Hong Kong Three Years Later.

An economic report card after three years of "special autonomy."

After three years of "special autonomy," the unexpected happened to Hong Kong. The People's Republic of China (PRC) left Hong Kong pretty much to its own devices. Public fear of Mainland intervention has been replaced by a view of poor political leadership. Unfortunately, July 1997 not only saw the inauguration of Hong Kong as a Special Autonomous Region (SAR) of China, but also the start of the Asian financial crisis.

The collapse of overvalued stock and property markets was the first test of the government, specifically the Hong Kong Monetary Authority's (HKMA) attitude towards intervention in financial markets. Speculators engaged in a series of sales of Hong Kong Dollars on spot and forward markets. The HKMA followed the rules of its currency board system and in one attack, overnight interest rates rose to over 100 percent, creating a semipermanent interest premium on Hong Kong Dollar paper. However, in an unprecedented move the HKMA also intervened in the equity market to alleviate "overshooting." This was caused by short-selling of index futures by (mostly) the same speculators -- what the HKMA referred to as "double play."

The Hong Kong Dollar currency board system survived intact, but the equity market fell by over 50 percent during the second half of 1997. The HKMA confused many market players and accumulated an embarrassingly large portion of the Hang Seng Index. This was hardly in line with free-market principles. Clearly, the HKMA reached the bruits of its traditional policy of positive non-interventionism. Afterwards, it had a big job persuading the markets that its equity intervention was not a departure from its primary role of maintaining the Hong Kong Dollar/U.S. dollar link.

The equity market recovery in 1999 enabled the government to kill two birds with one stone. The HKMA divested some of its equities in a non-market intrusive way while the government launched its first Mandatory Provident Fund (MPF) units -- on a voluntary basis. Unlike Singapore and Malaysia, Hong Kong had no mandatory occupational retirement scheme. The initial MPF success signified a fresh start for the new government.

In other areas of economic policy (including the property market), however, the Hong Kong government was constrained by the recession. Its hands were tied by the fiscal prudence measures in the Basic Law (BL), by the maintenance of the Hong Kong Dollar/U.S. dollar fixed link, and by a banking system under repair. Although international trade has since recovered, Hong Kong was hard hit by the downturn in Asian trade -- China included. However, thanks to a low incidence of negative equity and property repossession, Hong Kong has recovered just over a year later.

In the legal arena, interference by the Hong Kong government has appeared to further narrow the interpretive capabilities of the Court of Final Appeal (CFA). Since retrocession, the ultimate power to interpret statutes has been passed on from the CFA to the National People's Congress Standing Committee (NPCSC). The working of the Hong Kong judiciary under this new arrangement has been tested by a case of fight of abode. In this case, the government appealed against a High Court decision to grant fight of abode to some children whose Chinese parents claimed Hong Kong residency. The Government approached the NPCSC for an "interpretation" (that is, a clarification of legal intent) of the relevant article -- an interpretation that appeared to contradict the CFA's earlier ruling.

Under this hybrid judicial system, the long-term autonomy of the Hong Kong judiciary will be determined by the manner in which arbitration takes place. In High Court cases against the government where the CFA has ruled against them, frequent recourse to the NPCSC will undermine the integrity of the CFA. In addition, there may be disputes that could require not only NPCSC interpretation of BL articles, but also an amendment to them. Only the NPCSC can actually do this. If the CFA loses its integrity, the government's decision to approach the NPCSC for BL amendments is unbalanced. This is a concern, but not a reality.

In conclusion, Hong Kong is a small and flexible economy, so there has been little need for China to dictate policy. China's "arm's-length" approach towards Hong Kong affairs is also understandable when one considers the huge problem it faces in shifting to a market economy. This attitude serves the Hong Kong SAR well because it: (1) means there is little change to the basic fights and freedoms laid down in the BL, and (2) encourages the Hong Kong administration to find local solutions to what are local problems. However, the Hong Kong government has intervened on a number of significant occasions. It must be careful to allow the markets and the legal infrastructures to perform their respective roles. This means being more tolerant of market volatility and CFA interpretations.

Philip Wyatt is now a freelance economist after having spent the last eight years working for Warburg Dillon Read and Invesco (formerly LGT Asset Management). He is based in Hong Kong.