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p. 8 of 54 BACK | NEXT I. Developing Asia and the World - Economic Developments and Prospects II. Economic Trends and Prospects in Developing Asia Newly Industrialized Economies Hong Kong, China Republic of Korea Singapore Taipei,China Central Asian Republics, Azerbaijan, and Mongolia People’s Republic of China Southeast Asia South Asia The Pacific III. Asia's Globalization Challenge

Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia : Newly Industrialized Economies

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Hong Kong, China

Hong Kong, China’s high rate of economic growth in 2000 was broad based, characterized by a surge in external demand and a significant rebound in domestic demand. Prospects over the longer term will be influenced by the accelerating trend toward globalization fueled both by technological advances and by economic developments after the accession of the People’s Republic of China to the World Trade Organization.

Recent Trends and Prospects

The modest recovery of 1999 accelerated in 2000, to yield real GDP growth of 10.5 percent, compared with 3.1 percent growth in 1999 and a contraction of 5.3 percent in 1998. The underlying momentum was brought about by a buoyant external sector, which was partly responsible for expansion in both private consumption and domestic investment.

Private consumption rose by 5.4 percent in real terms in 2000, due to improved real income flows and employment expansion. Overall investment spending picked up by 8.8 percent in 2000 after contracting by 17.4 percent in 1999, on the back of private sector machinery and equipment acquisition, which rebounded sharply by 27.4 percent in real terms, and steady replenishment of inventories. These improvements were supported by strengthening investment sentiment as business prospects brightened. Public investment expenditure on building and construction declined, partly due to a scaling back of the public housing program. Private investment spending in this area was constrained by property market slackness that began in the third quarter of 1998.

The decline in manufacturing production moderated to an estimated 1 percent in 2000, based on stronger domestic exports. In the first three quarters, output of wearing apparel and textiles both rose by 3 percent in volume terms. Output from fabricated metal products and plastic products declined by 18 percent and 11 percent, respectively, reflecting the ongoing relocation of manufacturing to nearby mainland provinces and rising world oil prices. The dominant services sector strengthened. The upturn in external trade boosted growth in the transport and trade sectors, while an improvement in inbound tourism led to growth in hotels and communications. In the first three quarters of 2000, business receipts of the banking sector rose moderately by 4 percent in value terms, due to reduced mortgage interest income in line with a contraction in the real estate sector and keen competition in the mortgage market, while the nonbanking financial sector surged by 56 percent, benefiting from renewed net inflows of foreign capital.

In spite of the strengthening economic recovery, prices continued to fall. The Composite Consumer Price Index declined by 3.7 percent in 2000. Fierce retail price competition, a fall in apartment rents, and the continued freeze in government fees contributed to the sustained fall in the Index. Another element was the decline in the prices of retained imports of foodstuffs and consumer goods. The rise in international oil prices and local transport prices, particularly in the third quarter, brought in some inflationary pressures, but not enough to push the economy away from the deflationary environment of the previous year.

The residential property market was constrained in an environment of weak demand and expanding supply. Yet sentiment improved somewhat in this market over the middle months of the year, on the announcement of a program of adjustment by the Housing Authority, favorable mortgage loan packages, and an expanded mortgage insurance program. Nevertheless, property prices and rentals in 2000 remained about 50 percent and 30 percent lower, respectively, than their peaks prior to the onset of the Asian financial crisis in 1997.

Generally, financial sector growth improved. Under the linked exchange rate system, the Hong Kong dollar moved closely with the US dollar against other major currencies. Nominal interest rates were on a general upward trend, reflecting US interest rate hikes during the first half of 2000 and the upsurge in international oil prices. The volume of Hong Kong dollar and foreign currency deposits rose by 5 percent and 15 percent, respectively, reflecting increased US interest rates and export receipts. However, total loan demand continued to fall, by 12 percent in 2000, with the contraction in foreign currency loans for use outside the local market. The proportion of classified loans (i.e., substandard and doubtful loans, and losses) in total loans fell to 7.3 percent, because of the economic recovery and the write-offs of loans by banks. The capital adequacy ratio remained healthy, averaging 18 percent.

With a bullish outlook on telecommunications and technology stocks, the Hang Seng Index reached an all-time high of over 18,000 in late March 2000, and then began to decline because of interest rate hikes by the US Federal Reserve, the oil price surge, and corrections in other major stock markets. Overall equity prices, as measured by the Hang Seng Index, fell by 11 percent during the course of 2000.

The fiscal balance unexpectedly moved to a surplus of HK$10.0 billion in fiscal year (FY) 1999/2000, with strong earnings growth on fiscal reserve investment amid a buoyant stock market recovery in 1999. Nevertheless, the operating budget has experienced deficits since FY1998/99. The operating deficit is now expected to be at HK$19.2 billion in FY2000/2001, lower than the HK$25.0 billion originally estimated.

Partly the result of the previous economic contraction, successive operating deficits have raised concerns about the tax system. The base appears to be narrow and shrinking. In June 2000, the authorities launched a review of public finance to assess whether the operating deficits are cyclical or structural in nature. Studies on the tax base and new broad-based taxes to provide more stable revenues are also being conducted.

