Hong Kong's Exchange Fund, a reserve that backs the Hong Kong dollar, netted an 11.8 percent return in 2007, pushing the fund's investment income to a record high.

The Exchange Fund generated an investment income of HK$142.2 billion for 2007, up sharply from HK$104 billion in 2006.

And the 11.8 percent return exceeded a 9.5 percent return in 2006, helped by a near 40 percent rally in the local stock market last year.

Exchange Fund income was mainly boosted by rising equity prices, with a HK$55.8 billion return from the Hong Kong equities portfolio, and HK$61 billion from bonds and other investments. As the Hong Kong dollar is pegged with US dollar, the appreciation of other currencies against the US dollar resulted in a HK$18.7 billion foreign exchange gain for the fund.

However, Hong Kong Monetary Authority (HKMA) chief executive Joseph Yam sent a warning. "The outlook for 2008 can be summed up in two words: difficulties and challenges. Investment opportunity will be very difficult," Yam told a press conference.

"The subprime crisis has led to a credit crunch in the US and the possibility of a recession in the US would affect the rest of the world, and Hong Kong will be affected."

He, however, declined to comment on yesterday's stock market slump, but agreed that the market sentiment was very volatile recently.

"The sentiment could deteriorate even further," Yam said. "There could even be a doomsday mentality. I hope that won't happen."

Yam said the HKMA would keep a cautious investment strategy, but it has no plan to adjust the portion of Hong Kong stocks in the fund.

Soothing investors a bit, Yam said he does not see huge capital flow out of Hong Kong and some investors might re-enter the market when the market drops to a low-level.

Meanwhile, a fund manager advised that the HKMA could stick to investment in the stock market in order to maintain a good return this year.

"After the recent stock market corrections, some share prices dropped to a reasonable or even attractive level," said Daniel Chui, JF Asset Management head of investor communications.

He said the stock market correction would continue in the first half of the year, but he expected a rally when the uncertainties ease in second half.

With the handsome Exchange Fund investment income, as well as a better-than-expected stamp duty and land sale revenues, analysts now expect the government to offer a deeper tax relief in next month's budget.

Reuters contributed to the story.

(HK Edition 01/22/2008 page2)