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TRADE POLICY REVIEWS: FIRST PRESS RELEASE, SECRETARIAT AND GOVERNMENT SUMMARIES
Hong Kong, China: December 1998

Despite the present economic difficulties, Hong Kong has maintained its traditional openness to both trade and investment and has not taken any measures directly affecting imports or foreign direct investment.

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See also:

Second press release
Chairperson’s concluding remarks


PRESS RELEASE
PRESS/TPRB/95
4 December 1998

Hong kong, china's free market system will help facilitate economic recovery Back to top

Despite the present economic difficulties, Hong Kong has maintained its traditional openness to both trade and investment and has not taken any measures directly affecting imports or foreign direct investment.

According to a new WTO report on Hong Kong, China's trade policies and practices, the economic crisis which began in Thailand in July 1997 and then spread to other countries in South-East Asia, seriously impaired Hong Kong's economic performance and caused a dramatic slowdown in economic activity. Real GDP is expected to decline by 4% in 1998 compared to robust growth of 5.3% in 1997.

The WTO's report and a policy statement by the government of Hong Kong, China, will be the subject of two days of discussion at the Trade Policy Review Body on 7 and 8 December 1998.

The WTO's report points out two main events which marked Hong Kong since the last trade policy review in 1994. The first concerns the Hong Kong's reversion to the People's Republic of China on 1 July 1997 and its designation as a Special Administrative Region under the "one country, two systems" framework. The second concerns the economic crisis in Southeast Asia. With regard to the first, the report notes that there is no indication that Hong Kong's traditional openness to trade and foreign investment has been affected by reunification. In regard to the second, the report finds that even in the wake of the crisis, the government does not appear to have attempted to influence the long-term structural evolution of Hong Kong's economy.

A main feature of this evolution has been the increasingly closer links with the fast-developing adjacent region of South China. The report notes that the strong growth in cross-border trade and investment, together with the relocation of the lower, value-added assembly-type manufacturing operations to South China, has been accompanied by a growing demand for service-oriented activities in Hong Kong. The outcome has been a continuing erosion of manufacturing share of GDP, down to 7.3% in 1996 from 9.2% in 1994, while the share of services rose from 83.4% in 1994 to 84.4% in 1996. This continuous shift from manufacturing to services has been reflected in the composition of Hong Kong's imports and exports and the substantial and increasing trade deficit equivalent to 3.5% of GDP in 1997, compared to 1.4% in 1996. Aside from declining regional demand, the increase in the deficit may be linked in part to the recent sharp currency depreciations in

neighbouring countries, which weakened the competitiveness of Hong Kong's exports. Notwithstanding these devaluations elsewhere, the government remains strongly committed to the maintenance of its currency peg (in relations to the US dollar), which is viewed as the cornerstone of Hong Kong's financial and monetary system, even though it resulted in the Hong Kong dollar's effective appreciation and higher interest rates.

Recent developments in Hong Kong's trade policies include the modification of the rice control scheme, accession to the WTO Agreement on Government Procurement, stricter enforcement of intellectual property rights and the strengthening of some aspects of competition policy. With regard to the control scheme for rice, government officials introduced in 1997 an optional quota system to encourage competition among importers. This was partly in response to the urging of Hong Kong's Consumer Council which sought to introduce competition clauses into the import licenses to safeguard against anti-competitive behaviour.

The report notes that authorities in Hong Kong believe that competition is best nurtured and sustained by allowing the free play of market forces and keeping intervention to a minimum. The government has thus eschewed an all-embracing competition law. The authorities are persuaded that Hong Kong's high degree of openness to trade and foreign direct investment and its strong reliance on market forces - together with sector-specific regulatory, administrative and in the case of telecommunications, legislative measures - are sufficient to ensure highly competitive markets both for goods and services. However, the Consumer Council, has identified sectors where competition could be increased, including residential property, retailing, wholesaling and distribution, banking telecommunications and energy. The report notes that the government has recently established a body to handle complaints about anti-competitive private practices. In addition, certain sectors, particularly telecommunications and legal services, have been subjected to increased competition. The authorities are also studying the possibility of increasing competition in the energy sector.

Other domestic calls for government action focused on alleviating negative repercussions, notably the rise in unemployment, due to the economic slowdown. In June 1998 the government introduced a package of relief measures including a few "emergency" measures aimed at stabilising inter-bank interest rates as well as land, stock and foreign exchange markets. However, government officials have largely refrained from interfering with the normal functioning of the free-market system. The Hong Monetary Authority did intervene, however, in August 1998 to stabilize the Hong Kong stock market by purchasing substantial stakes in several major manufacturing and services companies that broadly represented the Hang Seng Index.

The openness of the Hong Kong economy to trade is such that all imports enter the region duty free, although it should be noted that tariff bindings, apply to less than half of all tariff lines. Non-tariff barriers are almost absent. The report notes that those that do exist either stem from Hong Kong's obligations under various international undertakings or are applied for health, safety, security or environmental reasons or to protect intellectual property rights.

In its conclusions, the report states that Hong Kong's trade deficit is expected to narrow considerably in 1998 and that this suggests that domestic product and factor markets may be adjusting so as to reverse Hong Kong's recent decline in export competitiveness. The recent fall in the value of the U.S. dollar, especially relative to the Japanese yen, and cuts in U.S. interest rates, will also help to improve Hong Kong's growth prospects. This, together with its traditional adherence to a free and open market system, should facilitate Hong Kong's emergence from the current economic crisis and contribute to a resumption of its strong economic performance.

