HONG KONG -- Hong Kong has long been viewed as the freest market economy in the world. The reality has always been rather more complex, given the government's monopoly over the land market and the existence of long-established price-setting cartels, including the banking industry.
It is therefore of profound interest that the territory looks set to enjoy over the next five years a sweeping program of Thatcher-like privatization straight from the libertarian tracts of Friedrich von Hayek -- long Greed & Fear's favorite author. This will take the form not only of selling public-sector corporations but also of contracting out services to the private sector, including, importantly, the building of low-cost housing. The long-term implications of this are both exciting and extremely bullish in terms of maximizing efficiencies, as capital is freed up, creating new business opportunities.
The privatization initiative should go a long way to answering the question of how Hong Kong reinvents itself yet again in response to the challenge posed by the Asian crisis, which has had the desired effect of undermining the former colonial government's previous extreme complacency. It will also inevitably end the banking and property sectors' dominance of the stock market.
A too-skeptical Greed & Fear has for several months been hearing whispers about the government's privatization agenda. Until recently there has been little public acknowledgement of this initiative due to the sensitivity of the vested interests at stake. There are, after all, 189,000 full-time civil servants in Hong Kong and another 140,000 people working for government-owned corporations. This constitutes 10% of the workforce.
Returning to Hong Kong this week, it has become clear to Greed & Fear from stories in the local press that the government is now prepared to go public on this agenda. "Privatization is the way to go" was the headline in the
Hong Kong Standard
on Tuesday, quoting a speech made by the head of the local civil service, Anson Chan, who after all represents the people with the most to lose. The next day an article buried inside
The South China Morning Post
quoted Housing Secretary Dominic Wong as saying that the Housing Bureau was looking into the feasibility of replacing home ownership-scheme flats with housing loans. This suggests that the Hong Kong government has decided to stop, not before time, being the world's largest developer of housing. (The Housing Authority currently has 100,000 public-sector housing units for sale!)
The Housing Authority, which now employs 15,000 people, has served the role of recycling the government's revenue from land sales to build public-sector units for the half of the population that cannot afford to buy homes because of the artificial supply constraints, which are why Hong Kong residential property remains so expensive. The plan would seem to be to replace this with government-subsidized housing loans provided to means-tested applicants. These loans can then be securitized.
The logic of this development is that private-sector developers will, going forward, have responsibility for providing all housing in Hong Kong, as they should. But they will in future be responding to the stimulus of final demand. Until now the process has been administratively driven, with the Housing Authority receiving about 30 hectares of land a year. Instead of building on this land, the government will increasingly place the land itself into the private sector via the "reserve list" system. This refers to the significant, though largely unnoticed, reform announced in February whereby there will now be a reserve list of sites that can be taken to auction at any time a developer expresses an interest in any one of them. This marks the conscious beginning of a move to do away with the reliance on traditional government land sales programmes. The key point of this reform is that supply will be freed up in response to demand. The government will also no longer be a price setter, as there will not be a reserve price set.
Freeing up the supply side is part of the conceptual framework that goes along with the whole privatization initiative. The financial-services aspect of this is the decision to phase out all residual interest-rate controls by 2001. This will allow for a more efficient allocation of capital at the expense of banks' interest margins -- the banks will doubtless claw the money back by charging customers for services that are currently free.
Involving the Private Sector
Another aspect of this is the government's decision to delegate tasks to the private sector. Information technology, waste disposal, education and care of the elderly are all areas where contracting out is now seriously being looked at. In this context the plan is to cut the number of full-time civil servants by 120,000 within 10 years. This process clearly offers huge commercial opportunities for the private sector. The expertise gained by the private sector within Hong Kong of supplying services to the government can then be used to offer the same services to local governments in China. What about waste disposal in Guangdong, for example?
Contracting out will be complemented, just as it was in Thatcher's Britain, by the privatization of pubic-sector corporations. The first deal to be done will be the
Mass Transit Railway
. Greed & Fear hears that this deal is going to proceed rather more quickly than the market realizes, with the mandate to sell a 25% stake due to be awarded in the next few weeks. Other candidates for sale include the
Water Supplies Department
Kowloon Canton Railway
Provisional Airport Authority
The opportunities are, however, endless, which is good news for investment bankers. All that is required is a bit of imagination. Why not privatize the Land Registry, for example, which tracks all property transactions in Hong Kong? The key point is that there is huge value locked up in Hong Kong's public sector. Capital can be freed up and allocated much more efficiently under this new radical environment, especially given Hong Kong's proven entrepreneurial skills.
Anyone interested in this stuff should note that the intellectual engine for much of this drive comes from the
Hong Kong Centre for Economic Research
, which has published more than 30 books on all aspects of deregulation in the local economy covering areas as diverse as social welfare, health care, pollution control and housing reform. The key point in all of them is the economic benefit to be derived from promoting competition.
Complementing Plans in China
This privatization agenda in Hong Kong goes, neatly, hand in hand with the renewed privatization drive in mainland China, symbolized by the change in the constitution at March's
National People's Congress
to give the private sector legal status. It is true that the reality of Communist Party rule means that there are clear limits to this trend. Still, the most exciting development in China in recent months has been the government's recognition of the need to get the state-controlled banking sector lending to private-sector entities as the best way (as opposed to yet more fiscal pump-priming) of addressing the profound deflationary pressure in China's economy. The Achilles' heel of 20 years of economic reform in China, thus far, has been the almost complete absence of any change in the command-driven banking system. That is now changing, as is clear from stepped-up efforts to deal with the chronic nonperforming loan problem via asset management companies.
