such "myths," including the notion that the territory was no longer a free market.
Certainly, Tsang's decisions look better after a 13% rise in stock prices since the end of intervention and the near-collapse of U.S. hedge fund Long-Term Capital Management, which shook world markets and sparked a Washington-orchestrated bailout. At a World Economic Forum meeting in Singapore, Yam proudly quoted Barton Biggs, chief global equities strategist for Morgan Stanley Dean Witter, as saying he had "come around" to agreeing with Hong Kong on the intervention.
Hong Kong-based businesses tend to agree that the safety of the peg and the stability of markets and interest rates were worth a brief official hand on the tiller. As for the new regulations, the question is what the alternatives are. "I was pleased that there were no issues of capital and currency controls," says Christopher Cron, Asian chief for U.S. insurer Reliance National in Hong Kong. "If the price is merely the government [placing] some controls on financial markets, then so be it."
Actually, Hong Kong has never been as laissez-faire as its purist rhetoric implies. The government has a firm hand on the key property market since it controls the land supply, selling sites to developers. And its heavy spending on infrastructure, in particular on the just-completed airport and related transport links, has been an essential economic driver for years. After Tung Chee-hwa became chief executive following Hong Kong's return to China in July last year, he outlined a more activist development strategy stressing high-tech and value-added industries. The Asian Crisis and the collapse of local stock and property markets have put a large part of such plans on hold. But the setbacks have also called forth a different sort of activism, with Tung suspending government land sales, in substance backing off a promise to build 85,000 new flats a year, and vowing to expedite $30 billion in infrastructure investments.
Indeed, the widespread disappointment with Tung's annual policy address on Oct. 7, criticized as lacking in action, implies that Hong Kong wants government to take on a greater - or at least smarter - economic role. The problem is, the government's vow of economic chastity has limited its thinking. "The so-called policy of positive non-interventionism before the handover was actually a policy of no commitment and no planning," says Tsang Shu-ki, economics professor at Hong Kong Baptist University. It created a bubble economy dominated by property, he adds, one less able to weather the current storm than more diversified economies like those of Singapore or Taiwan.
But the line between too little and too much government involvement is a thin one. "The economies hardest hit in the Asian Crisis are those subject to heavy government intervention," says lawmaker Sin Chung-kai of the Democratic Party, the largest in Hong Kong's legislature. "This sent a clear signal to the local authorities that intervention won't work in the long term." Even if the Hong Kong authorities were to take on a more conscious role in managing the local economy, blatant intervention such as Tsang unleashed is unlikely ever to be common. "Intervention is a dysfunction in a free-market environment," says Reliance National's Cron. "I don't think it will happen too frequently."
Tsang himself asserts that only circumstances as extraordinary as those that prevailed during August could trigger another round of government intervention. "It was not a question that we had abandoned our free-market principles," he says. "It was the other way around - the market had failed at that point." But even that is a long way from the days when a free-market believer thought that doing the right things by the book would make an economy invincible.
- With reporting by Law Siu-lan and Alexandra A. Seno/Hong Kong and Sam Gilston/Washington
BEFORE HONG KONG'S REVERSION to China in July last year, many people worried that communist Beijing's invisible hand might hamfistedly strangle the capitalist golden goose. Today, they may be more worried it is keeping its hands off as promised. Fifteen months ago, Hong Kong was in fine form: the stock market index was over 14,000 and a private home changed hands for a record $71 million. As long as Beijing didn't interfere in Hong Kong's business, many said, it would be business as usual. The good times sank, though, as the Asian Crisis flowed into Hong Kong's harbor. The market crashed, property prices plummeted and people lost confidence. Some began looking toward the stronger economy and firm leadership up north.
Beijing has been more restrained than many expected and less aggressive than many feared - yet the influence wielded by its mere presence has been growing. Its limited involvement in Hong Kong's mid-August stock market rescue operation is a perfect example. After Hong Kong's 10-day, multi-billion-dollar intervention, everybody asked the obvious: Did Beijing push Hong Kong's free marketeers to act? Financial Secretary Donald Tsang says Beijing gave moral support and stood firm on the renminbi exchange rate. But that's it: "Beijing had no role. No coordination. There was no need for consultation. We did it on our own." Democratic Party leader Martin Lee first said he suspected Beijing had ordered the intervention; several days later he retracted the accusation, saying he had no proof. There is evidence, though, that the reality was a little different than Tsang describes it. And many in Hong Kong will probably find some comfort in that.