Notes to Editors

The WTO's Secretariat report, together with a policy statement prepared by Hong Kong, China will be discussed by the WTO Trade Policy Review Body (TPRB) on 7 and 8 December 1998. The WTO's TPRB conducts a collective evaluation of the full range of trade policies and practices of each WTO member at regular intervals and monitors significant trends and developments which may have an impact on the global trading system. The Secretariat report covers the development of all aspects of each of Hong Kong's trade policies, including domestic laws and regulations, the institutional framework, trade policies by measure and by sector. Since the WTO came into force, the new "areas" of services and trade-related aspects of intellectual property rights are also covered.

To this press release is attached the summary observations from the Secretariat report. The full Secretariat and government reports are available for journalists from the WTO Secretariat on request (call 41 22 739 5019). They are also available for the press in the newsroom of the WTO internet site (www.wto.org). The Secretariat report, together with the government policy statement, a report of the TPRB's discussion and the Chairman's summing up, will be published in hardback in due course and will be available from the WTO Secretariat, Centre William Rappard, 154 rue de Lausanne, 1211 Geneva 21.

Since December 1989, the following reports have been completed: Argentina (1992), Australia (1989, 1994 & 1998), Austria (1992), Bangladesh (1992), Benin (1997), Bolivia (1993), Botswana (1998), Brazil (1992 & 1996), Burkina Faso (1998), Cameroon (1995), Canada (1990, 1992, 1994 & 1996), Chile (1991 & 1997), Colombia (1990 & 1996), Costa Rica (1995), C˘te d'Ivoire (1995), Cyprus (1997), the Czech Republic (1996), the Dominican Republic (1996), Egypt (1992), El Salvador (1996), the European Communities (1991, 1993, 1995 & 1997), Fiji (1997), Finland (1992), Ghana (1992), Hong Kong (1990 & 1994), Hungary (1991 & 1998), Iceland (1994), India (1993 & 1998), Indonesia (1991, 1994 & 1998), Israel (1994), Jamaica (1998), Japan (1990, 1992, 1995 & 1998), Kenya (1993), Korea, Rep. of (1992 & 1996), Lesotho (1998), Macau (1994), Malaysia (1993 & 1997), Mali (1998), Mauritius (1995), Mexico (1993 & 1997), Morocco (1989 & 1996), New Zealand (1990 & 1996), Namibia (1998), Nigeria (1991 & 1998), Norway (1991 & 1996), Pakistan (1995), Paraguay (1997), Peru (1994), the Philippines (1993), Poland (1993), Romania (1992), Senegal (1994), Singapore (1992 & 1996), Slovak Republic (1995), the Solomon Islands (1998), South Africa (1993 & 1998), Sri Lanka (1995), Swaziland (1998), Sweden (1990 & 1994), Switzerland (1991 & 1996), Thailand (1991 & 1995), Trinidad and Tobago (1998), Tunisia (1994), Turkey (1994 & 1998), the United States (1989, 1992, 1994 & 1996), Uganda (1995), Uruguay (1992), Venezuela (1996), Zambia (1996) and Zimbabwe (1994).

The Secretariat’s report: summary Back to top

TRADE POLICY REVIEW BODY: HONG KONG, CHINA
Report by the Secretariat – Summary Observations

Main Developments

The period under review (1994-98) was marked by two main events. The first was Hong Kong's reversion to the People's Republic of China, on 1 July 1997, and its designation as a Special Administrative Region (SAR) with a high degree of autonomy with regard to economic (and most other) policies under the "one country, two systems" framework established in accordance with the Basic Law. This framework involves a 50-year commitment to allow the SAR to maintain its existing free and open market system, which has long been the hallmark of Hong Kong's economy, making it one of, if not the most liberal among WTO Members and has contributed to a level of GDP per capita that is among the highest in the world (over US$26,000 in 1997). There is no indication that Hong Kong's traditional openness to trade and foreign investment has been affected by reunification, and as such, the present economic regime may be broadly characterized as "business as usual".

The second main event during the review period was the outbreak of the economic crisis in Thailand in July 1997 and its spread to other countries in and beyond South-East Asia. The crisis, and the associated drop in demand throughout the region, has seriously impaired Hong Kong's economic performance since the third quarter of 1997, causing a dramatic slow-down in economic activity. Real GDP is expected to decline by 4% in 1998 compared to robust growth of 5.3% in 1997. At the same time, the unemployment rate has more than doubled to 5% in August 1998, the highest level since 1983. It is noteworthy that, despite the present extraordinary economic difficulties, Hong Kong has maintained its traditional openness to both trade and investment and has not taken any measures directly affecting imports or foreign direct investment.

Nor, it would appear, has the Government attempted to influence the long-run structural evolution of Hong Kong's economy during the period under review. One of the main features of this evolution has been the increasingly closer links with the fast-developing adjacent region of South China. The strong growth in cross-border trade and investment, together with the relocation of the lower - value-added, assembly-type manufacturing operations to South China, has been accompanied by a growing demand for service-oriented activities in Hong Kong. The outcome has been a continuing erosion of manufacturing's share of GDP, down to 7.3% in 1996 from 9.2% in 1994, while the share of services rose from 83.4% in 1994 to 84.4% in 1997. This continuous shift from manufacturing to services has been reflected in the composition of Hong Kong's imports and exports.

Throughout the period under review, Hong Kong has run a substantial and growing merchandise trade deficit. This has been offset to a large extent by a rising surplus in non-factor services. For merchandise and services combined, a deficit equivalent to 3.5% of GDP was recorded in 1997, compared to 1.4% in 1996. Besides declining regional demand, this rise may be linked in part to the recent sharp currency depreciations in neighbouring countries, which have weakened the competiveness of Hong Kong's exports.

