`Hong Kong Has Lost Its Touch'

The economy is tanking, and things could get worse fast

It was only a year ago that Hong Kong was awash in light. As the British colony prepared for its return to Chinese sovereignty, skyscrapers competed for the most dazzling technicolor displays. Now, 12 months later, the neon is a dim memory. There's little to celebrate in grim Hong Kong these days.

Yes, Chinese President Jiang Zemin and U.S. President Bill Clinton are coming through to mark the anniversary, and the territory is about to open a new $20 billion airport. But the economic news is going from bad to worse (charts). Hong Kong has plunged into its first recession in 14 years. Unemployment is surging. Property prices have fallen by half. Although companies from banks to retailers are retrenching and switching strategies, analysts predict a jump in bankruptcies and bad loans in the second half of the year. "The mystique of Hong Kong is fast disappearing," says Peter Lau, CEO of clothing retailer Giordano International Ltd. "Hong Kong has lost its touch."

A desperate Chief Executive Tung Chee-hwa is resorting to drastic measures. Flanked by a handful of stone-faced officials at a hastily called news conference on June 22, Tung announced a $4.1 billion economic-stimulus plan. It attempts to shore up the failing property market by curtailing sales of government land and to pump liquidity into a banking system hit hard by the Asian crisis. It freezes upper-tier civil-servant salaries, provides property-tax rebates, and reduces taxes on corporate bank deposits. "We need to bring out all measures we have to relieve the difficulties," said Tung.

HAVOC. In the midst of the crisis sweeping Asia, Tung is struggling to maintain the Hong Kong dollar's peg to the U.S. dollar to keep the territory solvent. That has become more difficult in recent weeks as the yen has fallen and worries about China's ability to avoid devaluation have increased. The high interest rates needed to defend the Hong Kong dollar have wreaked havoc, and the Chief Executive has been feeling the heat from Hong Kong's jittery business and political elite.

The problem is there's little Tung can do except try to ease the pain. The property cartel that has long dominated the economy is weakening. Banks with huge exposure to the property market are watching warily as homeowners who bought property in the past two years are stuck with negative equity. And Tung's pro-business political allies, who suffered big losses in May elections, have even joined forces with Martin Lee's Democrats to denounce his policies. With another election less than two years away, the government is especially keen to blunt criticism that it has done little to stem the recession.

PROTRACTED SLUMP? Tung's measures come just a few weeks after an earlier rescue plan failed to spur a recovery. These are likely to meet the same fate. Standard & Poor's Corp. is reviewing the credit ratings of a dozen Hong Kong companies, including blue chips such as Swire Pacific Ltd. and Hutchison Whampoa Ltd., citing "the growing likelihood of a protracted economic downturn."

In fact, Tung's plan may make things worse. It calls for a budget deficit worth about 5% of Hong Kong's gross domestic product. Currency speculators might see that as a sign of weakness and attack the Hong Kong dollar, causing interest rates to spike again. "That could wipe out whatever positive impact is generated from the budget deficit," cautions Dong Tao, senior economist at Credit Suisse First Boston Corp., who sees unemployment reaching 7% by the end of the year, up from 2.5% in January. And to compensate for the loss of revenue from land sales, officials are dropping hints that the government might need to institute a new sales tax.

By freezing all land sales until next April, Tung made a gesture to some of his biggest supporters, the real estate tycoons, who have been slammed by the downturn. Property barons have been battling to get Tung to back away from his pledges to bring down prices by building more public housing. Indeed, many threatened to boycott a government land sale scheduled for June to show their displeasure with Tung's policies. Tung avoided the embarrassment by canceling all sales.

Still, the policy is unlikely to provide a floor for the market. The Hang Seng property index is off 26% this year, compared with a 22% drop for the broader Hang Seng index. And billionaire barons such as Li Ka-shing are slashing prices at their residential projects. Weaker developers are selling jewels just to salvage what's left of their Hong Kong businesses.

The property collapse--and overnight interest rates as high as 16%--have led banks to halt new lending. Part of the banks' concern is that they have built up a staggering exposure to the real estate market, with nearly half of all loans in the property sector. Only about 2% of loans are currently nonperforming. But that number is likely to jump to 8% by next year, as bad corporate and consumer debts start to take their toll. "The banking system is in deep trouble," says outspoken bear Peter D. Everington, chairman of Hong Kong's Regent Fund Management Ltd. If property prices fall much more, "nasty things will start to happen."

Banks are changing their game plans. At Hang Seng Bank, new CEO Vincent H.C. Cheng, who is also vice-chairman at the bank's parent, Hongkong & Shanghai Banking Corp., is learning from the downturn. Hang Seng's loan portfolio is 55% in real estate, but Cheng plans to shift the focus toward trade financing and infrastructure and to move staff to support small- and midsize-business customers. "I want to have less concentration on property," says Cheng.

"MORE DOABLE." Yet the property plunge offers good news to a few retailers. As rents come down, those with deeper pockets are taking advantage of cheaper rents. Park 'N Shop, developer Li Ka-shing's supermarket chain, is opening superstores that couldn't exist in Hong Kong before because of high rents. Esprit Holdings, which gets two-thirds of its revenue from outside Asia, has a similar idea. It will soon open two huge kids clothing stores. "Everything is more doable now," says Esprit Chairman Michael Ying. "We can get new shops with better rents, better locations."

Still, the retail sector as a whole is taking a heavy pounding. Sales are off 16% in April compared with a year ago. Upscale clothier Dickson Concepts, which has dropped its takeover bid for Barneys New York, reported 1997 earnings down 98%. Chairman Dickson Poon is now studying "anything having to do with cost." With the economy and markets in such a sorry state, the pressures on Tung to come up with solutions can only increase.

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