Tsang's story begins on Aug. 13, as he, Monetary Authority head Joseph Yam and Secretary for Financial Services Rafael Hui held an overnight meeting with Hong Kong Chief Executive Tung Chee-hwa. The four agreed to intervene the next trading day. "We informed the central people's government hours before we announced entering the market on Aug. 14," says Tsang. "I expected them to support us, because it was for the stability of Hong Kong, and quite naturally full support was expressed immediately afterward." And just how did Beijing express itself? Li Yihu, director of Peking University's international relations department, says Premier Zhu Rongji basically told Hong Kong authorities that should they request it, "the center will provide support at whatever cost and through whatever means."
First the money: Well before the handover in 1997, Beijing began to prepare for possible raids on the Hong Kong dollar by international speculators. It was generally believed to have set aside $15 billion of its $140 billion foreign reserves for that task. Beijing offered Hong Kong some of this - most believe about $5 billion - for the August intervention. It was a symbolic gesture: Hong Kong's $96.5 billion in foreign reserves were ample. Liu Jinbao, a Hong Kong-based Bank of China official, told Asiaweek that China was also prepared to buy into Hong Kong shares if requested by the government. "China was ready to invest part of its foreign reserves in Hong Kong shares," he says. "But since Hong Kong did not ask, no action was taken." Afterward, market sources said Beijing decided to hold another $10 to $15 billion of its reserves in Hong Kong dollars to support the currency more directly.
Many investors also heard that the People's Bank of China (China's central bank) sent two advisers to Hong Kong to help map out tactics during the 10-day intervention. The two experts, it was said, had formerly worked on Wall Street, were comfortable with derivatives and well-informed about hedge-fund operations. Peking University's Li says he heard that two vice governors of the People's Bank were sent to Hong Kong during the intervention. Wang Li, executive director of China's Stock Exchange Executive Council, says it would have been logical to send Liu Mingkang, a vice governor familiar with international banking. So far no one in the know will confirm this. But it fits Zhu's modus operandi, says the head of Daiwa Securities in Beijing, Ted Tokuchi. Dispatching advisers to facilitate communication between Beijing and Hong Kong is a tactic the premier would use.
Some insiders further speculated that Beijing warned U.S. brokers trading on behalf of major hedge funds to stop aiding the attacks on the Hong Kong dollar, or risk jeopardizing their business in China. Wang Li says: "Foreign investment banks must take a high-profile route [deal with China's political elite] to gain access to mainland markets. So they would be more prone to heed calls from Beijing." But, again, whether or not Beijing used its clout with international moneymen is unclear.
What we do know is that in August the leaders in Zhongnanhai were, at the very least, watching Hong Kong very closely. President Jiang Zemin, Zhu and Vice Premier Qian Qichen were briefed by Chinese central bank officials on the details of the intervention in a special meeting on Aug. 28. They said the operation was essential to safeguard Hong Kong's economy and the interests of its people. Zhu even said that the battle would "sharpen" the Hong Kong authorities' "skills and ability." But he also wanted to let people know that Hong Kong's "two unchangeables" - the dollar peg and the free-market economy - were still just that. It is another irony of Asia's economic confusion that criticism of Hong Kong's move (however temporary) away from strict free-market principles comes not just from foreign investors but from China too. Wang of China's Stock Exchange Executive Council argues that Hong Kong's authorities set a bad example. "I don't feel comfortable with the level of Hong Kong's intervention," she says. "It has certainly established a [negative] precedent."
Beijing's economic influence in Hong Kong of course was growing long before the Crisis or even the hand-over. China is Hong Kong's biggest investor, its major manufacturing base, and an increasingly important market, particularly now that growth has slowed in so many other places. State-owned and China-backed companies form a large portion of Hong Kong's stock market. All that gives China clout. Sometimes that clout has been welcomed - like when Beijing said more mainland visitors could enter Hong Kong and buck up the moribund tourist industry. Sometimes it has caused concern - particularly when the occasional Hong Kong businessman asks a little too explicitly for the center to lend a helping hand.
While Beijing's renewed attention surrounding the intervention has raised some concerns, few are arguing that the capital should not keep at least a close eye on the Special Administrative Region. And that is just fine with many in Hong Kong. Those who once believed that Hong Kong had to be protected from Beijing now hope China can help save Hong Kong. But even a full-fledged alliance is not necessarily invincible. As Zhou Bajun, China research director at Sun Hung Kai Investment in Hong Kong, says: "What Hong Kong needs badly are good fundamentals, not good war partners." In other words, China can only do so much.
- With reporting by Law Siu-lan/Hong Kong, David Hsieh/Beijing, and Sam Gilston/Washington
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