The financial crisis put considerable pressure on the Hong Kong dollar, which since 1983 has been pegged to the U.S. dollar under a currency board type of arrangement, whereby the Hong Kong dollar is fully backed by foreign reserves. The pegging of the Hong Kong dollar to the U.S. dollar has limited the authorities' scope for controlling the money supply and interest rates. The peg has also resulted in an effective appreciation of the Hong Kong dollar, particularly in relation to the devalued currencies of those countries in the region much more heavily affected by the Asian financial crisis. The Government is committed to maintaining the peg, which it views as the cornerstone of Hong Kong's financial and monetary system and which it believes has a long-run stabilizing effect on the economy and is essential to Hong Kong's role as a major international financial centre. Since the latter half of 1997, however, the Hong Kong dollar has come under increased pressure, largely as a result of spillovers from the financial turmoil elsewhere in the region. While this pressure has hitherto been successfully resisted through the corresponding tightening of domestic liquidity, the resulting higher interest rates have contributed to sharp falls in stock and property prices and depressed domestic consumer and investment demand.

In response to domestic calls for the Government to take action in order to alleviate, if not reverse, the recent slow-down in economic growth and the consequent rise in unemployment, in June 1998 the Government introduced a package of relief measures, which is expected to contribute to a budget deficit of 1.5% in 1998. Apart from the implementation of a few "emergency" measures aimed at stabilizing inter-bank interest rates as well as land, stock and foreign exchange markets, the authorities have largely refrained from interfering with the normal functioning of the free-market system.

Trade and Investment Policies and Practices

There have been several notable developments in Hong Kong's trade- and trade-related policies since the previous Trade Policy Review in 1994, including modification of the Rice Control Scheme, accession to the WTO Agreement on Government Procurement, stricter enforcement of intellectual property rights, and the strengthening of some aspects of competition policy. However, there have been no major changes in the trade policy regime since the transfer of sovereignty on 1 July 1997. The Government's basic approach is still to let markets operate freely and openly both for trade and investment. Thus, it has not sought to promote or rescue individual industries, even in the face of the Asian crisis.

The openness of the Hong Kong economy to trade is such that all imports enter the region duty free, although it should be noted that tariff bindings apply to less than half of all tariff lines. Non-tariff border measures (NTMs) are almost absent; those that do exist either stem from Hong Kong's obligations under various international undertakings or are applied for health, safety, security or environmental reasons or to protect intellectual property rights.

The most noteworthy of these NTMs is the Rice Control Scheme, under which the amount of rice an importer is licensed to bring into Hong Kong is linked to that importer's contribution to the maintenance of a reserve stock. The Scheme, whose rationale is security of supply, has remained in place since Hong Kong's reunification with China. Clearly, the Scheme grants a certain market power to importers, with the associated economic rents meant to defray the cost of participation in the reserve scheme; however, price mark-ups can be high, 100% of the c.i.f. import price in the case of Thai fragrant rice, for example. The Government reviewed the Scheme in 1997 and introduced an Optional Quota System in October 1997, with a view to encouraging competition among importers; the Consumer Council had urged the Government to introduce "competition clauses" into the import licences to safeguard against anti-competitive behaviour. In 1998, the level of the reserve rice stock was reduced from 45,000 tonnes to 40,000 tonnes.

There are virtually no government controls on the composition or destination of exports, except in the case of restrictions maintained under the WTO Agreement on Textiles and Clothing and for UN sanctions (for which the Central People's Government is now responsible). Nor has Hong Kong resorted to unilateral action to address trade disputes and problems.

Hong Kong has few restrictions on inward investment. Moreover, it has hardly any sector-specific measures that could constitute incentives to foreign direct investment (FDI), although the tax exemption for profits from certain international shipping services is an important exception. Hong Kong's openness to FDI combined with sound macroeconomic policies, its transparent rules-based legal environment, the availability of financial facilities and infrastructure, a skilled and reliable labour force, together with its proximity to other major markets, notably China, as well as a simple and predictable tax system, with low tax rates across the board, have greatly contributed to Hong Kong's attractiveness to business.

Shortly before the transfer of sovereignty, the authorities acceded to the WTO Agreement on Government Procurement (GPA), which entered into force on 19 June 1997.

The Government, during the period under review, also confirmed its commitment to a policy of "minimum intervention and maximum support". Furthermore, it indicated that, within the framework of a free-market, it would pursue an industrial support policy aimed at sustaining and promoting the productivity and international competitiveness of manufacturing and service industries. This policy does not appear to be aimed at "picking winners" through the use of industry/firm-specific measures or incentives. Instead, the authorities have sought to ensure a business environment conducive to structural adjustment, investment and growth by emphasising broad initiatives to enhance the skills and technology base of economy, encourage new products and processes, remove infrastructural and land constraints, and liberalize regulated industries, particularly those providing basic business inputs (e.g. telecommunications services). In the face of the exceptional difficulties arising from the Asian financial crisis, the Hong Kong Monetary Authority (HKMA) did intervene in August 1998 to stabilize the Hong Kong stock market, by purchasing substantial stakes in several major manufacturing and service companies; according to the authorities, the acquisitions broadly represented the Hang Seng Index (HSI) without preference for particular companies or sectors. As a result of this market intervention, the HKMA's shareholding in three major conglomerates now exceeds 10%. It is worth noting that, however carefully done, intervention can work to the advantage of some market participants; thus, for example, by maintaining the price of their shares above levels that might otherwise have prevailed, HSI-listed companies may be provided with an advantage vis-Ó-vis non-listed companies in the cost of acquiring capital through new share issues. Also, in the case of the roughly 9% stake purchased by the HKMA in Hong Kong and Shanghai Banking Corporation (HSBC), Hong Kong's largest bank, there is the possibility of a conflict of interest because the regulator is a major shareholder in one of the banks it regulates.

