Global imbalance and macroeconomic adjustments on the Mainland are likely to be the two most important factors affecting financial stability in 2007, Monetary Authority Chief Executive Joseph Yam says.

In his latest Viewpoint article, Mr Yam said the much politicised global imbalance is the most prominent factor in sight.

Hong Kong, because of its very liquid and open financial markets of considerable capacity, has increasingly been treated as one of the first international financial centres in which to obtain liquid funds in case of need.

"Whenever there is a need for a substantial supply of water to put out fires in the backyards of other jurisdictions, Hong Kong is one of the first pumps that people in international finance turn to. This makes us prone to greater financial market volatility than other centres.

"There is also a tendency for the impact of financial shocks in other parts of the world, whether or not they affect Hong Kong in a real economic sense, to be magnified in the financial markets of Hong Kong. What is orderly and benign in the eyes of others could well be quite troublesome for Hong Kong."

Trade imbalance

This is particularly so when the global imbalance has become so associated in many peoples' minds with the bilateral trade imbalance between the Mainland and the United States, and there has been a correspondingly sharp focus on the trend of the exchange rate between the two currencies, Mr Yam said.

"Further complicating the situation is the fact that our capital markets have an increasingly heavy weighting in financial instruments of Mainland enterprises that have been attracting increasingly keen interest from international investors.

"While the Linked Exchange Rate means that Hong Kong dollar interest rates generally track their US counterparts in the medium to long term, there is a possibility of short-term deviations that we should all be alert to."

Mr Yam said macro adjustment and control on the Mainland is the second most prominent factor on our radar screen. The combination of administrative and market measures being taken seems to have been quite effective, when judged by the headline economic numbers.

Alert issued

"But there is still more to be achieved, in terms of more balanced growth, continuing control over inflation, increasing consumption and slowing domestic fixed capital formation, not to mention the many longer-term structural issues identified in the 11th Five-Year Plan.

"What we should be alert to are not only the headline numbers on the Mainland and their implications for Hong Kong through the close economic and trade channels, but, arguably more importantly, developments that might affect us through the financial channels.

"Financial markets, particularly free and open ones with considerable depth like those in Hong Kong, typically give a telescopic view of the future and reflect it efficiently in spot prices, which then may exhibit behaviour quite different from what the headline economic numbers suggest."