SINCE THE SUMMER OF 1997, THE WORLD HAS BECOME acutely aware of the 'Asian financial flu' that has dislocated the economies and destabilized the politics of Asia. Its symptoms have been manifest: major banks and corporations have defaulted on their loans and failed to repay foreign debts; nervous native and foreign investors have with drawn vast amounts of capital; and property and stock values have plummeted, while inflation and unemployment have soared. According to the World Bank, the worst hit countries, such as Thailand, the Philippines, Malaysia, Indonesia, and South Korea, have lost the equivalent of 80 per cent of their gross domestic product. Moreover, the World Bank predicts that overall the region will experience negative growth rates, ranging from -2 to -15 per cent. In short, Asia is in a recession from which it may take as long as five years to recover.
At the beginning of the crisis, from summer through the early autumn of 1997, the conventional wisdom was that Hong Kong would be protected by its healthy economy. Since Hong Kong's economy was based on free market economics underpinned by the rule of law rather than on the 'crony capitalism' prevalent elsewhere in Asia, it was thought to be immune from the contagion. Unfortunately, it too succumbed to the region's economic turmoil. By the summer of 1998, the Hong Kong Special Administrative Region (SAR) government was forced to declare that the economy was in recession for the first time in 13 years. Because this was an unprecedented as well as an unwelcomed experience for almost an entire generation of Hong Kongers, it produced an uncharacteristically pessimistic mood in a usually upbeat society. Restoring confidence in Hong Kong and safeguarding its economy has proven to be the SAR's greatest challenge. Its failure to respond effectively to the economic crisis has led to the politicization and nationalization of Hong Kong, unexpected changes that have profound implications for its future.
THE ECONOMIC EFFECTS OF THE CRISIS
The Asian financial crisis that began with the devaluation of the Thai baht on 2 July 1997, finally caught up with Hong Kong in late October 1997. To combat fears of an assault on the Hong Kong dollar and stem the withdrawal of capital from Hong Kong investments, the Hong Kong Monetary Authority (HKMA), which acts like the United States Federal Reserve, raised its interest rate. This in turn prompted local banks to raise their prime lending rates and caused the Hang Seng Index to plunge 1,700 points or 14.6 per cent, the largest point drop and the third largest percentage loss in its history.
Any doubt that Hong Kong had contracted the 'Asian financial flu' was laid to rest with the spectacular collapse of Peregrine Investment Holding, a regional investment powerhouse known for its risk-taking. The main reason for Peregrine's fall was its unsound investment in the ironically named Indonesian taxi company, Steady Safe. On the eve of its destruction, Peregrine held $270 million in promissory notes, denominated in United States dollars, from Steady Safe - or about one third of its capital assets. In addition, it held an estimated US $400 million in other Indonesian debt securities. Because of the dramatic decline of the value of the Indonesian rupiah and its failure to hedge against currency risk, Peregrine's investment became worthless virtually overnight. Besides Steady Safe, Peregrine had other so-called illiquid assets, such as loans to two other Asian companies that totaled US$310 million. Altogether Peregrine's exposure to creditors was approximately US$1 billion dollars.
With no 'white knight' to come to its rescue, Peregrine was forced to liquidate on 12 January 1998. News of its demise had an immediate impact on the stock market, causing the Hang Seng Index to drop 8.7 per cent. Peregrine's collapse raised questions about the lack of transparency in Asian business dealings in general and Hong Kong's regulatory systems in particular. …