Prides: solid strength, substantial capacity, and sound financial standing

Judging from the statistics, Hong Kong can pride itself on having solid financial strength, huge capacity and sound financial standing.

Hong Kong's strong financial strength is reflected by its sizeable and ever-increasing net IIP assets. IIP is a balance sheet showing the stock of external financial assets and liabilities of an economy at a particular point of time. An economy is said to have net IIP assets or net external financial assets when its external financial assets exceed liabilities. According to statistics of the last three years, Hong Kong has been a net creditor with increasing net external financial assets, which were up 19.6% at end-2001 and then up another 28.0% at end-2002 to HKD2646.1bn. The ratio of its net external financial assets to GDP also surged over the years from 134.2% in 2000 to 162.8% in 2001 and then to 210.0% in 2002. The net assets Hong Kong owned abroad were twice the size of its GDP. This also compared favorably with the IIPs of a number of developed economies including the United States, the United Kingdom, Canada and Australia, which all recorded net liability positions. When compared with Japan, Singapore and Germany that had net external financial assets as well, Hong Kong also fared better with relatively much higher net IIP assets to GDP ratio. As for per capita net external financial assets, Hong Kong was also ranked high, reaching close to HKD390,000 in 2002. This demonstrates that Hong Kong's financial strength remains strong although its economy has been struggling for years.

Hong Kong's huge capacity is showcased by its detailed net IIP assets statistics. At end-2002, Hong Kong's net IIP assets were HKD2646.1bn after netting out HKD5378.6bn of liabilities from HKD8024.6bn of assets. Its ratios of external financial assets and liabilities to GDP remained substantial at 637% and 424% respectively. This illustrates that Hong Kong is a highly external-oriented economy with considerable cross-border investments at both ways. Its large net IIP assets substantiate Hong Kong's role as a wealthy net exporter of investments. In fact, at end-2002, direct investment (DI) abroad by Hong Kong residents amounted to HKD2375.8bn. Other forms of investments ranged from portfolio investment (PI) in equity and debt securities to trade credits, loans, currencies, deposits, other investment (OI) and financial derivatives (FD). Hong Kong's official reserve assets (RA) reached HKD872.8bn. Most of the broad IIP components were in large net asset positions after netting out liabilities from assets, with the only exception in DI. This proves the point that although the size of Hong Kong's economy is relatively small, it possesses enormous capacity and exerts substantial influence on other economies by way of exporting capital/funds and facilitating economic developments.

By end-2001, Hong Kong's DI stock in the mainland (exclusive of funds routed through offshore tax havens) had reached HKD844.0bn. Today Hong Kong remains the largest source of China's FDI inflows, still commanding a share of nearly 40%. And according to the US Treasury Department, Hong Kong held USD49.8bn worth of US Treasuries by the end of March this year, second only to Japan and China in Asia, and was considered one of the most influential forces on the US dollar exchange rate in Asia. Most of Hong Kong's OI was held by banks in the form of interbank deposits and loans, reflecting Hong Kong's status as an international financial center. As seen from the above data, Hong Kong should not underestimate its own capabilities.

IIP is crucial to the financial stability of emerging markets. The commonplaces found in the Mexican, Brazilian and Asian financial crises were excessive external debts owed by the government, the financial sector and the private sector but insufficient external assets, therefore transforming the currency crisis into debt crisis. Hong Kong is free of such a problem, which further substantiates its sound financial standing.

At end-2002, Hong Kong's IIP liabilities were HKD5378.6bn but its ED was only HKD2739.6bn. The reason behind the difference was that not all IIP liabilities were ED owed by residents, i.e. FDI and FD. Amongst Hong Kong's gross ED, the banking sector had the largest proportion at HKD1741.9bn while the SAR Government remained debt free. Meanwhile, Hong Kong held more external credits. For example, the RA was external assets held by the Government and the financial authority. The banking sector's external assets amounted to HKD3062.5bn excluding equity investments and FD, which were HKD1320.7bn more than its ED. Other sectors demonstrated similar assets and debts structure, with the only exception in affiliated enterprises and direct investors. After netting out debts from assets, Hong Kong had net external claims amounting to HKD3355.1bn or USD430.0bn.

It was these huge external claims that cushioned the shocks during the Asian financial crisis. Statistics showed that in 1998, local enterprises sold over USD19bn offshore assets to meet funding needs amid speculative attacks on the HKD and contracting credit supplies. Sound external financial standing enabled Hong Kong to withstand large-scale speculative attacks. Besides, although all IIP and external financial assets/debts are recorded in HKD statistically, in reality they are mostly denominated in foreign currencies, especially the external assets such as borrowings and loans in the banking sector and foreign securities holdings in other sectors. It is therefore inferred that Hong Kong holds large amounts of net assets in foreign currencies. If HKD appreciates against foreign currencies, then Hong Kong in general will be worse off when the conversion effect results in less HKD assets. On the other hand, if HKD depreciates, Hong Kong will be better off with more HKD assets. In other words, an appreciation of HKD will pose a far more negative impact than depreciation.

Concerns: shrinking assets and liabilities, declining competitiveness

However, further analysis on changes in Hong Kong's IIP and external assets and liabilities reveals some concerns.

