LC Paper No. CB(1)838/98-99
(These minutes have been
seen by the Administration)

Ref : CB1/PL/FA/1

Legislative Council
Panel on Financial Affairs

Minutes of Special Meeting held on
Friday, 9 October 1998, at 3:45 pm
in the Chamber of the Legislative Council Building

Members present :

Hon Ambrose LAU Hon-chuen, JP (Chairman)
Hon Eric LI Ka-cheung, JP (Deputy Chairman)
Hon Kenneth TING Woo-shou, JP
Hon James TIEN Pei-chun, JP
Hon David CHU Yu-lin
Hon Cyd HO Sau-lan
Hon Albert HO Chun-yan
Hon NG Leung-sing
Hon Ronald ARCULLI, JP
Hon James TO Kun-sun
Hon CHEUNG Man-kwong
Hon HUI Cheung-ching
Hon Bernard CHAN
Hon SIN Chung-kai
Dr Hon Philip WONG Yu-hong
Hon Jasper TSANG Yok-sing, JP

Members attending :

Hon LEE Cheuk-yan
Hon LEE Kai-ming, JP
Hon Christine LOH
Hon CHAN Yuen-han
Hon CHAN Kam-lam
Hon TAM Yiu-chung, JP

Members absent :

Dr Hon David LI Kwok-po, JP
Hon Margaret NG
Hon Ambrose CHEUNG Wing-sum, JP
Hon Timothy FOK Tsun-ting, JP

Public officers attending :

Item I

Miss Denise YUE, JP
Secretary for Treasury

Mrs Carrie LAM, JP
Deputy Secretary for the Treasury

Mr Colin Sankey, JP
Head, Efficiency Unit

Item II

Mrs Rebecca LAI, JP
Acting Secretary for Financial Services

Mr David Carse, JP
Deputy Chief Executive
Hong Kong Monetary Authority

Commissioner for Census & Statistics

Mr Gordon Jones, JP
Registrar of Companies

Mr A Hearder, JP
Official Receiver

Mr Alan WONG, JP
Commissioner of Insurance

Mrs Pamela TAN, JP
Director, Mandatory Provident Fund Office

Miss Glenda CHAN
Acting Government Economist

Clerk in attendance :

Ms Estella CHAN
Chief Assistant Secretary (1)4

Staff in attendance :

Ms Pauline NG
Assistant Secretary General 1

Ms Connie SZETO
Senior Assistant Secretary (1)1

I Briefing by Secretary for the Treasury on the Chief Executive's Policy Address
(Booklet on Prudent Management of Public Finances - Policy Objective for Finance Bureau, speaking note of Secretary for the Treasury tabled at the meeting and annexed to these minutes)

In briefing members on the work of the Finance Bureau (FB) in the coming year, the Secretary for the Treasury (S for Tsy) highlighted two important aspects namely, the overall position on Government expenditure and provision of funds for the initiatives announced in the 1998 Policy Address, and the launching of an Enhanced Productivity Programme (EPP) in the public sector.

Overall position on Government expenditure

Budgetary planning and the gross domestic product trend growth rate

2. Anticipating a drastic decline in revenue in 1998-99 and next few years as a result of the moratorium on the land sales programme and adversities in the economy, some members enquired about the means to achieve prudent management of public finances.

3. In response, S for Tsy advised that Financial Secretary (FS) had recently indicated that a deficit of over $20 billion would likely be incurred in 1998-99, which would have to be made up by fiscal reserves. She also said that FS would consult LegCo Members in compiling the 1999-2000 Budget in the coming few months. In working out Government projected expenditure in 1999-2000, the Administration had adopted a 4% gross domestic product (GDP) trend growth rate estimated for the Medium Range Forecast period of 1998-99 to 2002-03 as a planning tool for the time being. The planned growth rate of 4% in Government expenditure in 1999-2000 would amount to an additional $6.8 billion for new or improved services. The growth would cover all the pledges in the 1997 Policy Address and the 1998 Policy Address.

