Fighting talk by the Hong Kong government, anxious to scare off currency speculators, did nothing yesterday to reassure investors who flooded the stock market with sell orders, causing the blue-chip Hang Seng Index to plunge 619 points, wiping 3.8 per cent off its value.
Hong Kong is the latest financial centre to suffer from the turmoil that has hit Far Eastern stock markets in recent weeks, following sharp falls in many local currencies.
The fall in the Hang Seng, the fifth-biggest in the exchange's history, was alleviated by a mid-afternoon bout of buy orders, which lifted the index from a 741-point loss earlier in the day.
Alone among important East Asian currencies, the Hong Kong dollar has withstood heavy currency speculation which yesterday saw the Thai baht slump to a new low of 33 against the US dollar.
The Korean currency fell to a seven-year low against the dollar, while the Indonesian rupiah dipped below the psychologically important 3,000 rupiah mark against the US currency in hectic trading.
Meanwhile the Philippine peso, the Malaysian ringgit and even the once rock-solid Singapore dollar were subject to selling pressure, countered by heavy government intervention.
The outbreak of speculative activity is putting to test a host of agreements signed last year under which East Asian countries pledged mutual assistance to fend off currency speculation.
The biggest beneficiary has been Thailand which has received considerable financial support, principally from Hong Kong and China, yet the value of its currency continues to slide.
In Hong Kong yesterday the local currency, which is tied to the US dollar at a fixed rate, remained steady against the greenback. On Monday, Joseph Yam, the chief executive of the Hong Kong Monetary Authority, claimed victory against the hedge funds, which he alleged had launched an offensive against the local currency the previous Friday.
"We have won the game so far with the help of the banks which pushed the interest rate up," he said.
Yesterday, Tung Chee-hwa, Hong Kong's new Chief Executive, stepped in to repeat claims made by his officials. "Any speculator who tries to attack the Hong Kong dollar will not succeed," he said firmly.
Analysts point out that Hong Kong and its new sovereign state China have combined foreign exchange holdings in excess of US$200bn. This places the monetary authorities in a strong position to plunge into the market and battle it out with the speculators.
Hong Kong appears to have got within the speculator's sights simply because it is in a region perceived to have overvalued and vulnerable currencies.
Many Hong Kong-based investors are playing it safe and pushing funds into US dollars but the real winner may turn out to be the Japanese yen which has already slumped against the greenback and looks increasingly undervalued.
Meanwhile the decline in Hong Kong share prices is seen by some analysts as a useful correction in the market, the fastest-rising in the region this year, aside from Taiwan. Before yesterday's sell-off the local market was up almost 20 per cent since the beginning of the year. Most other Asian markets are well down on the year.
No one in Hong Kong was brave enough yesterday to predict whether the share sell-off marked the beginning of a bear market. This uncertainty was linked to concerns that the Hong Kong government's aggressive market activity to protect the local currency might ultimately prove too costly even for a treasury filled with foreign exchange reserves.
Despite the assistance of the People's Bank of China, which is said to have set aside $50bn to defend the Hong Kong dollar, constant intervention in the market and the raising of interest rates might prove too costly to an economy dangerously vulnerable to external influences.
The pressure on the Hong Kong dollar is rekindling the debate about whether the territory should retain its fixed link with the US dollar. Prominent advocates of breaking the link, such as the banker David Li, argue that it would be better to tie the local currency to a basket of currencies.