Mr. Sheng looks at asset prices, capital flows and risk management Address given by the Deputy Chief Executive of the Hong Kong Monetary Authority, Mr. Andrew Sheng, at the Asian Securities Analysts Federation Conference in Bangkok, on 17/11/97 (slightly abridged). 1. I am very honoured to be invited today to address this distinguished Conference. The title of my paper is “Asset Prices, Capital Flows and Risk Management”. All these factors have been the main players in the recent market turbulence in the region. I will therefore focus my discussion today on the lessons from the recent Asian market turmoil and also the impact on Hong Kong. The Surge in Capital Flows 2. In the past decade, capital flows surged within the Asian region and globally. According to IMF statistics, average annual net capital inflows to developing countries exceeded $ billion in 1990-96, and more than 40% of which actually came to Asia. In the last two years we saw even more capital inflows to the region, recording a net total of $ billion in 1996 and a similar growth rate in the first half of 1997. In some Asian economies, net inflows have averaged 5-8% of GDP over long periods, with over half of such capital flows in the form of foreign direct investment. 3.
Thus, markets adjust irrespective of the exchange rate regime and the unit of account. 28. Is there any easy way of avoiding the pain of adjustment in Asia due to rising global competition? The answer is clearly no. As a general rule, the faster we adjust, the less the pain. BIS Review 109/1997  -6-  There have been different approaches to this issue. There are some who think that a floating exchange rate regime would cushion the pain, but many forget that Hong Kong has tried the floating exchange rate regime before, in 1974-83. During that period, growth was more volatile and inflation much higher than what we are experiencing now. As an open economy with trade accounting for 285% of GDP, any inflation would be immediately imported under exchange rate volatility. The recent experience in Asia actually shows that contrary to the theory, floating exchange rates requires even higher interest rates, because of the higher risks associated with exchange rate volatility. 29. Here I would like to correct the common image that the Hong Kong’s exchange rate regime is a peg. The Hong Kong dollar is a fixed exchange rate, not a peg which can be adjusted from time to time. The linked exchange rate system in Hong Kong operates as a currency board system whereby the issue of Hong Kong dollar notes is fully backed by the US dollar at the fixed rate of $ to $ Such a note-issuing mechanism ensures that currency issued is fully backed by foreign exchange.