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HONG KONG'S NO.2 WORRY: THE FED

What Greenspan does may affect the Hang Seng as much as Beijing's moves

It's going to be the party of the year when Britain hands Hong Kong over to China on June 30. Optimists think that the end of Sino-British squabbles will set off a tremendous boom. In fact, investors started celebrating already in 1996, driving Hong Kong's benchmark Hang Seng Index up 27% through Dec. 13. Capital and people are streaming into the territory from China and abroad, and property prices are at record highs. ''One gets the impression that people just decided not to think about the first of July,'' says Stephen Clark, director of the Anglo Chinese Investment Co., a Hong Kong-based merchant bank.

Perhaps they should. Even as the territory sets up the fireworks for its June 30 bash, fears about political corruption and an end to the rule of law are lurking in the background. That leads some analysts to conclude that the likely path for the Hang Seng in 1997 is down--moderately so, but down nonetheless.

One cloud over Hong Kong is the chance of a rise in U.S. interest rates if the Federal Reserve Board moves against inflation. Because Hong Kong's currency is linked to the U.S. dollar, its interest rates would move up, too. That would deflate its real estate prices and stock market.

NEW FEARS. Then there's the handover itself. As soon as the celebration ends, Hong Kong's political climate will undergo a radical change. The Chinese will dismantle the democratically elected Legislative Council as soon as they assume control, replacing it with a provisional legislature handpicked by Beijing's supporters. No one knows if Hong Kong's courts will uphold the rule of law, which has been key to the territory's success. The chief executive-designate, C.H. Tung, has fueled fears for Hong Kong's freedoms by saying that he won't allow advocates of Tibetan or Taiwanese independence to stay.

Finally, 1997 will be a pivotal year for China's leadership. During their annual summer retreat at the coastal resort of Beidaihe, Beijing's top leaders will approve a new leadership lineup to be rubber-stamped this autumn at the National Party Congress, which takes place every five years. President Jiang Zemin will try to cement his position as the Paramount Leader in the post-Deng Xiaoping era at the congress, but the biggest change will be a new Prime Minister to replace the stolid Soviet-trained engineer Li Peng, who cannot seek another term. Li Lianqing, currently Vice-Premier in charge of international trade, is believed to be the top choice for Prime Minister.

Whoever gets the nod, the appointment, along with a reshuffle in the Communist Party's politburo standing committee, ''will have a significant impact on which way the Chinese economy will go for the next five years,'' says Kim Eng Securities (Hong Kong) Ltd.'s China analyst, Tai Ming Cheung. Li is a cautious moderate, but he may provide support for China's flagging economic reform program. That would boost confidence in mainland growth, and, by proxy, in Hong Kong equities.

LOOSE MONEY. Investors are also keeping a sharp eye on the People's Bank of China. The central bank has cut interest rates twice this year, by about 200 basis points, signaling an end to a three-year austerity program. With gross domestic product growing by 9.5% in 1996--modest by Chinese standards--authorities are still under pressure to boost the economy, especially to ensure that there's no discontent at such a sensitive political time. How far and how fast the bank moves will be key to determining whether China can avoid repeating the boom-bust pattern that has characterized its growth for the past two decades.

Despite fears about the handover and uncertainty about China's economic stability, several analysts and money managers are bullish on the Hong Kong market. Peter Churchouse, Hong Kong-based research director for Morgan Stanley International Inc., says that thanks to the influx of Chinese investment, Hong Kong companies' earnings will pick up. He expects the Hang Seng index to hit 16,600, up 30%, by the end of 1997 and to double by 1999.

In the end, however, global liquidity will make the real difference for stocks in Hong Kong. Right now, cash from abroad looking for ways to play the China story is buoying them up. As long as U.S. interest rates remain low, the Hang Seng is likely to stay high, and Alan Greenspan will remain as important to Hong Kong investors as Deng Xiaoping or Jiang Zemin.

By Mark L. Clifford in Hong Kong


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Updated June 13, 1997 by bwwebmaster
Copyright 1996, Bloomberg L.P.
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