A few days ago, I delivered the second policy address of my current term as Chief Executive. It is not my intention to repeat what I said there, but I would like to use this opportunity to share with you some of the broader economic considerations that shaped my thinking and that of my colleagues as we considered the various policy options.

As I looked at Hong Kong's economic performance over the last few years, and the forecasts for the period ahead, I was struck by two things, the unprecedented scale of the economic storms we have had just weathered, and the enormous opportunities that lie ahead to rebuild our fortunes. We have gone through great pain, but we have now laid the foundation for unprecedented gain. 

Restructuring painful and protracted

Over the past six years, Hong Kong's economy has been undergoing a difficult process of restructuring. 

Our GDP deflator has fallen 21% in the last five years. But our people persevered in face of these difficulties and our financial market and banking system stood the test of stress and strain imposed by the economic downturn. 

Throughout this period of time, in addition to the dealing of the constant challenges facing us every day, we also frequently and carefully evaluated the challenges and opportunities posed by the changes on the Mainland and indeed around the world. 

Should we delink our currency? The answer has constantly been a resounding no! What are our own competitive strengths and weaknesses and what are those of our competitors? How can we emerge from the restructuring and be more successful than at any time in our history? 

HK benefits from Mainland economy

One thing is clear - we have benefited greatly from the rapid and orderly development of the Chinese economy, an economy which in the year 2003 continued to be the largest recipient of foreign direct investment in the world, the fourth largest trading nation in the world as well as potentially one of the largest consumer markets in the world. 

Therefore, throughout the last few years, we were exploring with the Central Government as to how Hong Kong's competitive advantages can best be leveraged and how Central Government can help us to eventually emerge from our economic restructuring. 

These discussions accelerated in 2002 and came into fruition during 2003 with the signing of CEPA on June 29, 2003 here in Hong Kong. 

We have indeed gone through a prolonged period of difficulties. But, in every cloud there is of course a silver lining. 

The economic difficulties that Hong Kong faced were severe, but they did lead to the bursting of an unsustainable bubble. High costs and inefficiencies had crept into our economy during the long boom that we enjoyed. In the decade of the 1990's, we were perhaps no longer the lean, efficient economy that we were in the decades before. 

Excess fat has gone

I believe that, over these last few years, a lot of excess fat has been burned, and we are today once again on our way to becoming an extremely competitive and dynamic economy.  Deflation has been painful, but it has brought down the cost of doing business here. Our currency peg with the US dollar has proven to be a hard economic taskmaster. But with the US dollar weakening, we are reaping the benefits.

At the same time, agreement with the Central Government on CEPA, agreements with the Guangdong Provincial Government and the Shanghai City Government on closer collaboration created enormous confidence in Hong Kong and enormous interests both on the Mainland and overseas. 

A scheme to allow individuals from the Mainland to travel to Hong Kong has instantly injected new life into our economy. Global economic recovery is also working in our favour. Property prices have stabilised and are edging up. Deflation is also easing. Indeed since SARS, we are in V-shape recovery.  Prospects of this year and next year are encouraging indeed.

Look for external and internal dangers

Although the prospects are better, we must generally look for dangers both internally and externally that may hit us again. Deflation and the fiscal deficits are internal issues that need to be resolved. 

Externally, globalisation may bring sudden and unpredictable fluctuations in areas such as shocks to financial markets, new diseases and epidemics, and international terrorism.  Geopolitics and international conflicts could also affect us directly. These are of course challenges to overcome when they happen. In many cases, we are not in control of the situation. But, nevertheless, we must be on guard at all times. 

In general, I am optimistic of our medium to long-term future. We have overcome economic difficulties of unprecedented scale and although economic restructuring may continue for some time, we have laid down the foundation to rebuild our fortune. 

Indeed, by 2020, the size of the Chinese economy will be quadruple and reach US$4 trillion. Obviously, given Hong Kong's special position, Hong Kong will benefit greatly from the continued expansion of the Chinese economy. Our long-term prospect is bright so long as we work hard to capitalise on the opportunities that lie before us.

Gov't ensures smooth CEPA implementation

What are the major tasks of the Government over the next 12 to 18 months? First, of course, to ensure the smooth implementation of CEPA, so that the full benefit of CEPA can be felt by our businesses and professionals.

Second is to consolidate our core activities in areas of financial services, logistics, tourism and trade and trade-related support services. Third is to encourage new areas of economic activity. On this front, it is for our business sector to lead the way and as a government, I can assure you, we would do the best to support you with necessary policies. We will also continue to support medium and small enterprises and the work of our professionals.

We will obviously need to tackle deflation and the budget deficits. On the deflation front, I am happy to note that the picking up of economic activity is helping deflation to ease. And there are reasons to believe that the prolonged period of deflation will end in the next 12 to 18 months. 

Budget deficits need to be dealt with too. The Financial Secretary has rightly announced the delay to the fiscal year of 2008 - 2009 to balance the budget. I have every confidence we will be able to do so. Given the pick up of the economy, we will also have the opportunity to find the right balance between the need to reduce budget deficit on the one hand and to safeguard people's livelihoods and the momentum of the economic recovery on the other. 

Stay in close touch with community

One of our major tasks is to stay in close touch with our community and to improve our government's governance. We will work towards enhancing the accountability system, improving our policy-making capability and better grasp the public sentiment. We will strengthen advisory and statutory bodies so that they can truly participate in the process of policy making and in monitoring policy implementation. 

A legislature which monitors the work of the government is a cornerstone of effective governance. We will continue to work closely with the legislature. We will also enhance the work in the 18 districts to ensure that we can promptly and properly respond to the many needs of the local community. 

We understand the concern of the community over our future constitutional development and the importance of the constitutional review. The Government of Hong Kong has always attached great importance to the matter, and has consistently taken the position that we will be taking the matter forward in full accordance with the Basic Law. 

I have also been asked by the Central Government that before the beginning of the constitutional review, the Central Government needs to be consulted. There are issues of principle as well as legal issues that need to be clarified. 

Task Force set up to examine consitutional issues

I have decided to establish a Task Force, headed by the Chief Secretary for Administration with members including the Secretary for Justice and the Secretary for Constitutional Affairs to seriously examine these issues, particularly those concerning the understanding of the relevant provisions of the Basic Law, and to consult relevant authorities of the Central Government. 

The Government will also encourage all sectors of the community in Hong Kong to continue considering these issues and expressing their views. We hope relevant arrangements may be made as soon as possible.

For the last few years, we have been building on the theme of Hong Kong being the world city of Asia. The role that New York plays in North and South America and London plays for Europe. 

What is a world city? The world city is a city that has developed tremendous strengths in internationally oriented service industries and other high-level corporate service functions, which generate significant levels of added value as well as good employment opportunities. 

If you look around, of all the cities in Asia, Hong Kong does have the best opportunities to continue to be the world city of Asia. Indeed, I would say it is for Hong Kong to lose it and that I know it would not happen because we would all be working very hard for it. Business sector is the best catalyst for us to continue to stay ahead.

Indeed for our society as a whole to move forward, the business sector always has a very important role to play. The Government values your views, your input and your efforts. And we look forward to working with you in the months and years ahead on all fronts.

(This is an extract of Chief Executive Tung Chee Hwa's speech at the Joint Business Community Luncheon on January 12.)