How to Finance
Fiscal Deficits
(25 June 2003)
This article was supposed to finish by the end of last year but due to the fact that I have been very busy with my ordinary work in the business. Nevertheless, I hope that we will all understand more about various policies to solve fiscal deficits in this article, especially that Hong Kong has been facing serious budget deficits since the Asian Financial Crisis 1997-98 (The deficit will still be a problem in the next 4-5 years.).
As I argued in my last article, the current budget deficit situation of Hong Kong is mainly the consequence of cyclical downturns, therefore, the government should not worry to raise taxes and/or cut spending in order to balance the budget. The deficit will disappear once the economy recovers. However, it is true that deficits are not good for long-run economic growth. On the other hand, it is unlikely that the Hong Kong economy will fully recover before 2007-08 at the macroeconomic level. As a result, Hong Kong will still face budget deficits in the next few years.
Last year, the government set a target to balance the budget in the financial year 2006-07 through spending cuts, imposing charges on public services and maybe increasing taxes. Some people have proposed various policies in order to solve the deficit problem. I shall try to summarise these policies and give you a full picture about how to finance budget deficits.
Apart from using fiscal reserves (what the government is currently using) and selling off government-owned assets, there are commonly three ways to finance budget deficits:
(1). Taxes: No doubt the tax base of Hong Kong is narrow at international standards. Increasing taxes (e.g. sales taxes) can give the government extra income to run the budget. However, is it suitable or necessary for Hong Kong to increase taxes at this stage as the current deficit problem is mainly caused by cyclical downturns? Many people agree that one of the advantages of Hong Kong is its low and simple taxation. Will tax rises decrease Hong Kong's competitiveness in the world market?
(2). Money Supply: In a simple term, increasing money supply means that the central bank prints more money for the economy. This will lower interest rates and increase money circulations in the economy. In the long run, increasing money supply will lead to higher inflation. Having said this, a little bit of inflation is good for Hong Kong's present situation. However, there are three reasons that money supply policy is not suitable for Hong Kong:
Ø Can the Hong Kong Monetary Authority (HKMA) act as a 'real' central bank?
Ø Hong Kong is a small open economy. There is a tendency that a small open economy has to follow interest rate movements of a large economy such as the United States.
Ø The Hong Kong dollar has been linked with the US dollar since 1983. Interest rate levels have to be right in order to maintain the link (USD1 = HKD7.8). Increasing money supply will have a downward pressure on interest rates and thereby depreciation of Hong Kong dollar (USD1 > HKD7.8) because of capital outflows.
(3). Government Bonds: Over the last 30 years, the Hong Kong government issued bonds three times. All of them were for capital works projects and/or market development purposes. The largest amount was less than HK$4billion for the years 1991-93. This time, we have expected almost HK$90billion of deficits to finance.
Which of the above policies is the best? In general, selling government bonds is more favourable than the others to finance budget deficits. I am not a finance expert and not sure whether the size of Hong Kong's bond market is big enough to achieve the goal? (Unlike many Western countries, Hong Kong does not have any public debt. Therefore, issuing bonds and using fiscal reserves should be good enough for Hong Kong's current problem.) Until November last year, I had missed out one thing: I always forgot the fact that Hong Kong had Mainland China at its back. Zhu Rongji, who was our Premier, gave us an encouraging speech when he came to Hong Kong at that time. He mentioned that Hong Kong could issue 50-year government bonds to Mainland's people. If this comes true, I am sure that it will be good for Hong Kong, as an international financial centre.