In the course of the discussions leading to this Review, the authorities emphasized that it is not their intention to interfere with the management and operation the companies in which the Government now holds shares. To address concerns over potential conflicts of interest, the authorities announced, in September 1998, the establishment of a new company, the Exchange Fund Investment (EFI) Limited, to manage these shares, at "arm's length" from the Government and regulators; the EFI will have its own board of directors, one third of whom have been drawn from the Government.

During the review period, the authorities implemented comprehensive legislation aimed at ensuring Hong Kong's compliance with the TRIPS Agreement. More recently, the authorities have taken steps to strengthen the enforcement of laws intended to protect intellectual property rights.

In the authorities' view, competition is best nurtured and sustained by allowing the free play of market forces and keeping intervention to a minimum. Hence, the Government has eschewed an all-embracing competition law; the authorities are persuaded that Hong Kong's high degree of openness to trade and foreign direct investment and its strong reliance on market forces in combination with sector-specific regulatory, administrative and, in the case of telecommunications, legislative measures are sufficient to ensure highly competitive markets both for goods and services. This approach has been questioned by the Consumer Council, which has pointed to a lack of competition in certain sectors, including residential property, retailing, wholesaling and distribution, banking, telecommunications and energy. However, the Government has taken steps to strengthen some aspects of it competition policy. These steps include the establishment of guidelines and of a body to handle complaints about anti-competitive private practices. In addition, certain sectors, particularly telecommunications and legal services, have been subjected to increased competition. The authorities are also studying the possibility of increasing competition in the energy sector.

Prospects

The recent marked decline in real GDP and the associated sharp increase in unemployment can be traced in large part to the adverse effect of regional demand on Hong Kong's external trade and the fall in domestic demand. The deterioration in Hong Kong's external trade balance is probably also linked to a certain loss of net-export competiveness in the face of large devaluations by some of its neighbours. The fall in domestic demand owes much to the higher interest rates that have been needed under the currency board arrangement for the Hong Kong dollar. Higher interest rates have increased the cost of borrowing to consumers and businesses alike, and contributed to the recent decline in property and stock prices. The consequent negative wealth effects of the decline in such asset prices may have exacerbated the fall in domestic demand.

Wages and other prices will need to be sufficiently flexible downwards, and productivity improved, to help regain growth momentum, given the relative currency appreciation and decline in demand. Although nominal and real wages reportedly rose 4.5% and 0.1%, respectively, on an annual basis in the second quarter of 1998 despite the economic recession, more recent newspaper reports indicate that some firms may be starting to cut wages substantially. Property prices and rents have already undergone sharp declines during the past year. While labour productivity in the economy as a whole has grown only 1%, in manufacturing it increased by 9% in the 12 months ending June 1998 (up from 8% in 1997). The fact that the trade deficit is expected to narrow considerably in 1998 suggests that domestic product and factor markets may be adjusting so as to reverse Hong Kong's recent decline in export competitiveness. The recent fall in the value of the U.S. dollar, especially relative to the Japanese yen, together with cuts in U.S. interest rates will also help to improve Hong Kong's growth prospects. This, together with its traditional adherence to a free and open market system, should facilitate Hong Kong's emergence from the current economic crisis and a resumption of its strong economic performance.

Government report Back to top

TRADE POLICY REVIEW BODY: HONG KONG, CHINA
Report by the Government

TRADE AND ECONOMIC ENVIRONMENT

Economic Environment

Structure and Development of the Economy

Hong Kong is strategically located at the doorway to the mainland of China. It is also situated on the international time zone that bridges the time gap between North America and Europe. Both attributes reinforce the HKSAR's position as a global centre for finance, business and communications. Hong Kong is ranked the eighth largest trading entity in the world. It operates the busiest container port in the world in terms of throughput, and the busiest airport in terms of the volume of international cargo handled. It is the world's sixth largest banking centre in terms of external banking transactions, and the seventh largest foreign exchange market by turnover. Its stock market has Asia's second largest market capitalization.

The HKSAR owes its strength to sound economic fundamentals, substantial fiscal reserves and foreign exchange reserves, zero fiscal debt, business-friendly government policies, a competent workforce complemented by a pool of shrewd entrepreneurs, an extensive and efficient network of transport and communications infrastructure, a high degree of internationalization, and open financial markets. Added to these are a simple taxation system with low tax rates, free and fair market competition, a fully convertible and stable currency, tight fiscal discipline, a well-supervised banking sector, sound monetary system and a comprehensive legal framework. On these virtues, the World Economic Forum ranks Hong Kong as the world's second most competitive economy, while the U.S. Heritage Foundation and Fraser Institute of Canada rank it as the freest economy in the world.

Over the past two decades, the Hong Kong economy has more than tripled in scale. Hong Kong's GDP has been growing at an average annual rate of about 7% in real terms, twice as fast as the world economy and considerably outperforming the OECD economies. Per capita GDP in the HKSAR reached US$26,600 in 1997.

The open-door policy and economic reforms in the mainland of China implemented since the late 1970s have not only opened up a huge production hinterland for Hong Kong's manufacturers, but also created abundant business opportunities for a wide range of service activities in Hong Kong. The past two decades therefore saw a significant transformation of Hong Kong into a predominantly service-based economy. The growth and development in financial and business services was particularly rapid. The significance of the service sectors as a whole in terms of their contribution to GDP thus rose steadily, from 70% in 1985 to 74% in 1990 and further to 84% in 1996. The contribution of the manufacturing sector to GDP concurrently declined, from 22% in 1985 to 18% in 1990 and further to 7% in 1996. The fall in GDP contribution by the manufacturing sector should nevertheless be viewed in conjunction with the concurrent substantial growth in import/export firms engaged in sub-contracting arrangements in the mainland of China. Many of these firms are formerly manufacturing firms which have shifted almost all of the labour-intensive manufacturing processes to the mainland of China, leaving such high value-added functions as marketing, orders processing, materials sourcing, design and product development, and quality control with the local firms. So a fair part of the HKSAR's services are generated from traditional "manufacturing" industries whose production base has been expanded into the mainland of China.

