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Don't cry for the SAR . . . at least not yet
South China Morning Post | Sep 11, 2002
By Sin-ming Shaw
Byline: While it may not be on the brink of financial meltdown, Sin-ming Shaw writes that there are parallels between Argentina and Hong Kong
IS HONG KONG the "next Argentina"? Don't dismiss the comparison so readily.
The perception of Argentina is that it is a laid-back Latin country, mismanaged by leaders better at tango or drug-trafficking than public governance.
Before the peso collapsed last year, the country supposedly was heavily in debt, had a weak banking system and a public sector that was a bottomless pit. Further, the yawning gap between the rich and the poor was a social disaster waiting to happen. And it did.
According to conventional wisdom, Hong Kong cannot possibly become another Argentina. The SAR has a workaholic labour force, a strong banking system, abundant reserves and a public sector surely smaller than any of the Latin countries. It has no foreign debt to service. The people, imbued with Confucian values, respect authority and shun disorder.
Look closer. Argentina and Hong Kong have both relied on currency boards to regulate their exchange rates. The Argentine peso was fixed at one to the US dollar for nearly a decade, the Hong Kong dollar for nearly two decades at 7.8 to the greenback.
In 1998, the International Monetary Fund (IMF) praised Argentina for its prudent financial management and its currency board. In May of this year, the IMF gave Hong Kong a clean bill of heath, upholding the linked exchange rate system as ideal for the territory.
In 1998, the World Bank gave Argentina and Hong Kong the same score of 21 in terms of how well banks were regulated among a list of 11 potential problem countries. Indonesia, the worst, scored a 51. Singapore, the best, got a rating of 16. In terms of capital adequacy, Argentina and Singapore were rated 1, Hong Kong got a 3. Smaller numbers indicated a higher performance in the rating.
The public sector in Argentina in 2000 consumed about 24 per cent of gross domestic product (GDP), roughly the same as Hong Kong today. The SAR budget deficit is running at 5.5 per cent of GDP, against only 2.5 per cent for Argentina in 1997-98, and 3.6 per cent in 2000. Public-sector employment here is about 10 per cent of the labour force, against 12.5 per cent in Argentina.
Debt? In Argentina, domestic debt was 41 per cent of GDP in 1998, well below the 60 per cent ceiling imposed by the Maastricht Treaty on countries of the European Union. Total foreign debt was 51 per cent of GDP in 2000, better than several European Union countries. The IMF was clearly not worried in 1998. Malaysia's external debt was over 60 per cent. Hong Kong has no public debt, but external private debt is 220 per cent of GDP.
Anne Krueger, deputy managing director of the IMF, speaking with 20/20 hindsight in July this year, observed that there were essentially two factors that broke Argentina - an overvalued peso, now above 3.6 to the US dollar, and an increasingly weak fiscal policy. That being so, then Hong Kong should be on red alert for it also faces these two problems.
Recent figures confirm SAR deficits are between $60 to $70 billion a year. At this rate, official reserves will evaporate in five years. If the deficit continues at this level for another year, it will convince financial markets that a currency crisis is a matter of when, not if.
Raising taxes to balance the budget now or later in a deflating economy would further depress demand and stifle growth. There is only one way out. The government must drastically cut its deficits.
The SAR pays 70 per cent of its budget in salaries. The over-paid civil service has agreed only to a two per cent cut after 30,000 officials took to the streets. The chief executive, lacking a mandate from universal suffrage, seems swayed easily by street politics.
Ministers can get $4 million a year. Some at such institutions as the Hong Kong Monetary Authority (HKMA) make more than $8 million. Shouldn't the wages of these public servants be cut more than the rank and file? Besides, the top 3.7 per cent of the civil service - fewer than 4,000 officers - receives 21 per cent of all salary outlays. The top 13.5 per cent get 52 per cent of outlays. The bottom 67 per cent receives a mere 8.2 per cent of the total.
An across-the-board cut is neither fair nor effective. The public pays local academics, part of the public sector, a 40 per cent premium over the top US payer, Harvard University. Are we that good?
Backed by huge reserves, the Hong Kong dollar is supposedly impregnable. However, it is, by most estimates, roughly 40 per cent overvalued against the US dollar and twice that against the yuan, prolonging deflation.
The 7.8 peg against the US dollar will stay only as long as holders of Hong Kong dollars remain confident the rate will not change. If enough lose conviction and wish to convert to other currencies, they will drive interest rates to a level that no society could tolerate without unrest. In Argentina, the end game began when its citizens lost confidence in the currency.
Would floating the currency now be a viable option, even if the chief executive were to go back on his commitment to the 7.8 peg for five more years? No. Hong Kong lacks a proper central bank. Without it, a float could be disastrous.
The HKMA is not a central bank but a bank regulator with central bank ambitions. No senior staff have the appropriate education or the experience to conduct monetary policy.
The late Merton Miller, Nobel laureate in economics, said at a Legislative Council hearing in November 1998: "Joseph Yam [head of the HKMA] and I have somewhat different educational and professional backgrounds, and sometimes it turns out when we are discussing matters, he's talking about one thing and I'm talking about something else, even though the words are sometimes essentially the same."
The HKMA must be re-staffed before a float can even be contemplated.
The gap between the rich and the poor in Hong Kong is widening.
The Gini coefficient, a measure of income distribution, for Hong Kong stands at 0.53. In 1996 it was 0.476. The benchmark ratio of one means that one person gets all the income, the rest nothing. A zero means even distribution. Argentina's Gini coefficient was 0.49 in 1999, the same as the Philippines. China is at 0.42.
Hong Kong is under social stress. Polls show low and declining respect for top government leaders and for all political parties.
A month ago more than 500 triad members flaunted their presence in a prime tourist district in broad daylight.
Several months ago, the police chief openly challenged action by the head of the Independent Commission Against Corruption against a senior police officer. The row raged for more than a week, even after the chief executive reportedly had ordered the policeman to pipe down.
Hong Kong is not quite Argentina yet, but there are disturbing signs. Let's hope the world will not have to cry for Hong Kong one day.
Sin-ming Shaw, former chief international economist of The Capital Group and head of its office in Hong Kong, is a visiting scholar at St. Antony's College, Oxford University
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