Hong Kong is recovering from the 1997-98 Asian economic crisis. While this is good news worth cheering about, the city faces tough challenges. In particular, will Hong Kong be able to develop the "new economy", a development needed to sustain the current recovery and guarantee a competitive future? The answer is probably yes, but the path will be marked with a high degree of volatility both in financial markets and in society.
For anyone wishing to invest in Hong Kong, the beginnings of the new economy will offer tremendous opportunities in the stock market (through ADRs), though an awareness of risks is essential. This was most evident in March and April 2000, when the dramatic downturn of the NASDAQ in the United States hit Hong Kong tech stocks hard.
The 1997-98 Asian economic crisis hit the Special Administrative Region (SAR) of Hong Kong like a tidal wave. With the ceremonies from the cityÆs handover from the United Kingdom to the PeopleÆs Republic of China hardly over, Hong Kong was pummeled by a loss of confidence and a sharp decline in economic activity caused by the rest of AsiaÆs crisis. Both the banking and property sectors, key elements of the economy, suffered, prompting the government to intervene in the stock market in August 1998.
The massive buying of stocks was geared to support a stock market that threatened to collapse. Even the neighboring Chinese economy, which avoided much of the so-called Asian contagion, slowed as it grappled with strong deflationary forces. The combination of these negative factors put the Hong Kong dollar, based on its currency board and peg to the U.S. dollar, under massive pressure to devalue.
A dismal contraction
After a dismal 5.1% contraction in economic activity in 1998, Hong Kong is making a sustained comeback. Real GDP growth was 2.9% in 1999 and 4%-5% growth is expected for 2000. In contrast to much of Asia, the banking sector staved off collapse, with non-performing loans stabilizing at around 10% of assets. In late November 1999, the Hong Kong government successfully launched the Tracker fund, a listed investment vehicle linked to the Hang Seng Index, as a first phase to reduce the equities they had purchased in the 1998 intervention. The HK dollar, once expected to suffer the fate of the Thai baht, Indonesian rupiah and Korean won, remained pegged to the dollar.
For Chief Executive Tung Chee-Hwa, the upswing in the economy is a sweet victory in what has been an unexpectedly difficult tenure. Initial expectations in 1997 with the Chinese takeover had been that the politics would probably be the primary concern. The reality has proven the reverse. Although political issues, such as the authority of the legislative body, human rights and the role of China remain important factors in the SARÆs daily life and political discussions, the economy has overshadowed everything else. Moreover, the overriding nature of economic issues is not likely to go away anytime soon.
Unemployment remains high though declining (down to 5.5% from 6.1% at the end of 1999), the recovery is not broad-based, and questions continue to nag about the SARÆs future economic foundations. The old manufactured base of the economy has long since packed up and moved north into the mainland, while Hong KongÆs role as a regional financial center is challenged by old-time rival Singapore and increasingly by Shanghai, which can offer cheaper real estate and an improving infrastructure. An additional point of concern is ChinaÆs entry into the WTO. This will force Hong Kong to reconsider how best to position itself to the ever-opening mainland economy.
Reaching saturation
Hong Kong, with a population of 7 million, also faces a challenge in its capacity to handle the inflow of migrants from China and elsewhere. Without some type of controls, Hong KongÆs population is expected to swell to 8.3 million by 2010, a greater than 20% increase. This threatens to overwhelm an urban center that is reaching its natural and economic limits in accommodating its population.
This situation could also have an impact on Hong KongÆs ability to compete with less densely populated rival, Singapore. Singapore has gone to great lengths to control both its own population increases as well as controlling the inflow of foreigners. As the Far Eastern Economic Review (March 9, 2000) noted: "That difference could prove decisive as the New Economy puts a higher premium on the ability of cities to offer a clean and pleasant living environment. Hong Kong, already one of the worldÆs most polluted and densely packed cities, could lose out to Singapore in the effort to be the most cosmopolitan city in the region."
Many of these concerns were reflected in the March 2000 budget presentation by the Financial Secretary Donald Tsang Yam-kuen. The key points of discussion in the presentation of the 2000-01 budget were the economyÆs turnaround, and improvement in public finances and no new taxes. The financial secretary announced that the economy is expected to expand by 5% in 2000, while the budget deficit came in at HK$1.6 billion at the end of the fiscal year 1999-2000, well below the projected HK$36.5 billion deficit.
The improvement is based on an increase in revenues, largely due to gains on the governmentÆs investment portfolio û something not expected to be repeated in the upcoming fiscal year. The proposed budget also contained new targets to control the number of civil servants. The total number of posts will be reduced by 10,000 or about 5%, in the next three years, back to the 1995 level.
Need more money
The most recent budget is growth-oriented. At the same time, Financial Secretary Tsang emphasized that Hong Kong needs to move toward a broader tax base, noting that in the fiscal year 1998-99, for the first time in half a century, Hong Kong had begun to experience deficits at the operating level. Consequently, the government faces pressure to raise revenues.