Recent Performance

As an integral part of the world economy, Hong Kong cannot be immune from the profound shocks emanating from elsewhere in the region and beyond. The economy has been in a state of consolidation and adjustment, amidst the slump in the asset markets, higher interest cost, subdued local sentiment and uncertain business outlook brought about by the impact of the financial turmoil. GDP fell by 2.8% in real terms in the first quarter of 1998 and by 5% in the second quarter, both figures over the relevant quarters in 1997.

Export performance slowed considerably, hit by a dip in import demand in Japan and East Asian economies feeling the pinch of the currency crisis, although consumer demand in the U.S. and E.U. provided a partial offset. Exports of services continued to be curtailed by the weakness in inbound tourism. Local consumer spending suffered a distinct setback. Labour market conditions slackened considerably. The unemployment rate rose sharply to 5% in the period ending August 1998. The HKSAR's GDP for 1998 as a whole is now forecast to contract by around 4% in real terms.

Yet the HKSAR economy has been adjusting expeditiously so as to recoup competitiveness. Property prices and rentals have fallen substantially from their peaks in 1997. Wages and salaries are softening. As inflation is now down to its record low, the cost of living and cost of doing business in the HKSAR have both moderated. The local workforce is adapting promptly to the more difficult employment conditions, and the corporate sector is slimming for greater operational efficiency. These are the necessary moves to be taken by the private sector for an efficient adjustment process to carry through. Thus, once the regional environment and the local sentiment improve, these will provide the HKSAR with a strong basis for prompt return to positive growth.

Linked Exchange Rate Back to top

Operation of the Linked Exchange Rate System

The linked exchange rate system (the link) was introduced in October 1983. It is a form of currency board system, which theoretically requires the monetary base to be backed by a foreign currency at a fixed exchange rate. The monetary base is normally defined as the amount of bank notes issued and the balance of the banking system (the reserve balance or the clearing balance) held with the currency board for the purpose of effecting the clearing and settlement of transactions between the banks themselves and also between the currency board and the banks. The expansion or contraction in the monetary base would lead to interest rates for the domestic currency to fall or rise respectively, creating the monetary conditions that automatically counteract the original capital outflow or inflow, ensuring stability of the exchange rate throughout the process. It is through such built-in autopilot mechanism that exchange rate stability is maintained under the currency board system.

The issue and redemption of bank notes, through the note issuing banks, are required to be made against U.S. dollars at the fixed exchange rate of HK$7.80 to US$1. Specifically, Certificates of Indebtedness, which give the authority to the note issuing banks to issue bank notes, are issued and redeemed against U.S. dollar at that fixed rate and for the account of the Exchange Fund. In other words, all Hong Kong dollar banknotes are fully backed by U.S. dollar.

At present, all licensed banks are required to maintain a clearing account with the Hong Kong Monetary Authority (HKMA) for the account of the Exchange Fund. The aggregate balance in these accounts represents the clearing balance of the banking system. In operating the clearing accounts, the HKMA ensures that this crucial part of the monetary base is also subject to the discipline of the currency board arrangements.

The HKMA also provides an undertaking to licensed banks to convert Hong Kong dollars in their clearing accounts into U.S. dollars at the fixed exchange rate of HK$7.75 to US$1 (the Convertibility Undertaking).

Performance of the Linked Exchange Rate System

In the last fifteen years, the link has ridden out a number of external shocks including the 1987 World Stock Market Crash, the Gulf War in 1990, the Exchange Rate Mechanism Crisis in 1992, the brief attack on the Asian currencies including the Hong Kong dollar in the aftermath of the Mexican crisis in January 1995 and the latest regional financial turmoil. The Hong Kong dollar has remained rock solid throughout these events. The maximum deviation of the Hong Kong dollar exchange rate from the linked rate of 7.80 is less than 1%.

The robustness of the link has been underpinned by the strong foreign exchange reserves (US$92.1bn as at end-August 1998), a consistent track record of fiscal discipline (average fiscal surplus around 2% of GDP since 1984), a healthy banking system (capital adequacy ratio above 17% and bad debt ratio less than 2% for 1997) and flexibility of the economy to adjust to external shocks.

The Asian Financial Turmoil

The successful defence of the Hong Kong dollar linked exchange rate amidst the Asian financial turmoil and heavy selling pressure on the Hong Kong dollar in October 1997, January and June 1998 is a clear demonstration of the effective operation of the linked exchange rate system in exactly the same simple and robust manner as described above. On all of these occasions, banks collectively sold more Hong Kong dollars than the balances in their clearing accounts kept with the HKMA. When those foreign exchange transactions were due for settlement, there was an acute shortage of interbank liquidity which led to a rise in interbank interest rates. This effectively stemmed capital outflow and restored the stability of the exchange rate. As a result, the Hong Kong dollar exchange rate has remained remarkably stable throughout the turmoil and only moved within a narrow range of HK$7.725 to 7.750. On the securities side, notwithstanding exceptional volatilities and heavy turnover, the market has been able to continue to operate efficiently and orderly throughout the period, demonstrating that the market reform over the past decade has been effective.

From October 1997 to January 1998, the market remained very volatile and sensitive. While we rode through this particularly stormy period with our currency remaining stable, and the securities and futures markets operating orderly and efficiently, we considered it prudent to conduct a comprehensive review on both the monetary side and the securities side of the market. The Report of the Financial Market Review was published in April 1998. Whereas the Report refrained from drawing conclusions while the turmoil was still very much underway at that time, it nonetheless noted that the defence mechanism for the currency has very effectively preserved the stability of the exchange rate and the monetary system. The prudential regulatory framework for both the banking and the securities sectors, which we have carefully built up over the years, have formed effective buffers against the recent shocks. The Report also identifies a number of areas in the current systems where improvement at a technical and operational level are warranted. Some of these measures have already been put in place while others are under active implementation.

