HONG KONG: POTENTIAL REACTION TO US TRADE PRESSURE

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP04T00907R000200570001-9
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 8
• Document Creation Date: December 22, 2016
• Document Release Date: May 29, 2012
• Sequence Number: 1
• Publication Date: February 12, 1987
• Content Type: MEMO

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Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
February 12, 1987
Hong Kong: Potential Reaction to US Trade Pressure
We expect Hong Kong to resist any further pressure to reduce
exports to the United States by claiming that the new bilateral textile
accord will keep Hong Kong's trade surplus with the United States from
growing significantly during the five-year agreement. We believe Hong
Kong will also continue to strongly oppose any change in its exchange
rate, which is pegged to the US dollar, because it fears that concerns over
the transition to Chinese control would eventually force the local dollar's
value to fall, damaging Hong Kong's trade-based economy. We believe
Hong Kong can maintain the peg indefinitely by manipulating
interest rates.
This memorandum was prepared b , Office of East Asian Analysis.
Information available as of 9 February 1987 was used in its preparation. Comments and
queries are welcome and may be directed to the Chief, Economic Assessments Branch,
China Division, OEA
EA M NO 87-20026
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Because Hong Kong's trade-dominated economy depends on access to US
markets, Hong Kong businessmen and the government worry about rising protectionist
sentiment in Washington. Over 40 percent of exports go to the United States,' and
account for almost 22 percent of Hong Kong's GDP. Hong Kong's $6.1 billion trade
surplus with the United States last year set a record, but Hong Kong's growth rate
slowed considerably (see table). Sales of textiles and apparels--Hong Kong's leading
export category--moderated. And although some electronics exports were up, radio
sales dropped sharply. On the other side of the ledger, Hong Kong's imports of US
agricultural products grew slightly, but US computer sales to the territory were down.
Table 1
US-Hong Kong Trade: 1981-86
US data in billion US $, FOB.
Trade Surplus
US Imports From US Exports to Hong Kong's Growth Rate
Hong Kong Hong Kong Trade Surplus Percent
1986* 8.95
1985 8.39
1984 8.23
1983 6.39
1982 5.53
1981 5.34
2.87 6.08 5.2
2.61 5.78 8.0
2.88 5.35 34.4
2.41 3.98 22.8
2.29 3.24 14.1
2.50 2.84
* Estimate based on January-November data
Moreover, Hong Kong's role as a major Asian entrepot earns it additional revenues.
Protectionist measures that would dampen trade through Hong Kong between the
United States and other nations such as China would cut into those revenues as well,
a prospect that only underscores Hong Kong's concerns about market access.
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We believe Hong Kong officials--in their routine conversations with US officials
and businessmen--will try to avoid intensifying disagreements over bilateral trade
issues, but instead will maintain their low-key approach, iterating their policies and
concerns to calm business jitters and to parry US pressures. For examplem, we expect
Hong Kong trade officials to explain to US counterparts that their trade surplus with the
United States is unlikely to grow significantly during the next few years because the
five-year bilateral textile agreement signed last summer allows for virtually no growth in
exports. Textiles and ap arel-accounted for 45 percent of Hong Kong's exports to the
Moreover, Hong Kong officials will probably restate several arguments they have
made against further US protectionist pressures. They will probably point out that Hong
Kong has a totally unrestricted market--in contrast to other countries in the region,
which run large trade surpluses with the United States--and therefore Hong Kong
traders should not be restricted from US markets. In addition, Hong Kong may argue
that its 5.5 million people buy more US goods per capita than any other US trading
partner. Finally, Hong Kong probably will raise the need to maintain the territory's
prosperity during the olitically sensitive transition period leading to China's resumption
Hong Kong is also likely to seek forbearance because its manufacturing sector
will have difficulty maintaining its share of the US market over the next few years.