4. Some members expressed strong reservations about the accuracy of the forecasted 4% GDP trend growth rate in view of the negative growth rate in GDP in the first quarter of 1998 and anticipation of continuing poor economic performance in the ensuing periods. They were concerned that the Administration would be working against the cardinal principle of prudent financial management when adopting such an overly optimistic figure for planning government expenditure for 1999-2000. In response, S for Tsy explained that the 4% trend growth rate was provided by the Government Economist (GE) after conducting professional analyses and assessment of local and global economic conditions. Although the prevailing economic situations were still difficult, GE forecasted that the situation would improve toward the latter part of the medium-term period. S for Tsy stressed that the Administration had no intention to over-estimate the figure and an updated trend growth rate would be available in March 1999, when Government would have reassessed all relevant factors and forecasts of the performance of individual components of the economy in the 1999-2000 Budget compilation process over the next few months. In this connection, the Chairman advised members that more information on this subject could be sought from the Financial Services Bureau in the latter part of the briefing.

Expenditure on social services

5. Miss CHAN Yuen-han opined that the planned growth of about $2.2 billion in the expenditure for the Comprehensive Social Security Assistance (CSSA) Scheme and a further grant of $500 million to the Employees Retraining Board in 1999-2000 were insufficient in relieving financial hardship of the needy and addressing the unemployment problem in view of the continuing economic downturn. Mr LEE Cheuk-yan urged the Administration to consider using the fiscal reserves to alleviate hardship of the general public and stimulate economic growth. He further requested the Administration to give an undertaking to maintain the increase in Government expenditure of at least 4% regardless of the outcome of the reassessment of the medium term trend growth rate of the economy.

6. S for Tsy re-iterated that due to the deficit this year, it was already planned that fiscal reserves accumulated in the past would need to be utilized. She confirmed that even if the medium term trend growth rate were adjusted downward in March 1999, the expenditure commitments for fulfilling all new service initiatives in the Chief Executive's Policy Address would not be reduced. As far as allocation of financial resources among various competing programmes was concerned, S for Tsy remarked that as resources were limited, an increase in allocation for a certain programme would need to be met by a reduction in other programmes. The Administration would welcome Members' views on the relative priorities of these programmmes. She stressed that the growth in the key areas of social services for 1999-2000 was substantial, and within the 12.5% real growth for social welfare, over three-quarters of that increase in spending (i.e $2.2 billion) was due to CSSA Scheme. The Deputy Secretary for the Treasury supplemented that planned improvements in other social welfare services, including those for the elderly, children and family, would amount to about $700 to $800 million.

Expenditure on infrastructure projects

7. Mr CHEUNG Man-kwong expressed the view that in the present difficult time, the Administration should be more prudent in embarking on infrastructure projects to avoid over-spending, which had led to financial problems in some Asian countries. S for Tsy advised that the Administration would fully assess both the economic and financial benefits of every capital works proposal before a decision to undertake the project was made. She assured members that the Administration would continue to adhere closely to the principle of prudent management of public finances.

Review on the taxation system

8. Miss Christine LOH suggested the Administration to embark on a comprehensive review of the overall revenue collection system for financing government services. She was particularly concerned about adherence to the 'polluter-pays' principle in setting fees and charges for the disposal of wastes.

9. In response, S for Tsy advised that a comprehensive review of profits tax was completed in early 1998 and some of the tax concession measures had been introduced in the context of the 1998-99 Budget. However, the Administration had no other plan to conduct a comprehensive review on the taxation system at the moment. She stressed that in order to achieve the objective of maintaining an effective revenue collection and protection system which was also conducive to business development, one of the important principles of the taxation policy was to maintain a simple, low and predictable tax regime. As regards the 'user-pays' principle, S for Tsy confirmed that the principle was applied to the setting of fees and charges for most government services. She further advised that although the Administration's proposal to increase sewage disposal charges to recover the cost of providing the service did not get the support of the legislature and there had been no increase in the sewage charge since 1995, the Administration would continue to uphold the "polluter-pays" principle in setting waste disposal charges as far as possible.