However, following a number of negative factors surfacing in July, including the political uncertainty in Japan and the poor corporate results locally, the Hong Kong dollar came under fierce, continuing and concerted speculative attack in end July. At the same time, the open interests in the Hang Seng Index futures market also started to build up substantially between end July and early August, strongly suggesting a "double-play" tactic that aimed to attack the currency and money market and sell down the stock market on the one hand, and profit from the futures markets on the other. The selling pressure on the Hong Kong dollar continued into the first week of August, fuelled by repeated and escalated rumours on Reminbi devaluation and the delinking of the Hong Kong dollar. Open interests in the futures market rose to the unprecedented level of 100,000 contracts and above. It became clear that the speculators’ strategy was to undermine the stability of the linked exchange rate of the Hong Kong dollar, which in turn would jack up the interest rate sharply and send the already nervous stock market further down, reaping the huge profits from the accumulated short open interests in the stock index futures market.

It was under such circumstances that the Government of the HKSAR launched the counter-activities in the second half of August. The purpose of the operation in the stock and futures markets was to frustrate the "double play" strategy of speculators. The Government was conscious of the possible downside of the market operations, including in particular, possible misunderstanding of both local and international investors that the Government might be interfering with market forces with a view to artificially jacking up the stock market prices. We believe, however, doing nothing in such circumstances would entail even greater risks and cause damages to our economy and the society as a whole, that would be difficult and far more expensive to repair. The situation was exceptional and commanded exceptional measures. We continue to believe that should the government have not acted promptly as it did, the stability and integrity of our financial markets would have been severely undermined to such extent that public confidence would have been put under serious threat.

The market operations by the Government lasted for about two weeks until end August. Since then, the Government has basically been inactive in the market. In order to make our markets less susceptible to cross-market manipulation and volatilities, a series of measures were introduced in both the currency market, and the securities and futures markets. To further strengthen the currency board arrangements, the HKMA announced on 5 September a package of seven technical measures. In sum, the HKMA undertakes to convert the Hong Kong dollars in the banks’ clearing accounts with the HKMA into U.S. dollars at the fixed exchange rate of HK$7.75 to US$1. The rate will move to 7.80 when market conditions permit. This represents our strong commitment to the linked exchange rate system. We also provide banks with greater access to the Discount Window for liquidity assistance through repurchase agreement using Exchange Fund papers, which are fully backed by foreign reserves. On the securities and futures side, the Government put forward a 30-point programme with a view to strengthening the discipline and transparency of the markets. The proposed measures cover six specific areas including short selling activities, system improvement, risk management, rule enforcement, inter-market surveillance and contingency power. The programme also proposes, as longer term measures, full participation of investors in the central electronic clearing and settlement systems for securities transactions, and the implementation of a completely scripless securities market in the HKSAR.

The Government of the HKSAR is fully committed to the maintenance of the linked exchange rate system which is a cornerstone of Hong Kong's monetary and financial stability. No foreign exchange controls will be practised in the HKSAR, as clearly provided in the Basic Law. The preservation of the link, which has buttressed confidence in the our monetary and financial systems, is in the long term interest of the HKSAR. We also remain committed to maintaining a free, open and transparent financial market in the HKSAR that promises a level playing field for both local and overseas investors and market operators.

External Trade Relations Back to top

External trade plays a vital role in the HKSAR’s economic development. Trade in goods and services expanded by about 13 times and four times respectively over the past two decades. The value of our total trade in goods and services amounted to around 265% of its GDP in 1997.

Merchandise Trade

External Trade

From 1994 to 1997, the value of the HKSAR’s merchandise trade grew from HK$2,421 billion to HK$3,071 billion with an average annual growth rate of 8.3%.

Table 3.1

The HKSAR’s External Merchandise Trade Performance, 1994-1997

(HK$ billion)

Trade

Year

Percentage Change over Previous Year

 

’94

’95

’96

’97

95

96

97

Total Trade

2,420.7

2,835.2

2,933.5

3,071.0

17.1

3.5

4.7

Imports

1,250.7

1,491.1

1,535.6

1,615.1

19.2

3.0

5.2

Exports

1,170.0

1,344.1

1,397.9

1,455.9

14.9

4.0

4.1

of which Domestic Exports

222.1

231.7

212.2

211.4

4.3

-8.4

-0.4

Re-exports

947.9

1,112.5

1,185.8

1,244.5

17.4

6.6

5.0

Source: Census and Statistics Department.

In 1997, the HKSAR was the world’s eighth-largest trading entity in terms of value of merchandise trade; the fifth-largest if all Member States of the European Union are counted as a single entity. Its largest trading partner is the mainland of China, followed by the U.S. and Japan.

The HKSAR’s external trade, nevertheless, slackened considerably in the first half of 1998 upon the impact of the financial turmoil. Exports of goods were dampened by the dip in import demand in Japan and in all the other East Asian economies. But exports to the conventional markets such as U.S. and E.U. performed better and provided some offset. As a whole, total trade fell by 6.7% in value term in the first eight months of 1998 over a year earlier. Yet with imports showing an even faster decline along with the consolidation in domestic demand, the ratio of visible trade deficit to imports narrowed to 7.4%, from 11.4% a year earlier.

