Exploding the deficit myth

March 13^th 2001 South China Morning Post

I will begin by commending Financial Secretary Donald Tsang for prescribing a cautious, valedictory Budget, which is a tonic for the recovering economy. I must follow the kudos up with a criticism, which is that Mr. Tsang has pleaded poverty once too often. The deficit he has been referring to is a myth, which I am about to explain.

The Financial Secretary believes it is better to be safe than sorry. He has consistently deflated our expectations and braced us for rainy days. In the present Budget he projects a deficit of $11.4 billion and blames that on reduced returns from the sale of government land. Fiscal reserves are to drop from $444.3 billion last March to $432.9 billion soon, about which he wants us to be alarmed because he thinks the decline signifies not an aberration but a terrible trend.

But all along Mr. Tsang has been harping on only one of two reserves, the other being the exchange fund, which his Budget does not mention, a most curious omission. I will now challenge the Financial Secretary's accounting practice and prove we are not becoming insolvent.

Hong Kong has lived in an illusion of misery when it is actually suffering from an embarrassment of riches. Back in 1989 Hong Kong had fiscal reserves of $61.5 billion, which was not only sufficient to weather an acute bout of ailing confidence but also to convince the government to embark on a series of major infrastructure projects. By 1996 the fiscal reserves had gone up to $147.9 billion, enough to put us in a boisterous mood for the 1997 celebrations of national reunification. In 1998, as Hong Kong entered recession, the Land Fund was transferred to the fiscal reserves, topping these up at $457.5 billion, which enabled the Monetary Authority to rout with ease hedge fund speculators who were waging a leveraged assault on our stock market.

The Authority also manages the fiscal reserves, giving back to these the same rate of return as the rest of its investments since 1998. The fiscal reserves, though huge, are worth less than half of the total foreign exchange fund valued currently at $892 billion (US$114.3 billion). The Authority cannot of course use all the money at its disposal since a portion of the assets belongs to the "Backing Portfolio" to underwrite the Hong Kong dollar. But still the Authority's "Investment Portfolio" is substantial and some of the earnings should be plowed back into the treasury along with income from the fiscal reserves. In the year 2000 the Authority had a net investment income of $34.3 billion, of which only $18.1 billion went to the treasury when, conceivably, the whole amount could be added to government revenue without damage to the Hong Kong currency. This is the crux. This is the bottom line.

The government has made it an article of faith that our reserves must be teeming. Mr. Tsang stressed that point during a televised talk show last Wednesday during which he explained his budgeting premises. But, disingenuously, he did not spell out how much Hong Kong really needed to secure the dollar. Back in December 1997 the government claimed an exchange fund total of $727 billion, then deemed more than adequate to deal with any eventuality. Today enough is never enough.

Since then, after the Asian financial crisis, the danger being posed against Hong Kong markets has diminished. The World Bank and the Group of Seven industrialized nations have been discussing a global strategy not just to thwart but to ruin speculators. They are now talking about pooling their financial resources to act as antibodies to the viruses of international market manipulators.

Mr. Tsang and his successor Antony Leung cannot go on pretending that the fiscal reserves and the rest of the exchange fund are entirely separate, with the former as money of last resort and the latter as money completely out of reach. Future financial chiefs should be able to tap into the dividends from the "Investment Portfolio" to help balance the budget rather than let that sum expand indefinitely. Money, whether it is labeled recurrent income or the exchange fund, belongs to the taxpayers, who should not have to sacrifice improvements to their lives, education and healthcare just to earn the Monetary Authority bragging rights.

Hong Kong established the exchange fund in 1935 with money from past surpluses. The government in 1976 siphoned more resources from the general revenue account to bolster the exchange fund, which, two years later, even consumed the coinage security fund.

The government's miserly mentality in husbanding the exchange fund is so set these days that the Financial Secretary never bothers to explain why and what for he has to forget those assets. Singapore's government is famously prudent and yet over the past year it has decided not to leave its foreign exchange to mushroom at the expense of its recurrent needs. The Lion City's exchange in March was US$77.5 billion - marginally more than what it was a year ago. Hong Kong can likewise spend a little of the dividends while preserving the integrity of the exchange fund without doing any harm to the sanctity of the dollar. Mr. Leung, previously a private sector banker, perhaps supports this logic better than his predecessor does. He knows how corporations, flushed with cash, would invest and improve their prospects rather than have accountants sit in a room to count the coins and ruffle the bills. Mr. Leung did say how "money you earn isn't yours but the money you spend is."