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To: Alex who wrote (18874)	9/15/1998 6:09:00 PM
From: goldsnow	Respond to of 116753

CSFB sees Hong Kong confidence crisis in 1999 06:57 a.m. Sep 15, 1998 Eastern HONG KONG, Sept 15 (Reuters) - Hong Kong could confront a cash-flow triggered crisis of domestic confidence and severe deflation within months, Dong Tao, economist at Credit Suisse First Boston, said on Tuesday. ''We think it's likely a cash-flow triggered crisis and severe deflation may happen next year and this may put confidence in the peg to the test,'' Tao said. A loss of domestic confidence is considered the only real threat to the Hong Kong dollar peg, established in 1983 at a rate of HK$7.80 per U.S. dollar under a currency board system. Tao said the Hong Kong government's efforts to stabilise money markets would be effective, but the territory's economy would continue to worsen due to three domestic ''faults'': + High and rising real interest rates; + A severe credit crunch led by local, not foreign, banks; + Rising unemployment in the property-owning class. ''For the time being these domestic faults are still developing separately but towards the end of this year, possibly at some point early next year, these faults will start to merge and this will be the time when there will be a structural challenge,'' Tao said. With banks refusing to lend, unemployed property owners unable to service their mortgages and no relief in sight from real interest rates approaching double digits, some of Hong Kong's largest companies could find themselves in trouble. If the cash-flow difficulties trigger problems at local banks, the domestic population could start to question the fate of the Hong Kong dollar, Tao said. ''Domestic confidence is likely to be under strain soon,'' Tao wrote in accompanying notes. At the same time, deflation is taking hold in Hong Kong. Consensus expectations of a rise of one percent in the consumer price index does not make sense against a backdrop of a strong currency, falling rents and wages, deflation in China and a decline in global energy prices, Tao said. ''Deflation does not kill you in a spectacular way, it's a slow burn,'' Tao said. He forecasts a fall of three percent in the CPI for 1999 -- a drop that indicates a real rise of almost 500 basis points in interest rates over the next 12 months. If nominal interest rates remain steady as inflation falls, real interest rates -- the cost of money less inflation -- rise. Tao also expects gross domestic product to contract by 5.2 percent in 1998 and 6.4 percent in 1999. His earlier forecasts were for a GDP contraction of three percent in both years. The situation is sufficiently severe to consider an alternative to the peg, which will cause ''endless suffering'' as the cost of capital keeps on rising and the price of assets keeps on falling, Tao said. But de-pegging would prompt high inflation, even higher interest rates and a debt crisis, with Hong Kong banks holding $212 billion in external debt due to mature within two years. Tao argued that dollarisation ''has many loopholes and cannot solve all of Hong Kong's problems, but seems to provide an emergency exit, if things go wrong.'' Dollarisation would replace the Hong Kong dollar with the U.S. dollar, reducing Hong Kong interest rates to U.S. levels and removing the opportunity for market speculation over the fate of the Hong Kong dollar peg. Tao estimated the cost of dollarisation at $64 billion but said a ''psychological anchor'' would be more important than money if dollarisation occurred at a time of capital flight. This ''anchor'' could be provided by early involvement from China and the International Monetary Fund and support from the U.S. Federal Reserve, he said. -- Sarah Davison (852) 2843 6470; Fax 2845 0636 -- hongkong.newsroom+reuters.com Copyright 1998 Reuters Limited.