Domestic Exports

In the first half of 1998, domestic exports declined by 5.4% in value terms over a year earlier. Clothing continued to be the largest component of domestic exports, valued at HK$72.2 billion or 34.2 per cent of the total in 1997. This percentage has remained stable over the past decade. At HK$33 billion, electrical machinery, apparatus and appliances came second. Other domestic exports included photographic apparatus, equipment and supplies and optical goods; watches and clocks; and textiles. In 1997, the mainland of China, the U.S. and the United Kingdom were Hong Kong's largest markets, absorbing respectively 30.2%, 26.1% and 5.1% of total domestic exports.

Re-exports

Re-exports remain the main driving force in the HKSAR’s total exports. In the first half of 1998, however, re-exports fell by 1.6% in value terms over a year earlier. The slow-down was mainly attributable to the distinct slackening of intra-regional trade, but the further shift in the structure of the HKSAR’s external trade to offshore trading also tended to dampen the growth in re-exports.

Principal commodities re-exported included electrical machinery, apparatus and appliances, and telecommunications and sound recording and reproducing apparatus and equipment, valued at HK$253.6 billion in 1997. The mainland of China, Japan and Chinese Taipei were the main origins of the re-exports; the mainland of China, the U.S. and Japan were the major destinations.

Imports

The HKSAR is heavily dependent on imported resources to meet the needs of its people and its diverse industries. In the first half of 1998, imports fell by 5.7% and 2% in value and real terms respectively over a year earlier. This decline was caused in large part by the weak domestic demand. The slow down in re-export trade also contributed, though of much less significance.

Consumer goods constituted the largest share of the HKSAR’s total imports, reaching HK$587 billion in 1997. This was followed by raw materials and semi-manufactured goods (HK$562.4 billion) and capital goods, foodstuffs and fuels (HK$465.7 billion). The mainland of China, Japan, and the U.S. were the main suppliers of HKSAR’s imports in 1997, accounting for respectively 37.7%, 13.7% and 7.8% of the total.

Service Trade

The HKSAR’s export and import of trade in services registered robust growth in the past decade, with average annual growth rates reaching 6% and 8% in real terms respectively. The HKSAR ranked 12th in the world league of commercial services trading entities in 1997 - the ninth largest exporter and the 15th largest importer, according to the latest estimates by the WTO Secretariat. The major components of the HKSAR’s trade in services are shipping, civil aviation, tourism, and various financial services. There has also been an increasing demand for professional and other support services. Offshore trading, cross-border land transport services and other business services, including exports of construction, legal, accountancy, computer and management consultancy services to the mainland of China and other East Asian economies, have all shown rapid increases.

In the first half of 1998, exports of services suffered a setback along with the weakness in inbound tourism and the slow-down in visible trade. Yet inbound tourism began to show the first signs of revival most recently. Import of services had a modest increase, due to the continued growth in outbound trips by the HKSAR residents. Offshore trading should have also continued to rise on the back of sustained growth in exports by foreign-funded enterprises in the mainland of China. The invisible trade surplus attained should still be sizeable, rendering a considerable offset to the visible trade deficit.

TRADE PRACTICES : RECENT DEVELOPMENT Back to top

Import and Export Measures

The HKSAR's import and export system is characterized by :

(a) zero tariff;

(b) minimum controls; and

(c) no subsidies or assistance to exports.

The HKSAR applies zero tariffs on all imports and exports of goods. Import and export controls are kept to the minimum, and either stem from obligations under various international undertakings, or are applied for health, safety or security reasons. A list of principal statutory provisions under the purview of the Director-General of Trade and other government agencies which provide the legal backing to the control of imports and/or exports to the HKSAR is at Annex 2.

Sectoral Measures

Only a few items are under absolute prohibition. Such items include: chloroflurocarbons, 1,1,1-trichloroethane, tetrachloromethane, hydrobromofluro-carbons and halons imported for local consumption; ozone depleting substances imported from non-parties to the Montreal Protocol on Substances that Deplete the Ozone Layer; smokeless tobacco products which the WHO has ruled to be carcinogenic; food containing non-permitted colouring matter, artificial sweeteners, aflaxtoxins, erucic acid, preservatives, anti-oxidants; and certain metals which are prohibited to protect public health.

Certain items are subject to import and export licensing requirements, as set out in paragraphs 4.5 - 4.18 below. Such requirements are administered by the relevant government departments. In some cases, fees are charged to recover the operating costs of import and export licensing systems. Exports of a wide range of textiles and clothing are subject to quantitative restraints under the WTO Agreement on Textiles and Clothing (ATC). Imports of rice must meet, but may not exceed, minimum levels prescribed by the Director-General of Trade. Quantitative import restrictions apply to certain ozone depleting substances. The HKSAR also enforces trade sanctions against certain countries in accordance with the Resolutions of the United Nations Security Council.

Textiles and Clothing

Domestic exports of textiles and clothing are important to the HKSAR’s trade, accounting for more than 40% of the HKSAR’s total domestic exports. Among these, about 60% are for export to the four restrained markets which have imposed quantitative restraint on Hong Kong. They include the U.S., the E.U., Canada and Norway.

Hong Kong, China takes its obligations under the WTO ATC seriously. In order to fulfil such obligations, the Government of the HKSAR has instituted a comprehensive control regime on the import and export of textiles and clothing. Legal framework of the control system is provided for under the Import and Export Ordinance and its subsidiary legislation, which stipulate that all imports and exports of textiles and clothing, other than a few exempted items, are required to be covered by valid licences or notifications.

In order to uphold the integrity of the control system, the HKSAR maintains an effective checking system to detect and prevent fraudulent import and export of textiles and clothing. The Commissioner of Customs and Excise is responsible for enforcement work of the control system. To further enhance the control system, a more targeted approach in conducting checks and investigations has been adopted. Factory Audit Check, which was introduced in 1996, enables customs officers to conduct more comprehensive and in depth checking on factories manufacturing textiles and clothing.