With no general income tax, the governmentÆs revenues are heavily dependent on property related revenue. Furthermore, only a small part of the population pays the maximum rate of 15% tax on salaries, while more than 60% of the working population pay little or nothing. The need to broaden the tax base will have to be balanced with the need to spend more on education and the environment, two items essential to maintain a competitive soft infrastructure necessary for the new economy.
New economy fever
While the debate has opened up about the need to broaden the tax base, the private sector is shifting gears to the new economy. This was evident on March 1, 2000, when one of the first public forays into the Internet caused a considerable stir in the local stock market. Billionaire Li Ka-shing issued shares of his tom.com a Chinese-language internet portal.
Tom.com is billed to be AsiaÆs answer to AOL-Time Warner, a portal, initially in Chinese and later multilingual, for China-related news, entertainment and educational information. The IPO was nearly 670 times oversubscribed and the issue price shot up from HK$1.78 (23 US cents) a share to HK$9.05 (US$1.16) in the first hours of trading. Considering the lines of would-be investors who were turned away with nothing, no-one seemed to care that the portal is still under construction.
Hong Kong was also stirred in February 2000, when Pacific Century CyberWorks (PCCW), AsiaÆs third largest internet investment company, made a successful takeover bid for Cable & Wireless HKT. The drama was even greater as CyberWorks beat out Singapore Telecommunications (SingTel), which was interested in Cable & Wireless HKT. CyberWorks had a market value of $26 billion at the time, larger than that of Amazon.com. At the end of May, Cable & Wireless HKTÆs board approved the merger offer.
Hong Kong has a number of other new internet and internet-related stocks, some of which are available through ADRs. These include I-Cable (ICAB), Hong Kong Telecom and China.com (CHINA). I-Cable is a unit of blue-chip conglomerate Wharf Holdings and is the cityÆs only pay television provider and an internet access and content provider. It operates Hong KongÆs largest broadband network and plans to diversify into telephony.
While the excitement vis-a-vis internet stocks is taking off in Hong Kong, the government is also pro-active in helping to develop a support system for the new economy. The SAR administration has already launched the Growth Enterprise Market (GEM), which functions like the NASDAQ, and will launch sometime in the year the fully automatic exchange trading system AMS3, which allows online trading.
Since opening in November 1999 GEM has raised $1.3 billion. It now has a roster of 23 companies and in May had a market capitalization of $8 billion. The government will also be launching the eIRC (electronic Investor Resource Center), which will bring investor education to the public.
Reinforcing these actions, Andrew Sheng, Chairman of the Securities and Futures Commission stated: "The potential of the new economy is huge and Hong Kong should be in the forefront of that growth."
Another development that the government has promoted, which is reinforced by the Internet, is greater transparency and disclosure. To strengthen the sanctions against false or misleading information, there is now a bill before the Legislative Council that creates offences for anyone who provides the Securities and Futures Commission and the recognized exchanges and clearing-houses false or misleading information.
The Composite Bill, which was published for public discussion in April and is expected to be put into the Legislative Council before the end of the year, will contain a number of provisions aimed at strengthening corporate disclosure. As Sheng stated in March 2000: "Our legal framework has to ensure that issuers and management do not provide bad or misleading information."
The issue of transparency and disclosure points to a critical issue û upholding the rules. Concerns have been raised that the rapid development of GEM as a local NASDAQ, has been accomplished by a bending of the rules. For example companies are supposed to be in business for two years before listing. In a number of cases, this rule has not been adhered to. Tom.com hardly had a Web Site when it went public. GEM has sought to provide a degree of flexibility so that it can compete with the NASDAQ.
Moreover, those companies given waivers are spin-offs of already well-established companies, led by Hong KongÆs billionaire club. Yet, there is no escaping the reality that if Hong Kong wants to seriously develop a lasting market for new economy startups, it has to start exercising greater discipline. Otherwise, it will face the same crisis in investor confidence that occurred in Asia in 1997-98.
Enthusiasm steady
Although most of the companies trading on the GEM are below their IPO levels, enthusiasm remains widespread about the new economy. Moreover, there are plenty of new companies lining up for a listing on the Gem. Three dozen companies have filed for applications for the GEM and it is expected that 70 to 100 more are in the process of exploring taking that route.
Hong Kong remains one of the most advanced economies in Asia. For it to remain that way it will have to fully embrace the Internet and related technologies that allow it to make the most competitive use of its human capital. This, however, poses difficult challenges in terms of dealing with such issues as population control, broadening the revenue base, and cleaning up the environment û all issues that include consultation and politicking within the Legislative Council and with the SARÆs counterparts in the PeopleÆs Republic of China.
Yet, success has its monetary rewards, something that both the private and public sectors in Hong Kong and China can appreciate. With the trend toward greater numbers of new economy companies setting up shop, issuing shares on the GEM, and plugging Hong Kong into the global grid, prospects for the territoryÆs future economic development might have made a giant step forward. Only time will tell.
Scott B. MacDonald is a Senior Consultant with KWR International in New York.