Although Hong Kong's net IIP assets kept on rising, its external financial assets and liabilities continued to shrink. Not only did assets and liabilities fall continuously throughout 2001 and 2002 (assets down 5.2% and 3.9% respectively, liabilities down 10.6% and 14.4% respectively), their ratios to GDP contracted substantially during the same period as well (assets down 34 and 21 percentage points respectively, liabilities down 60 and 73 percentage points respectively). Because IIP assets and liabilities serve as important indicators for the degree of external exposure for an economy as well as its international investments and financial transactions, the falling external financial assets and liabilities means that Hong Kong's external orientation and economic relationship have been weakening.

The decline in Hong Kong's IIP assets was not broad based. Instead, it concentrated on DI abroad and OI, which proved worrisome upon a detailed review. Starting from the year 2000, Hong Kong's DI abroad had been decreasing at an average rate of 11.4% per annum to HKD2375.8bn in 2002. But according to the BoP statistics, flows of DI abroad in 2001 and 2002 were HKD88.5bn and HKD138.0bn respectively. Whatever the reasons may be (price change, exchange rate change or structure change), this phenomenon of increasing flows yet decreasing stock in DI abroad meant diminishing production or service capacities controlled or directed by Hong Kong residents abroad. For the same period, Hong Kong's OI had been falling by 12.2% annually. OI recorded inflows of HKD461.2bn and HKD324.1bn in 2001 and 2002 respectively while OI assets were down HKD512.5bn and HKD292.0bn respectively. The simultaneous declines in both the OI flows and stock could be explained mainly by contracting loans to non-residents and overseas interbank deposits. This reflected the rapidly declining international banking businesses in Hong Kong's banking sector, thereby undermining Hong Kong's status as an international banking and financial center.

On the other hand, the major components of Hong Kong's IIP liabilities had registered broad based contraction, signaling substantial weakening in both its attractiveness to international investors and the radiating capabilities of its financial services. Since 2000, Hong Kong's DI stock had been falling consecutively at an average rate of 13.7% annually to HKD2643.9bn in 2002. A partial reason was declining inflows. But the major cause was foreign investors reducing their shareholdings and withdrawing their investments from Hong Kong. Examples include Cable and Wireless selling its Hong Kong Telecom shares, and British Telecom selling its Smartone shares, etc. According to statistics from the Companies Registry, there were 448 and 447 overseas companies withdrawing their registration in Hong Kong in 2001 and 2002. Other smaller companies entering Hong Kong with smaller investments could not make up the difference.

Judging from the above, it is safe to say that increasing net IIP assets due to decreasing IIP liabilities is not as good as it suggests. Besides, non-residents' PI stock in Hong Kong had been declining by 22.0% annually since 2000. Among them, investments on equity securities saw a larger decline than debt securities investment. This was due to investors selling stocks as well as the declining valuations caused by the market slump. The decline in PI liabilities signaled decrease in non-residents PI in Hong Kong, which hindered the further developments of Hong Kong's stock and bond markets. OI liabilities also fell by 10.9% annually since 2000, mainly due to decreasing inflows. Again, declining flows and stock in OI liabilities demonstrated that foreign banks and other non-residents had been repatriating their loans and deposits from Hong Kong's banking and other sectors, or Hong Kong's banking and other sectors simply reduced fund transfers from abroad due to lackluster local demands. Along with the contracting OI assets, this argued for a weakening status of Hong Kong as an international banking and financial center.

Many investment incomes had under-performed. EFIF statistics capture investment incomes earned by Hong Kong residents abroad and non-residents in Hong Kong. Comparison of Hong Kong's IIP assets and liabilities to its EFIF inflows and outflows can measure investment performances both in Hong Kong and abroad.

A Comparison on IIP Incomes (in HKD billion)

The above IIP assets and liabilities figures are calculated by taking the average of year-end figures of this and last year. In addition, price changes and exchange rate variations have not been considered, resulting in a rough comparison only. The calculations show that returns from Hong Kong's DI abroad trailed returns from non-residents DI in Hong Kong by a wide margin. This could be attributed to better than average returns earned by some renowned multinational companies in Hong Kong. But in terms of PI and OI, returns from Hong Kong's investments abroad were higher than returns earned by non-resident investors in Hong Kong, which could be one of the reasons for Hong Kong's capital outflows. Another major factor is Hong Kong's large current account surplus that may lead to capital outflows looking for investment opportunities.

In this case, Hong Kong's net IIP assets will continue to grow with higher capital outflows than inflows. And net positions in IIP assets will result in higher factor income inflows than outflows, thus greater GNP than GDP in both the absolute size and relative growth rate. On one hand, this demonstrates the maturity of Hong Kong's economy. On the other hand, insufficient local investments could hinder economic growth, threaten job increase and produce higher unemployment rate. Under these circumstances, it is of great urgency for Hong Kong to stimulate and attract investments from abroad while continuing to encourage cross-boundary economic activities. Before such measures can bear fruits, the trend of investing abroad will continue. Judging from statistics of the past two years, PI was the popular choice among Hong Kong residents, with investments in PI abroad totaling HKD313.0bn in 2001 and HKD283.7bn in 2002. In 1Q03 alone, PI investments amounted to HKD59.4bn. For the banking sector, this should present viable business opportunities.