Other newly industrialized countries and LDCs in the region have become more
competitive because of lower wage and property costs. In addition, Hong Kong's
high-technology manufacturers do not have the government assistance enjoyed in other
Sheltering the Hong Kong Dollar
On the basis of official and public reactions, we believe the Hong Kong
Government will continue to strongly resist suggestions that it revalue its currency
against the US dollar. The Hong Kong dollar has been pegged to the US dollar since
October 1983 at a rate of 7.8 to 1. Hong Kong fears that, if it demonstrates a
willingness to adjust that rate, the uncertainty associated with the transition to Chinese
rule would eventually cause a selloff of Hong Kong dollars, forcing a potentially
destabilizing devaluation. Hong Kong has demonstrated its resolve before--it chose not
to devalue in 1985 even though the high relative value of the local dollar caused a
decline in Hong Kong's exports, resulting in a GDP growth rate below 1 percent.
Can Hong Kong Maintain Its Exchange Rate?
The Hong Kong Government maintains the pegged exchange rate by manipulating
interest rates on Hong Kong dollar accounts (see the inset). For example, Hong Kong
raised its effective prime interest rate above 15 percent in 1983 and again in 1984 to
stop selloffs of Hong Kong dollars. During the September 1983 dollar crisis, some
overnight interest rates exceeded 30 percent. Of course, not even high interest rates
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can always stop a panic sellofff of dollars, nor could the local economvwith high
interest rates for long. Thus, the peg remains somewhat vulnerable.
Barring such a selloff, we believe Hong Kong can continue to maintain the
7.8-to-1 peg against the US dollar:
? Hong Kong slashed its interest rate from 6.5 to 5 percent in mid-January to
dampen speculative demand stemming from rumors of a pending revaluation (see
chart). The new low rate combined with Hong Kong's 3.5-percent inflation
created a negative effective interest rate for some Hong Kong dollar deposits;
consequently, we expect transfers of funds to foreign currency accounts, which
will relieve the demand.
? Hong Kong has no restrictions on holding or transferring foreign currencies, and
more than half--53 percent--of the territory's money supply 2 is held in foreign
Hong Kong will probably also reject calls for a revaluation because its overall
trade account was nearly balanced last year. According to preliminary Hong Kong trade
data, the territory's total exports grew by 18 percent in 1986 to $35.4 billion, while
imports grew by 19 percent to $35.3 billion. Hong Kong's trade surplus narrowed to $73
2 Based on the broadly defined measure, M-3 which includes currency, demand
deposits, savings, and certificates of deposit
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Hong Kong's Pegged Exchange Rate
Hong Kong's dollar was pegged at the rate of 7.8 to 1 US dollar in
October 1983 following months of downward speculative pressure created by
the lack of progress in what were then the year-old Sino-British talks on the
territory's future. Initial hopes in Hong Kong that the British could retain a role
in Hong Kong after 1997 began to fade by mid-1983. Capital outflows and
currency speculation grew under the existing free-floating exchange rate
system. The exchange rate fell from an average of 6.5 to 1 US dollar in January
1983 to a low of 9.6 to 1 US dollar on 24 September 1983.
On 15 October 1983, the Hong Kong Government announced the
imposition of the US dollar peg to stabilize the currency. Hong Kong's lack of a
central bank forced the government to develop a unique system requiring the
cooperation of Hong Kong's two private note-issuing banks (the Hong Kong
Shanghai and Chartered) and the Hong Kong Association of Banks (HKAB), the
cartel that sets Hong Kong's effective prime interest rate. We believe that Hong
Ko~Financial Secretary essentially dictates interest rate changes to the HKAB.
To initiate the peg, the Hong Kong Government announced that
thereafter the two note-issuing banks would be required to provide the
government with US $1 or the equivalent foreign exchange to receive a
certificate authorizing them to issue 7.8 Hong Kong dollars. Similarly, the banks
could redeem these certificates to buy back foreign exchange from the
government at the same rate. These transactions were to be conducted with
the government's foreign exchange holdings, known as the exchange fund. The
extent of these holdings is a tightly held secret known only to a handful of
people inside the Hong Kong Government.