Enhanced productivity programme (EPP)

10. In response to Mr CHEUNG Man-kwong's concern about whether EPP could be rigorously carried out across all departments, S for Tsy re-iterated Government's full commitment in undertaking EPP across all government departments and subvented bodies with a view to achieving productivity gain of 5% of the operating expenditure from 2000-01 to 2002-03. She advised that government departments and subvented organizations would be required to regularly review their baseline expenditure to ensure that it was directed to Government's main priorities and to identify areas of savings, which would be re-allocated for implementing new services. She stressed that productivity gains had to be results of improvements in productivity and efficiency rather than cutting back essential services and lowering the standards or quality of the services concerned.

11. Mr CHAN Kam-lam pointed out that savings of 15% or more could often be achieved in the private sector in difficult times and doubted whether the EPP target of 5% was too conservative. S for Tsy responded that there were fundamental differences between Government and the private sector in controlling expenditure during a period of economic adversity. In a slower growth environment, there would be increasing need for Government services in the provision of social welfare and training and re-training opportunities. She advised that the 5% target had been worked out carefully taking into account current social and economic conditions and was considered both attainable by the Administration and acceptable by the community at large. Nevertheless, the Administration would strive to achieve better productivity gains over the pledged target wherever possible. It would also keep members informed of the progress and report to the Panel as required. She noted members' view on the need to pay particular attention to contain Government expenditure on consultancy fees.

12. S for Tsy further advised that exemptions from EPP included statutory or contractual payments required under existing policies and school education expenditure in recognition of the many demands placed on schools with their baseline expenditure barely adequate to cope. The Administration estimated that about $70 billion out of the total $170 billion recurrent expenditure in 1998-99 belonged to these categories.

Management of Government's investment

13. While expressing support for Government's strategic investments in statutory bodies, Mr NG Leung-sing cautioned against possible role conflict of the Administration as both the shareholder and monitor of these bodies. In response, S for Tsy said that it had been a long established policy for Government to make strategic investments in statutory bodies by equity, loans or other means of financing to help finance infrastructural development. While FB assumed the role of a shareholder in securing a reasonable rate of return, respective policy bureaux were responsible for monitoring the performance of these bodies. She assured members that effective overall monitoring of these bodies was made possible by close liaison between FB and the policy bureaux concerned.FB

II Briefing by Secretary for Financial Services on the Chief Executive's Policy Address
(Booklet on International Financial Centre - Policy Objective for Financial Services Bureau)

14. At the invitation of the Chairman, the Secretary for Financial Services (Ag) (SFS(Ag)) briefed members on the main policy commitments of the Financial Services Bureau, emphasizing that the Administration was committed to maintaining the Link Exchange Rate (LER) system and developing Hong Kong further as an international financial centre. The Deputy Chief Executive, Hong Kong Monetary Authority (DCE/HKMA) briefed members on the progress of major on-going projects and new programmes to be undertaken by HKMA in the year ahead. The Registrar of Companies and the Official Receiver also briefed members on their respective areas of work.

Regulatory framework for the financial services sector

15. Responding to members' enquiries on the comparison of the local financial regulatory framework with those of other developed international financial centres, SFS(Ag) said that no two markets would be the same in terms of scope and method of regulation but the local financial regulatory framework could be regarded as being close to reaching the best international standards. The banking supervisory regime was already in almost total conformity with all international standards and the local securities and futures markets were open, fair and efficient. On whether the Administration would follow other countries' examples of revamping the entire regulatory regime, SFS(Ag) said that the Administration was aware of new developments in regulatory frameworks of financial markets of other developed countries. While the trend in the United Kingdom and Australia was towards consolidating the regulatory systems under a single authority, the United States had taken a very different approach. The Administration would surely make reference to international experience and examine whether these experience could apply in Hong Kong.

