Differing forex regimes create growth fallacy

You may recall that Singapore has reported an economic recovery for the first quarter this year, with a 1.17 percent year-on-year growth rate in gross domestic product, while Hong Kong still languishes in recession, with a 3.5 percent decline.

Singapore's growth rate has in fact been much better than Hong Kong's throughout the financial crisis, which broke in mid-1997. Yet when you look at the nominal GDP (prices of the day rather than the deflated prices used for measuring growth rates) and put it into US dollar terms for comparison, it is Hong Hong Kong which had done much better over the same period.

Different inflation rates account for some of this, but most of the difference obviously stems from the movement of exchange rates.

Hong Kong's has remained locked solid against the US dollar over the period, while Singapore has declined by more than 20 percent. It may be obvious enough, but it is worth thinking about again because of the difference in the way currencies are managed in the two locations.

In Hong Kong we operate a fixed exchange rate system through a currency board while Singapore's system is a mix of floating and a fixed exchange rate.

The Singapore dollar moves against the US dollar, but within a range tightly controlled by the authorities to keep it stronger, than, but generally in line with, currency movements in neighbouring countries.

What this means in a financial crisis is that the pressure on our economy comes through interest rates alone. They go sky high to attract enough money back into Hong Kong dollars so that our economy can continue to function at its fixed exchange rate.

In Singapore the pressure hits both the exchange rate and interest rates. The currency falls, but interest rates rise nowhere near as high as they do in Hong Kong. The currency movement takes some of the pressure off rates.

Now bear in mind, and this is the key to the equation, that when any country reports its real economic growth rate it does so only in its local currency.

In Hong Kong, we take the full hit. Our sky-high interest rates slow the economy way down in local currency terms and we report it all.

But in Singapore, where interest rates have not gone as high, their impact on the economy in local currency terms is less than in Hong Kong, and Singapore naturally reports a better economic growth rate.

Of course, there has also been an impact on the exchange rate, which Hong Kong has not suffered, but this is not picked up in those currency terms in which GDP growth is reported except only marginally and indirectly.

So what we have here is a comparison of apples and oranges, You cannot in the short term directly compare the local currency growth rates of economies operating such different currency regimes. They show up in longer term, however, and here Hong Kong needs yield no pride of place to Singapore.