The renewed deregulation drive in China is also clear in such areas as energy and telecoms, a process which has been given added impetus, just as has happened in the area of banking, by China's renewed push for entry into WTO. Thus, this week China announced that it plans to privatize half of its state-run power plants. Meanwhile, it is worth remembering that in telecoms China has agreed (in WTO-related negotiations) with the U.S. to phase out all geographical restrictions on the paging and mobile phone businesses for foreign investors. It will also open fixed-line services in Beijing, Shanghai and Guangzhou to foreign competition. Opportunities created as a result of concessions made by China for the WTO can be seized by American multinationals but, and perhaps more likely, also by companies based in Hong Kong.
The free-market allocation of capital and economic growth through competition are phenomenally bullish for the winners, since the upside can be infinite. This is the inverse of schemes of control in the utility sector. How can this change the composition of Hong Kong's stock market, where the banking and property sectors still account, formally at least, for 56% of the benchmark
in terms of present market capitalization? The answer is radically. Britain, for example, now has 18 quoted education-service providers, nine listed electrical companies and 12 listed domestic telecom plays to cite just some examples. In five years, Hong Kong's stock market should look radically different. Net asset values in the property sector will be one of just many valuation parameters, not the overwhelming obsession.
Stock-broking salesmen will ask what all of the above has to do with the issue of where the stock market goes tomorrow. The answer may be nothing. But confirmation that the Hong Kong government seems prepared to set its economy really free, and that this policy complements the present direction of policy in China, is profoundly bullish in a strategic sense. In this respect it should be noted that, thus far, Singapore has won the propaganda war in Asia in terms of who has fashioned the correct response to the Asian crisis. The restructuring initiative in Singapore is clearly genuine, although it is a reality that it is government-driven, reflecting the reality of a command-driven society. What now seems about to happen in Hong Kong is infinitely more radical and exciting than anything being considered elsewhere in the region, including Singapore. It therefore requires a more bullish long-term view on the territory's equity market.
Asset allocation within the Asia ex-Japan region has become less important, with most regional stock markets enjoying similar performances. This is making top-down indexing strategies increasingly prevalent among fund managers. Thus the
Far East Free ex-Japan
index was up by 30% in the year to 28 April. Only three markets have outperformed in terms of the
country indices, namely Korea, the Philippines and Thailand, of which only Korea's outperformance (up 45%) is significant.
Reducing a Singapore Weighting
Fortunately Greed & Fear has been overweight in all three markets. Our one overweight market that has not outperformed is Singapore. Still, Singapore is up 25% so far in the second quarter, which is not bad. Greed & Fear will reduce that weighting now to neutral, removing 3 points from our Singapore exposure. We will allocate that money to Hong Kong along with the 4 percentage points raised by the premature removal two weeks ago of the profitable out of the index bet in Malaysia. This will take Hong Kong to 37%.
If the direction of the policy change described above continues to be confirmed, Greed & Fear will move more money into the territory. It is worth noting that while Singapore has outperformed Hong Kong from the low reached last summer -- in spite of the Hong Kong government's intervention -- in the longer run Hong Kong has massively outperformed, reflecting the reality of a more dynamic environment where capital is allocated by market mechanisms rather than by economic planners, however rational and well intentioned. It should be remembered that socially engineered entrepreneurs are a contradiction in terms.
The risk in this strategy is to have no cash. The temptation to raise cash at present is nearly overwhelming given the scale of the rallies seen in the second quarter, with the benchmark index up 23%. Still, Greed & Fear believes that while the recent rally in Asia has in part been driven by asset-allocation flows, retail liquidity has also played a big part, most particularly in a market like Korea where interest rates have collapsed. There therefore remains huge potential for asset allocation flows to increase to the region on any sort of correction, which makes valuations more palatable. It is also a continuing fact of short-term investor sentiment that since the Chinese New Year, all bad news in Asia has been ignored and all good news celebrated. This is not a sign of a bear market.
Global equity investors continue to celebrate the global reflation theme, as is clear from the recent performance of
in the U.S. and the broadening of the U.S. stock market. The question then becomes what will end this liquidity nirvana where central banks pursue reflation while inflation remains dead and buried.
The answer is some statistical confirmation of a real pickup in U.S. inflation, which would force the
hand, or renewed demand for credit in the global economy to fund the likes of capacity expansion that would absorb excess liquidity. Both for now seem unlikely.
Meanwhile, the reality remains that Mr.
and his colleagues continue to calculate that pre-emptive anti-inflationary moves are too fraught with danger in a world where excess capacity makes consumption the only plausible driver of economic growth. Hence the importance of keeping U.S. consumer confidence robust, which in turn means capitulating to the forces of irrational exuberance keeping the U.S. stock market up.
Christopher Wood is the global emerging market strategist for ABN Amro and the author of The End of Japan Inc. (Simon & Schuster, 1994). Under no circumstances is this to be used or considered as an offer to sell, or a solicitation or recommendation of any offer to buy. While Wood cannot provide investment advice or recommendations, he welcomes your feedback at