16. In reply to Mr NG Leung-sing's enquiry on the work progress and results of the inter-agency task force mentioned in the Report on Financial Market Review (FMR), SFS(Ag) advised that the task force met every four weeks to monitor the progress of implementation of recommendations made in the FMR as well as the 30-point programme announced recently for strengthening the order and transparency of the securities and futures markets. The task force was chaired by the Deputy Secretary for Financial Services and comprised of representatives from HKMA, Securities and Futures Commission, the Stock Exchange of Hong Kong, the Hong Kong Futures Exchange and the clearing companies. While many of the recommendations had already been put into practice, the Administration would ensure full and timely implementation of outstanding items as soon as possible. SFS(Ag) also clarified that the cross-market surveillance committee was a different organization proposed under the 30-point programme. It was a standing committee comprising top level representatives from regulatory and market bodies. Under the chairmanship of SFS, the committee was set up to exchange market information and to enable the authorities to take prompt and appropriate actions in response to anticipated market manipulation.

Stability of the banking system

17. Responding to Mr CHEUNG Man-kwong's concern about the impact of the financial problems faced by Guangdong International Trust and Investment Corp (GITIC) on the stablility of the local banking system, DCE/HKMA said that the GITIC case was an isolated incident and, at the moment, it was not considered that the incident would have any significant impact on the local banking system. Meanwhile, information was being gathered about the local banks' exposure to GITIC and its subsidiaries, in particular, the amount of loans provided to the corporation's subsidaries established in the Mainland and the window companies in Hong Kong, as well as the amount of debts that had been registered with the State Administration for Foreign Exchange Control. Moreover, information was also being sought from banks regarding their exposure to other Mainland-based financial groups.

Studies on options for maintaining monetary stability

18. On Mr HO Chun-yan's suggestion to study the feasibility of deposit insurance system to enhance protection for depositors, DCE/HKMA said that there were mixed views on the need to establish such a system as indicated in a survey conducted in the banking sector. Despite the advantages associated with the scheme, the major issue to be tackled was the funding arrangement for the scheme. While the consultancy study on the banking sector commissioned by HKMA would briefly touch on the subject, it was considered worthwhile to conduct further detailed studies on various related issues.

19. As to Mr HO's enquiry about viability of using dollarization or a dual currency system of both Hong Kong dollar and US dollar, as a means to enhance LER stability, DCE/HKMA remarked that there were complex issues and implementation problems associated with the proposals. Since the technical measures recently introduced to strengthen the currency board arrangements had been successful in bringing down the interest rates, HKMA considered it more practical to maintain the LER system under the current arrangements rather than pursuing other complicated options.

20. As regards the concern about the effect of the seven technical measures, under which bills and notes eligible for obtaining liquidity at the discount window were limited to Exchange Fund papers, on the development of the local debt market, DCE/HKMA said that HKMA was aware of the measures' possible impacts. While it was necessary to strengthen the currency board system by restricting the access to the discount window to debt instrument which was fully backed by foreign currency reserves, other bills and notes were made less attractive to investors in the debt market. As similar concerns had been raised by the Hong Kong Capital Market Association, HKMA had been working closely with the Association on measures to promote the trading of other debt instruments, such as to increase the appeal of bonds to retail investors.

Financial Services Institute

21. Members noted that based on results of the detailed study on the demand for and supply of human resources development needs in the financial services sector to be available by March 1999, the Administration would examine the need to set up a Financial Services Institute. In this connection, Miss Christine LOH opined that as the Administration would also need to develop its human resources in financial services, it would be desirable to second top level financial officials, who were non-professionals, to work in large private financial institutions to enable them to gain relevant market experience. She also questioned the effectiveness of having policy secretaries who were civil servants and typically generalists to make policy decisions on highly specialized matters.

22. In response, SFS(Ag) said that the existing civil service structure where policy making and implementation were carried out by policy secretaries in collaboration with professional grade staff and in consultation with experts in the relevant fields had proved to be successful. The making and implementation of financial policies were strongly underpinned by relevant experience of the staff of the Bureau and departments concerned and, the expertise of experts in regulatory bodies, amongst market practitioners and consultants. DCE/HKMA also advised that since HKMA was established in 1993, it had recruited staff with market experience in relevant fields including banking, accountancy, investment management etc. Nonetheless, HKMA recognised the importance of staff development in boardening their experience and expertise, particularly, in areas such as the use of information technology in the banking industry and knowledge of asset and liquidity management techniques. Besides providing training programmes to keep staff updated with the knowledge and skills required for working in the evolving financial market and banking industry, attachment programmes had been arranged for staff to work in financial institutions, such as the Bank of England and the Federal Reserve Bank of New York, to gain international exposure. Despite the success of these programmes, there was an issue of sensitivity on the part of local banks, which might be reluctant to have staff from the regulatory body to work in their organizations.

