Handle with Care: China and the Hong Kong Stock Market Crash

Article excerpt

The return of Hong Kong to the People's Republic of China as a Special Administrative Region on July 1, 1997, marked the first time since the 1945 Yalta Conference that a territory was reverted to a communist regime whose economic might and political stance are perceived as a threat to the Western hemisphere.

Pessimists tend to forget that Hong Kong is the world's eighth-largest trading economy, with an average annual GDP growth rate of about 7.5 percent for the past 20 years, when they suggest that the territory will suffer under the control of China's repressive political system and centrally-controlled markets. This view also ignores the fact that high volumes of trade between China and Hong Kong has long bound their economies together into one interdependent market. In this light, the latest stock market crash should be seen not as a prelude to disaster but as a warning to Beijing that Hong Kong's booming economy is sensitive and needs special care if it is to become an engine of China's development.

On Wednesday, October 22, the pessimists saw what they thought was the confirmation of their darkest fears: the Seng index dropped by six percentage points before hitting an all-time low the following day, when it dropped another ten percentage points. Suddenly, but not surprisingly in today's globalized financial markets, Hong Kong's volatility affected financial markets around the world, most significantly those in Europe. The London Stock Exchange lost more than three points in the space of 24 hours, suffering the most dramatic plunge since the infamous "Black Monday" of 1987. Similar effects were registered elsewhere on the continent. The Hong Kong crash was sorely felt in Japan due to that nation's heavy dependence on exports to other Asian markets. Even the New York Stock Exchange was affected, reversing its vigorous rise and dropping by more than two percent.

The pessimists were quick to blame China, but other experts attributed the crash to Hong Kong's accelerated growth pattern. Renato Ruggero, director general of the World Trade Organization, claimed that the crisis was more tied to the dynamics of growth than to the fundamental economic structure of South East-Asian countries, and was therefore temporary. A similar reaction came from the International Monetary Fund (IMF), which expressed concern but faith in the local Hong Kong authorities' capacity to monitor the crisis.

Many economists believe that the economic model adopted by the Asian tigers is unsustainable in the long term. GDP growth in these economies has been largely driven by exports. However, yearly export increases of 20 percent, generating a parallel upward shift of eight percent in GDP growth, seem unlikely to continue given that the GDP growth of most industrialized countries is stable around 2.5 percent. An occasional crash is expected, and can have a large impact if the country's banking system suffers from inefficiencies, as is the case with Hong Kong. Since financial markets are interdependent, it is unthinkable to believe that a crash in Hong Kong will not have global repercussions. From that point on, it is the role of financial institutions to control the crisis. Dominique Strauss-Kahn, France's minister of finance, requested the prompt intervention of the IMF and other international financial institutions, to avoid what he called "very serious risks of destabilization"; this request was a reasonable demand, not a cry of panic. …