HONG KONG RESIDENTS TOLD TO PREPARE FOR

UNCLAS SECTION 01 OF 02 HONG KONG 002010

SIPDIS

STATE FOR EAP/CM AND EEB/OMA, TREASURY FOR OASIA

E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD HK CH
SUBJECT: HONG KONG RESIDENTS TOLD TO PREPARE FOR
"PERSISTENT DIFFICULTIES"


1. Summary: Though they continue to assure the public that
Hong Kong's financial foundation is sound, senior Hong Kong
government (HKG) finance officials warned the global
financial crisis would strike further blows to Hong Kong's
economy. The latest government interest rate cut of 50 basis
points (directly tied to the U.S. rate cut on October 30) has
reportedly failed thus far to spur lending rate cuts by local
banks; this will delay the rate cut's eventual economic
benefits for Hong Kong businesses. Hong Kong's Consumer
Council has identified 50 retail holders of Lehman
Brothers-arranged "minibonds" it is prepared to support in a
lawsuit should mediation efforts between minibond investors
and the banks which sold the instruments fail. The Hang Seng
Index fell 2.5 percent on October 31 but was up 9.4 percent
for the week, reflecting the sharp mid-week rise in global
equity markets. Overnight and one week HIBOR rates remained
low at 0.6 and 1.0 percent, respectively, while longer-term
rates remained roughly unchanged from the previous week. End
summary.

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Preparing for "Persistent Difficulties"
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2. In remarks before the Legislative Council on October 30,
Financial Secretary (FS) John Tsang said he is "not
optimistic" about Hong Kong's economy next year. He
described the current global financial crisis as "the worst
since the Great Depression in the 1930s." He urged the
public to prepare for "persistent difficulties." On a
brighter note, FS Tsang restated the HKG's mantra that Hong
Kong's financial system remains well capitalized, and that
"the foundation of Hong Kong as a financial center is sound."


3. Although the Hong Kong Monetary Authority (HKMA) base rate
declined 50 basis points to an all-time low of 1.5 percent --
in lock step with the rate cut in the United States -- Hong
Kong banks have thus far not reduced their prime lending
rates. Hang Seng Bank General Manager Andrew Fung said Hong
Kong's banks are fearful of rising individual and systemic
credit risks. HKMA Chief Executive Joseph Yam said tight
lending policies at banks will delay the benefits to Hong
Kong's economy from the rate cut. Yam reiterated that the
HKMA stands ready to inject liquidity into the HIBOR market
as needed.


4. Yam warned that Hong Kong's USD 180 billion (HKD 1.4
trillion) Exchange Fund -- the reserve that backs the Hong
Kong dollar -- will post its third consecutive quarterly
loss, and is likely to record an annual loss for the first
time in the Fund's history. Bonds comprised 73.5 percent of
the Fund as of June 30, 2008, with equities and other
investments totaling 19.2 percent and 7.3 percent,
respectively.

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Contingency Planning for Minibond Litigation
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5. Mediation efforts continue between disgruntled retail
investors and the banks who sold "minibonds" arranged by
Lehman Brothers. Hong Kong's Consumer Council (HKCC)
announced on October 30 that it has identified 50
complainants it may support in joint legal proceedings
against the banks if mediation efforts fail. (Note: The HKCC
was created in 1974 and is a statutory body, independent of
the Hong Kong government. The HKCC carries out its work
through over 125 paid staff employed in a number of
functional divisions, including the Complaints and Advice
Division and the Trade Practices Division. The HKCC collects
and disseminates information to consumers and government on
matters affecting consumers in the marketplace, and receives
and examines complaints from consumers. End note.) If a Hong
Kong court were eventually to rule in favor of the joint
complainants, the decision might set a precedent for handling
the over 3,600 other complaints received by the HKCC.

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Market Wrap Up
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6. The Hang Seng Index (HSI) closed down 2.5 percent at
13,969 on October 31. Despite Friday's losses, mid-week
gains drove the HSI 9.4 percent higher for the week. The
short end of the HIBOR curve remained liquid, with the
overnight and one week lending rates at 0.6 percent and 1.0
percent, respectively. Other HIBOR rates as of 1730 local

HONG KONG 00002010 002 OF 002


time: one month 2.3 percent; three months 3.35 percent; and
six months 3.5 percent.
DONOVAN