Created: 6/23/1983

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DIRECTORATE Of IUTELlIGfHCE3Q: Deteriorating Econoalc Conditions

fna economicont *ong bee two *onthe. orhai waned uncertaintu hasrtrfor- or* ain IMJ .ndactor in tha tilde. ro'- ene payc/ie-orlcd. oarri/rrontinued Codc-apie*

Intervention and a two percentage point tncreaee Inaa. Tha dona Xong stock Index, which had baan on upward trend Mine* laat December, tamed sharply downward In Mau. Bfforts to

felling flnaaclal companies and three Concern! are little success.

Short term prospects tor an economic rebound are nevertheless oood. Speculative preatare agamic tha currency hat shown signs of* aaaf/tp somewhat aod Mono Kong exports have begun to respond to Veatern economic growth. Inflation, however, willajor problem, owing largely to the currency Sjp_r

Over the neit five to seven years, the continued political uncertainty1 retard positive econoalc growth and deepen econoalc downturns. Unless London and Belling can reach soae acreeaent for takeover that reassures Investors, we eipect cyclical fluctuations to becoae aore severe. The currency wi probably continue to weaken over tlae and the Hong Knnn tock market wieflect Increasing Investor uncertainty.

Economic Upturn and Investor Uncertainty

Hong Xpng3 with mostconoalc indicators Imorovlng. orts--the engine of growth In the colony-were up anercent In real teras during the first four monthsercent decline lankruotcles. aostly tied to

'pared bu

Questions author.

I* memorandum was p

ffice of Beat Asian Analysis welcome and may be directed to the

th- major slump lai th. prooertv

asia.ntlil buyersur-td to the the Mano Seno ofBtretntfron 1 January topril of

these positive Indication* af economic recovery, th, local currency has been gradually 'oslng its 'orelgn purchasing cower since January this year. Thf strenothening US dollar probably eiplains mUCh of the early define; most other Asian currencies -ere losing around during thi; period. Put waning Investor confidence too* over In Hayreercent off the currency's value against the IS major currencies and nearly io oercent off Its value against the dollarne month period. Byune, adirS HK per US dollar was Jnjhtiy1 JpM htstrengthened only

China plans to take control o* Hong Kong7 and local investors are J'ttery about economic prospectsommunist regime. hough Beijing has gone to great lengths to publicize Its Intention to leave the colony's social and economic status guo unchanged after takeover, local businessmen remain unconvinced. Moreover, talks between London and Belling, that

"2uld"meofCephave not gone lllk. II*fi *no progress for the past eight

again I ' " *r< p*rentl* oV-tln* underway

No figures for capital flight are available. Bankers In Singapore. Thailand. Sr1 Lanka, the United States, and Canada reported Increasing injections of Hong Kong capital late last year when a similar bout of nervousness sent *he Hong Kong dollaress severe tallspln. These same countries were probablyrecipients during the most recent scare. In addition, local Jjvers are shifting out of Hong Kong dollar deposits In ravor or foreign currencies and gold. Me estimate that aboutercent of Hong Kong bank deposits are now belno held In foreign

AZtl,tr earlier. Although

figures3 gold imports are unavailable, purchases from

ump'd? to more than

Jons* h *he exception of Singapore, other Far Eastrrn countries reportedjjieiperlenced declining gold Imports during tne same period.i

Government Attempts to Restore Stability

8 2 *

Thus far the Hong Kong Government's efforts to stem the flow of currency and to bolster sagging confidence have met with nine success. The government probably attempted to support the currency with small-scale open market purchases of Hongrsd-May and early June; with only an*ts foreign currency reserve fund, long-term, large-

scale intervention Is tv mlo-month trie government resortedore drastic measure to halt the outflow, oressurlnq the Hong Kong Association of Banks (HKAB) to raise interest rates two percentage points. hkaS's announcement of tr upcoming rate Increase bolstered the currency for two diys. By tht time the Increase actually went intoowever, the dollaronce again sinking to new lows. |Mpjj|f

lor was Its failure tc halt the downwardof the currency the only negative asoect of the rate Increase. Hongalways volatile stock market plunged esult of Investor fears that tht rate Increase would stymie economic recovery. Tht market lostointsercent) onay, the day the increase went Into effect. Two of Hong Kong's" textile manufacturers are among the many industrial firms currently attempting to stave off bankrupcy with short term r' borrowing. Major propertytht biggest Investors In the Hong Kong stock marktt-jjre also In need of significant amounts of short-term funds, fl

Outs 'c>

Tha) largest foreign holdtr of Hong Ken? currency is probably China's official foreign exchange bank--the Bank of China. Although no flqurts are available on total Bank holdings, Beijing's exports to Hong Cong2 alone amounted t

Hong Kong could probably also tarn to tht Bank of England for support. Althoughovt would be unprecedented, we betlevt that the Bank would be willing to work out some type of swap* arrangementht economic deterioration wis deemed extreme. Bank of England support would probably give Investor confidence aboost and, at leastly^could discourage speculative pressure on the currency.


Il tht short run, we believe Mono Kong's prospects 'or economic recoverya. During the oast few Cays the currency has shown signs of leveling-off it0S. Stronger than expected recovery In the West bodes well for sharp Increasesxports this year. Major gains in the export sector would help bolster confidence colony-wide and could contribute to overall economic stability during the remainder of the year. With? deadline stillears away. Investors probably continue to see sizable short-term ioportun1tles In the Hong Kong market. Although the recent hike In interest rates will hinder growth somewhat, we expect to see SOPercent by yearend on the strength of exports. Unemployment! below its current peakercent to cerhaps as low as percent. IHH

the colonyotally dependent on Inports for food, energy, and Industrial raw materials, we expect the recent depreciation will hamper efforts to arrest inflation. Gasoline prices Jumpedercent in May alone, and other Increases are imminent. By yearend the consumer price Index will probably be at least IS percent above last year's level. In fact, the price Increase "arfrobably offset any beneficial effect of the depredation on Hong Kong exports. Although the currency should regain some of the ground lost recently we do-jiot expect it to approach? average rate of S6 HK. flH

As long as residents remain uncertain about the Colony's future, long-term economic prospects for Hong Kong remain gloomy. arge number of the Colony's residents are flaking efforts to get et least one member of their immediate family establIshed. overseas; Hong Kong's most highly trained workers are likely to be among the most successful in leaving the colony. Moreover, Investors, even those publicly praising the current Chinese leadership and Its policies,rslfying their Investments end moving capital offshore. I

The drain on Investment funds and skilled workers will constrain Hong Kong's long-term growth. Although weenerally upward trend over theears. Hong Kong's growth rate will fall far short of historic levels and probably remain well below rates being achieved by its traditional competitors In the area. Mor will the Increase be smooth. Cycles--spurred ti Investor uncertainty and fueled byrobably be more frequent and of increasing magnitudes. Potential for econoalc collapse will be at Its peak during these cycles.


We believe that. In the long run, the floundering economy will pressure beljlng to exhibit flexibility In Its negjtlation* with the British. At present, however, Beijing appears convlnc'i that It can pacify Hong Kong Investors and maintain economic vitalityignificant British presence and, hence, vl'l probably continue toardline approach.




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