Money laundering

23. Mr James TO questioned whether there was any mechanism to detect banks' involvement in money laundering activities and enquired about the penalty on non-compliant banks in this regard. He remarked that the failure of local banks to make appropriate reports of suspicious transactions involving extremely large sums of money, which might be connected with certain alleged kidnap cases, might have adversely affected Hong Kong's reputation as a properly regulated international financial centre.

24. In reply, DCE/HKMA explained that according to existing procedures a bank on discovering a suspicious transaction should report to the Joint Financial Intellegence Unit (JFIU) of the Police. HKMA would be informed if the Police considered that the case should have been reported to HKMA. Moreover, if HKMA noted any suspicious cases during on-site examination of banks which should be reported to the JFIU, it would encourage the banks to do so although HKMA reserved the power to make the disclosure itself. As money laundering was very difficult to prove, the situation to be dealt with by HKMA mainly arose from failure in internal control system to deal with money laundering, rather than genuine collaboration by banks in such activities. Under such circumstances, HKMA would conduct examination into the bank's control system and make recommendations for improvement. As regards the penalty for banks not complying with the requirement to report suspicious transactions, DCE/HKMA said that the banks would be at risk of being liable to criminal charges of aiding money laundering offences. To this end, HKMA might review the bank's status as an authorized instituion and consider revocation of its licence.

25. On whether banks had reported any suspicious transactions connecting to the alleged kidnap cases referred to by Mr TO, DCE/HKMA confirmed that none of such reports had been brought to HKMA's attention. While HKMA had come across cases where money laundering activities were undetected by banks due to their ineffective internal control systems, it was not aware of any cases where banks were involved in money laundering offence.

Medium term gross domestic product trend growth rate

26. Responding to members' enquiry about the basis for adopting 4% as the medium term trend growth rate, the Acting Government Economist explained that the rate was an estimated figure arrived at after careful assessment of relevant factors underpinning the medium term economic outlook for Hong Kong including forecasts on domestic demand and export trade, as well as growth trend of the regional and global economy. She stressed that the forecast figure was an overall assessment of the trend growth rate for the medium term rather than a calculation of each years' GDP growth for the coming five years.

27. Members remained unconvinced of the reliability of the 4% trend growth rate and requested the Administration to provide more detailed information on the methodology adopted and the quantitative analyses and/calculations involved in arriving at the 4% trend growth rate. The Administration undertook to do so.

(Post meeting note : Additional information on the trend growth rate was circulated to members vide LC Paper Nos. CB(1) 332/98-99 and 357/98-99.)

Clarification on financial assistance to Brazil

28. Responding to Mr CHEUNG Man-kwong's concern about the FS's reported comments regarding Government's intention to use the Exchange Fund to offer assistance to Brazil for its financial crisis, SFS(Ag) stressed that FS's comments might have been taken out of context by the press. She clarified that FS was only referring to Hong Kong's obligation to participate as a member in the multi-lateral financing arrangements to assist troubled economies under the International Monetary Fund (IMF). Nevertheless, since IMF had yet to formulate the concerned rescue plan, it was pre-mature to comment on the manner in which Hong Kong would be assisting Brazil. SFS(Ag) pointed out that there were relevant provisions under the Exchange Fund Ordinance (Cap66) which empowered FS to direct the use of the Exchanged Fund. She, however, undertook to reflect Mr CHEUNG's view to FS on consulting the LegCo before proceeding with any financial assistance to Brazil.

III Any other business

29. There being no other business, the meeting ended at 6:15 pm.

Legislative Council Secretariat
1 February 1999