Contagion spreads to take further toll in Hong Kong

The turmoil in the Asian financial markets spread to Hong Kong yesterday as nervous investors drove share prices down to their lowest point in almost three years in the wake of official confirmation of the collapse of Peregrine Group, Hong Kong's largest home grown financial conglomerate. Stephen Vines, in Hong Kong, and Diane Coyle, in London, report.

Interbank rates touched 20 per cent during the day, confirming the worst fears of yet another rise in prime rates which in turn threaten to further weaken the property sector which dominates the Hong Kong stock exchange.

By the end of the morning's trading the blue chip Hang Seng Index slumped to 7,909 points, a loss of some 11 per cent, before it closed almost 9 per cent down at 8,121. The leaves the stock market at half the level it reached during the optimistic days of last summer.

"It's like sitting on the Titanic", said one harassed broker rushing out of Exchange Square which houses the stock exchange. Inside, the market makers were pondering how much damage would be inflicted on the property market as interest rates moved relentlessly upwards.

After last Friday's interest rate rise, the mortgage rate hit a six year high. "What the market is now coming to grips with is the question of affordability", said James Osborn, the director of sales at ING Barings Securities in Hong Kong. He believes that with interest rates at current levels existing borrowers will have difficulty maintaining repayments while potential home purchasers will shy away.

Hong Kong's interest rates are high because the government protects the local currency through a currency board which defends the Hong Kong dollar's fixed link to the US dollar by squeezing liquidity out of the market at times when the local currency comes under pressure. The main weapon in its armoury is interest rates. Pushing rates up as high as 300 per cent, at one point during the crisis, both makes the Hong Kong dollar attractive as an investment and makes it hard for speculators to acquire because the cost of short-term borrowing is prohibitive.

However, as Sir Donald Tsang, Hong Kong's financial secretary, freely admitted over the weekend, preserving the US dollar link causes a great deal of pain, in the form of high interest rates. "We all reckon it's the price we have to pay for the stability we need", he said.

Yesterday Tung Chee-hwa, the Chief Executive, stressed that the link "definitely" would not be changed, "we have the determination and the ability to continue the link". He said: "Without this link Hong Kong's stock market and financial market would be in a state of chaos".

Since October the currency board which backs the link has survived stiff tests with the result that the Hong Kong dollar has emerged from the crisis as the only freely tradable currency in Asia to have avoided even the smallest amount of deflation.

Hong Kong foreign currency reserves have actually increased since the crisis began and the high rates of interest in the local currency have helped keep Hong Kong dollar deposits high. It therefore seems unlikely that anything will shake the fixed link, at least for the time being.

Confirmation of Peregrine's pending liquidation came after the stock market closed yesterday. It followed the collapse of last ditch talks with an unnamed white knight. At the end of last week the Swiss based Zurich Group walked away from a deal to take a 24 per cent stake in Peregrine which is believed to have incurred losses of as much as $600 million, equivalent to almost two thirds of its shareholder's funds.

Tom Grimmer, Peregrine's spokesman, said that ``various parties are interested in a number of divisions'' of the failed company. Investors in Peregrine funds managed to get their money back yesterday.

The biggest stock market impact of the Peregrine collapse was felt by China associated companies. Francis Leung, one of Peregrine's founders, had been known as the Godfather of so called Red Chip listings, having handled most of the bigger issues. Red Chip investors took fright, sending the index which tracks these listings, down by over 21 per cent.

All support levels for the Hong Kong stock market have crumbled. "I think we're in no man's land," Mr Osborn said.

In London and other European stock markets share prices dived in reaction to the overnight Asian movements and in anticipation of another sharp decline on Wall Street. The nervous tone was set as much by Friday's share price fall in the US, when the Dow Jones index lost 222 points, as by the overnight slump in Hong Kong and Singapore.

In early trade the US market, too, fell sharply. But it recovered in time to repair some of the earlier damage in London.

The FTSE-100 index ended nearly 70 points lower at 5,068.8, having recovered from a drop of 150 points to well below the 5,000 level at one point. The index closed yesterday just 40 points lower than a month ago.

The Dow fell fast on opening and was as much as 133 points lower at one stage. By late morning it had climbed back to 7,583.66, a gain of 3 points.