The key to the peg's success has been Hong Kong's ability to shift
interest rates to reflect the supply and demand for the local dollar. The only
time the local dollar threatened to slip out of the peg was in July 1984, when
rumors of last-minute snags in the Sino-British talks caused a speculative
selloff. The Hong Kong dollar briefly sold for as high as 7.94 in Europe, but a
3.25-percent increase in the prime rate to 17 percent quickly brought the
exchange rate down closer to the peg (see graphic). The system also probably
returned to the peg because the note-issuing banks found it profitable to sell
Hong Kong dollars back to the govermment in exchange for foreign exchange
still available at the 7.8-to-1 rate, thereby reducing the supply of Hong Kong
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Hong Kong: Effective Prime Interest Rates
27 September 1983 to Present
US Dollar
P e~ gins,
Last minute snag in Sino-British
talks causes brief run on dollar
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7
Interest rate
lowered to stop
speculation
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SUBJECT: Hong Kong: Potential Reaction to US Trade Pressures
Distribution:
National Security Council
1 - Doug Paal, Senior Assistant for China, Taiwan and Hong Kong, Old Executive Office
Building, Room 302.
Department of State
1 - Richard Williams, Director, Office of Chinese Affairs (EAP/C), Room 4318.
1 - Joan Plaisted, Deputy Director of Economic Affairs, Office of Chinese Affairs,
Room 4318.
1 - Robert D. Goldberg, Office of Chinese Affairs, Room 4318.
1 - Henry Bardach, Office of Economic Policy, Room 5321.
1 - Tom Fingar, Chief, INR/EAP/CH, Room 8840.
1 - Tom Martin, Deputy Director, EB/EPC, Room 3329.
Department of Treasury
1 - Douglas Mulholland, Deputy Assistant to the Secretary for National Security,
Main Treasury, Room 4326.
1 - Jonathan Hill, Office of East-West Economic Policy, Room 4426.
1 - James A. Griffin, Director, Office of East-West Economic Policy, Room 4450.
1 - Todd Crawford, Office of Developing Nations Finance, Office of Assistant Secretary
for International Affairs, Room 5221.
Department of Commerce
1 - Jeffrey Lee, Office of PRC and Hong Kong, Room 2317.
1 - Christine Lucyk, Office of PRC and Hong Kong, Room 2317.
1 - Myna Stoltz, Country Policy Analyst, Office of East Asia and the Pacific, Room 3820.
1 - Betsy Hudson, Office of Intelligence Liaison, Room 6854.
Office of the US Trade Representative
1 - William Abnett, Director of China Affairs, 600 17th Street N.W., Washington, D.C.,
Room 300.
Department of Defense
1 - John J. Sloan, Defense Intelligence Officer, East Asia and Pacific, Pentagon,
Room 2C238.
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Central Intelligence Agency
2 - C/OEA/CH, Room 4G20.
1 - C/OEA/CH/TT, Room 4G32.
1 - C/OEA/CH/lS, Room 4G32.
1 - C/OEA/CH/PA, Room 4G32.
1 - C/OEA/CH/EA, Room 4G32.
1 - OEA/Production Officer, Room 4G48.
1 - D/OEA, Room 4F18.
1 - DDI, Room 7E44.
1 - Senior Review Panel, Room 5G00.
1 - PDB Staff, Room 7F30.
1 - NIO/EA, Room 7E62.
1 - C/PES, Room 7F24.
1 - C/DO/PPS, Room 3D01.
1 - FBIS/NEAAD/China Branch, Room 306, Key Bldg.
1 - EA/CO/SA Room 5D54.
1 - OGI/ECD/FF, Room 3G46.
1 - OGI/ECD/Dl, Room 3G46.
1 - OGI/ECD/T, Room 3G46.
1 - OGI/ECD/ES, Room 3G46.
1 - C/EAf Room 5E 18.
1 - LDA/AN/CHINA, Room 1H18.
1 - NIC/AG, Room 7E47.
1 - CPAS/ILS, Room 7G50.
5 - CPAS/IMC/CB, Room 7G07.
2 - Congressional Liaison, Room 7B02.
1 - NC/IS/CH, Room 814 Key Bldg.
1 - rono
10 - Author
'(9 February 87
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