run into unavoidable problems because of the regional situation while others may have over - extended themselves. however, it is worth noting that the corporate sector in general in hong kong has avoided the excesses seen in the rest of the region. in general, companies in hong kong are not highly leveraged compared with their counterparts in the region and have not poured resources into an indiscriminate build - up of fixed assets. the banks have also tended to follow more prudent lending policies than those elsewhere and are better protected by their ability to take and realise good collateral. we do not therefore expect to see the collapse of asset quality that has occurred in some regional economies where corporates and the banks have also had to contend with massive exchange rate depreciation. the local banks in hong kong also have the benefit of the cushion provided by their high capital adequacy ratios. this means that even if the banks do have to make higher provisions this year, it will be their profitability rather than their solvency that is affected. while lower profitability is by no means welcome, it is not, by itself, a cause for concern in terms of the stability of the banking system. it is important to keep in mind that the local banks are still making money so far this year despite the more difficult operating conditions. equally, you will not be surprised to hear that profits are generally lower than the same period of last year due to a combination of increased funding costs, flat lending volume and increased bad debt provisions. the outlook for the year as a whole is uncertain. if banks can record the same profits as last year, they will be doing very well. certainly, nobody should have exaggerated expectations about the 1998 outturn. it will be a tough year, but i am confident that the banks can manage their way through it. what kind of strategy are the banks adopting to achieve this? i have already mentioned some of the steps : namely, to build up liquidity and to be more selective and cautious in their lending. loan review and collection procedures are being stepped up to ensure that banks can identify problem loans at an early stage and take action to safeguard their position. banks are also being more proactive in their asset and liability management, particularly in terms of their funding strategy and how to price their deposits against the competition. although banks in hong kong are highly efficient in terms of the cost - income ratio, the pressure on revenues means that they need to pay even more attention to costs

to focus on making substantial progress in shifting the development pattern, and make sure that progress in this front is in line with the objective of supporting sound and rapid economic development, so that the two facilitate and reinforce each other. recently, in parallel with rapid recovery, china observed a rapid increase in foreign exchange inflows and a substantial rise in liquidity, which remains abundant despite of vigorous sterilization efforts. this leads to potential risks of heightening inflation expectation and asset speculation. in this context, economic policy makers need to carefully balance the relations between supporting sound and rapid growth, restructuring the economy, and managing inflationary expectation. historical experiences from many countries show that inflation and inflation management is not only an important topic in the study of economics, but also a key issue that affects social and political stability. inflation, as put by milton friedman, the nobel laureate in economics, is a dangerous disease that can be fatal and destroy the whole society if unchecked. in china, it is the low - income groups, especially over 40 million urban low - income groups and nearly 100 million migrant workers that will be hit the hardest by inflation. any mismanagement in this issue would undermine social justice and stability. for the central bank, this means it should take preserving the value of domestic currency as the primary responsibility and prevent risks of high inflation. as monetary policy proves to be the most important and effective tool in managing inflation, the central bank should enhance the effectiveness of monetary policy to ensure price stability and, by doing so, promote economic growth. ii. monetary policy effectiveness has faced challenges in recent years the independence and effectiveness of china ’ s monetary policy has met with serious challenges from rapid expansion of rmb supply as a result of foreign exchange purchase. prior to 1993, china ran current account surplus and capital and financial account surplus on an alternate basis. the situation changed in 1994 when china began to have twin surplus, and intensified following china ’ s accession to the wto in 2001, as current account surplus widened markedly and became the major contributor to bop surplus. in the context of relatively stable exchange rate, the expansion of bop surplus and inflow of foreign exchange forced the pbc to passively inject base money via foreign exchange purchase. in recent years, the pbc has strengthened the capability of macroeconomic management according to the overall arrangements of the central government in line with the country ’ s development strategy. in response to changes in economic and financial circumstances and foreign exchange flows both at home and abroad