Furthermore, a new Production Notification (PN) arrangement was implemented with effect from 1 July 1996 for the purpose of strengthening the textiles export controls system and for ensuring origin compliance in respect of cut-and-sewn garments. The PN is a notification required to be lodged with the Trade Department before production starts. Based on the notification, customs officers will be able to conduct real-time verification of the origin conferring production process. This mechanism proved to be very effective in enforcing the origin rule for cut-and-sewn garments and for combating origin frauds.

Reserved Commodities

Imports of rice, frozen meat and poultry are subject to licensing control under the Reserved Commodities Ordinance and its subsidiary regulations. The purpose behind is to ensure a regular and adequate supply, and to provide a reserve stock for emergency situations.

Rice

Rice is the most important staple foodstuff in the HKSAR. Yet, there is no commercial production of rice, and we rely entirely on imports for local consumption. Importers are free to import rice from any source. Major sources of imports in 1997 were Thailand (73.8% of total imports), Australia (19.5%) and the mainland of China (3.2%). Importers are registered with the Trade Department as stockholders to ensure that they share the responsibility of maintaining a reserve stock of rice in the HKSAR. Imports of rice require licences. Imports for local consumption are governed by quotas. However, applications for imports for subsequent re-export are freely approved.

The amount of import quotas is determined on a half-yearly basis taking into account the demand and supply of rice in the coming import period to ensure that at any given time there is reserve stock equivalent to the amount required for 45 days’ consumption. Unlike most other import quota regimes which aim at curbing imports, under the rice control scheme, importers are required to import in excess of the amount required for consumption to a level which would ensure that at any given time there is an adequate reserve stock of 45 days. In essence, the establishment of import quotas is a regulatory measure to ensure that rice is imported in each import period not only to match consumption but to maintain a steady reserve stock to cushion any sudden disruption of supply in coming months.

With a view to introducing more competition in the rice trade, the Trade Department has operated an Optional Quota System since October 1997. Under this system stockholders can choose to import slightly more or slightly less rice than the amount allocated according to their basic quota units held.

The Reserved Commodities Ordinance (Cap. 296) and its subsidiary regulations provide the legal framework for the control of rice. The law confers extensive powers on the Director-General of Trade to control not just import and stock keeping of rice, but also on storage, movement, distribution, sale and pricing of rice. In practice the Director-General of Trade exercises his powers in relation to only import and stockholding (including storage), but has never taken any measures to regulate the price of rice. This is because the scheme has been developed for internal security rather than for economic purposes.

Frozen Meat and Poultry

Frozen meat and poultry refer to frozen or chilled meat (including beef, mutton, pork, lamb and all offals) and frozen poultry (including fowl, duck, goose or turkey and parts thereof). The control on frozen meat and poultry enables the Trade Department to monitor the imports and stock levels of frozen meat and poultry in the HKSAR, and helps maintain a reserve stock for emergency purposes. The licensing of frozen meat and poultry is under review to see whether they should continue to be controlled as reserved commodities.

Strategic Commodities

Strategic commodities are subject to both import and export controls so as to prevent the HKSAR from being used as a conduit for proliferation, and to secure Hong Kong’s continued access to high-tech goods and technology essential for its economic developments.

Under the strategic trade control system, the Trade Department is the licensing authority, and the Customs and Excise Department is the enforcement agency. The system is provided for in the Import and Export Ordinance. Items subject to control are listed out in the Import and Export (Strategic Commodities) Regulations to the Ordinance. The overall control list follows those adopted by the various international non-proliferation regimes.

The Weapons of Mass Destruction (Control of Provision of Services) Ordinance was enacted in June 1997 to prohibit the provision of services which assist the development of such weapons.

Other Licensing Control

Other products subject to licensing control and the purposes for imposing the control are set out at Annex 3.

Rules of Origin Back to top

Imports into Hong Kong are not required to be accompanied by certificates of origin (COs) issued by the exporting countries concerned. With regard to exports, the Government of the HKSAR provides an origin certification system to facilitate exporters to meet the requirements of importing countries. COs are required as a customs clearance document for the export of restrained textiles to the E.U. and Norway.

The Trade Department is the government agency responsible for administering the origin certification system and issuing COs. Apart from the Trade Department, five other organizations have been designated by the Government as competent to issue COs under Article 11 of the International Convention for the Simplification of Customs Formalities 1923. These Government Approved Certification Organizations are:

the Hong Kong General Chamber of Commerce;

Federation of Hong Kong Industries;

the Indian Chamber of Commerce, Hong Kong;

the Chinese Manufacturers’ Association of Hong Kong; and

the Chinese General Chamber of Commerce.

To uphold the integrity of the certification system, only registered manufacturers verified to have the manufacturing capability to perform the origin-conferring processes of their registered products may apply for certificates of origin. The Trade Department also ensures that all issuing organizations adopt the same practices and procedures in the issue of certificates of origin, and that the rules of origin are followed.

Hong Kong rules of origin are established in accordance with internationally accepted practice, and conform with the standards and practices set out in the Kyoto Convention.

Information Technology Agreement

Hong Kong, China is a party to the Ministerial Declaration on Trade in Information Technology Products (the "Information Technology Agreement" or "ITA") concluded at the WTO Singapore Ministerial Conference in December 1996. To demonstrate our commitment to trade liberalization, we bound our tariff on all products covered by the ITA at zero in one go, instead of in four stages, on 1 July 1997.

Hong Kong, China has also been participating actively and constructively in the work of the Committee of Participants on the Expansion of Trade in Information Technology Products, including the negotiation on expansion of product coverage of the ITA. Hong Kong, China takes a liberal approach in the negotiation and looks forward to its successful conclusion.
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