Why Peking is biggest investor in Hong Kong

THE HONG Kong government which prides itself on keeping its nose out of business is now almost certainly the biggest single institutional investor in the local stock market. And the authority, having spent more than HK$100bn (pounds 7.6bn) of its fiscal reserves on shares, says its buying spree is not yet over.

The precise level of its stake in Hong Kong companies is not known because local stock exchange rules require disclosure only of holdings which exceed 10 per cent of the issued equity. In London the stock exchange requires disclosure of any holding above 3 per cent.

For this reason it is known that the government owns almost 9 per cent of London listed HSBC Holdings, making it by far the largest single shareholder. Prudential Corp had been the biggest shareholder with 4 per cent of the equity.

The government may now own more than 3 per cent of all the shares in all the blue chips on the Hang Seng Index (HSI), giving it a big stake in companies controlled by tycoons such as Li Ka-shing, Lee Shau-kee and Cheng Yu-tung. They are all associates of Tung Chee-hwa, the former shipping tycoon who now heads the government, inevitably giving rise to charges of cronyism. But the government is also buying stakes in companies such as Hongkong Telecom, controlled by Cable and Wireless plc, and some Chinese government-controlled entities such as Citic Pacific.

The government strategy, executed through four medium- sized broking houses, seems to be to buy the market in line with the weightings of the HSI, thus having a direct influence on the index and the high volume of activity in the local futures market which is dominated by the Hang Seng Index contract.

The reason given for this unprecedented and totally unexpected flurry of activity in the financial markets is that the government wants to thwart a "double play" by speculators who are betting on the devaluation of the Hong Kong dollar, which would involve a break of its fixed link to the US dollar. This reasoning says that downward pressure on the equity markets feeds through onto the currency market.

The government claims that since last October the Hong Kong dollar has been subject to four rounds of frontal assault by speculators who have also taken massive short positions in local shares to create an atmosphere of weakness. Under Hong Kong's currency board system, which is used to maintain the US dollar peg, the government is supposed to keep the currency stable by withdrawing liquidity from the foreign exchange market, thus making it difficult for speculators to take positions in the Hong Kong dollar without incurring heavy costs in terms of high overnight interest rates and considerable risks if they take short positions in the currency and its value fails to fall.

Now the government seems to be saying that the currency board system, which it once described as pretty infallible, is not working. If it was working why would it have gone into the equity markets "to restore order", as the financial secretary Sir Donald Tsang, put it.

The effect of "restoring order" has been to provide a wonderful opportunity for holders of Hong Kong equity to get out of a market they see as inherently weak. Were it not for a government ready to buy all the blue chips offered for sale, big institutional investors would probably have kept their holdings because they were reluctant to record heavy losses. Now many investors can get out, without taking a bath. One major local trader said he had never seen anything like it.

"My screen's full of all these sell orders and, on the other side is nothing except this one buyer, and that buyer is buying everything," he said. "I've got people ringing me up asking whether these suckers would be in the market for every two- bit stock you've ever heard of".

The government does not see things this way. Sir Donald says that it "intends to hold these stocks for a while and they should be a very good long-term investment". He added: "We have switched part of our foreign reserves into blue chips which have been bought at very good prices."

Peking has supported this interventionist policy through the Bank of China (its securities department also got a large share of the buying action), although the stakes in the companies will not come under direct Chinese control. Yet the government has managed to hold the US dollar peg, and the Hong Kong stock market is performing better than others in the region. But overwhelmingly the market believes Sir Donald and his colleagues have scored a colossal home goal. Everyone is waiting for the fat lady to come on and sing.

Outlook, page 17