Total exports of goods attained growth of 16.1 percent in 2000. This reflected mainly a broad-based strengthening of import demand in major overseas markets, and improved price competitiveness of exports following the downward adjustments in prices and production costs in the local economy. Fueled by significant reexport growth and an expansion of retained imports, merchandise imports rose markedly by 18.5 percent, which more than offset the growth in merchandise exports. Services exports remained robust in 2000, rising by 13.3 percent, amid continued increases in exports of trade-related and other business services, offshore trading activities, and inbound tourism. Services imports registered modest growth of 2.1 percent over the year, reflecting the relatively slower recovery of domestic demand. The deficit of trade in goods increased to US$11.4 billion, while the surplus of trade in services increased to US$19.1 billion. Taken together, the combined goods and services trade account still showed an appreciable surplus, at US$7.7 billion in 2000 (including an estimate of imports of gold for industrial use), though smaller than US$8.5 billion in 1999.

With the sustained pickup in overall economic activity, labor demand further strengthened, and greater employment levels in services and construction more than compensated for declines in manufacturing. The seasonally adjusted unemployment rate continued on a decline from its peak of 6.3 percent toward mid-1999 to 4.4 percent at end-2000. Nominal wages and earnings rebounded modestly to positive year-on-year growth by the second quarter of 2000, having stayed virtually flat over the previous 12 months or so.

The economy is expected to slow, to 4.0 percent growth in 2001, as the US economy slows. With more government infrastructure projects scheduled to start and stronger growth in private sector investment propelled by the development of the knowledge-based economy and the accession of the People’s Republic of China (PRC) to the World Trade Organization, gross fixed investment will probably accelerate more rapidly during the next two years. Continued economic recovery will allow further employment generation.

Prices are likely to increase in 2001 by 1.0 percent, largely as a result of continued expansionary monetary policy. Real interest rates are likely to fall in 2001, due to eased deflationary pressure in the local market and interest rate cuts by the US Federal Reserve. The improvements in the external sector should continue, though at a slower rate, as growth of neighboring economies remains solid.

Issues in Economic Management

The forces of globalization and technological advancement that are shaping the financial landscape are having a profound influence on the long-term development of Hong Kong, China. The dismantling of entry barriers to markets, the availability of low-cost, high-speed transport, and the dramatic impact of advances in information and communications technology (ICT) have challenged the effectiveness of domestic market regulations.

The task facing the authorities is to strengthen the effectiveness of the regulatory framework as traditional boundaries melt away and to improve efficiency and innovation through a more open environment conducive to competition with safeguards to ensure continued stability of the financial sector. In banking, the authorities have developed policies to remove unnecessary market entry restrictions, improve transparency, and deregulate the rules for setting interest rates. The first phase of interest rate deregulation for short-term time deposits was implemented in 2000, while the restrictions on savings deposit interest rates will be lifted in 2001, depending on the economic and financial conditions at the time. This will encourage efficiency in pricing and provide incentives for bank mergers and acquisitions to enhance competitiveness. Measures to enhance stability were also undertaken. The Hong Kong Monetary Authority clarified its role as lender of last resort. A study to improve depositor protection was completed in 2000. Although a depositor protection scheme would provide a safety net for the banking system, the financial costs and the risk of moral hazard associated with the scheme would need to be carefully considered.

A three-pronged reform to enhance competitiveness and strengthen risk-based supervisory regime in securities and futures markets was announced by the authorities in 1999 in the face of global changes. The reform includes (i) enhancing market infrastructure, (ii) modernizing the market structure through the demutualization and merger of the two exchanges and three clearinghouses, and (iii) modernizing and rationalizing the legal framework for the regulatory regime. On market infrastructure enhancement, a number of short-term measures have already been completed, which among other things, enable the electronic submission of returns by intermediaries to the regulator. The Steering Committee on the Enhancement of the Financial Infrastructure is considering the possibility of introducing straight-through processing, scripless trading, and a single clearing system for securities transactions. In terms of market structure modernization, the exchanges and clearinghouses were demutualized and merged under the name of Hong Kong Exchanges and Clearing Limited on 6 March 2000. The merged entity was listed on the stock exchange on 27 June 2000. The merger has produced a new market structure that should achieve greater efficiency, cost reduction, and better risk management, and facilitate development of new products and services. As regards regulatory reform, the Securities and Futures Bill that consolidates and modernizes 10 existing pieces of legislation governing the securities and futures market was introduced into the legislature in November 2000. The Bill seeks to provide a more transparent and coherent regulatory regime in line with international standards and practice.

A US dollar clearing system was developed in 2000. It is expected to promote the issuance and trading of US dollar-denominated stock and debt securities in Hong Kong, China and to support its position as an international financial center.

All these structural changes are expected to deepen liquidity and investor participation in the market, reinforcing Hong Kong, China’s position as the PRC’s main window for international capital raising. Continued policy initiatives that enhance effective management by the banks themselves as well as careful monitoring by banking supervisors will also be needed. The financial sector reforms, which aim at enhancing competitiveness and tapping the enormous opportunities brought about by globalization and the knowledge-based economy, will further support Hong Kong, China’s long-term vision of itself as a global financial center.

Issues in Economic Management

The forces of globalization and technological advancement that are shaping the financial landscape are having a profound influence on the long-term development of Hong Kong, China. The dismantling of entry barriers to markets, the availability of low-cost, high-speed transport, and the dramatic impact of advances in information and communications technology (ICT) have challenged the effectiveness of domestic market regulations.

The task facing the authorities is to strengthen the effectiveness of the regulatory framework as traditional boundaries melt away and to improve efficiency and innovation through a more open environment conducive to competition with safeguards to ensure continued stability of the financial sector. In banking, the authorities have developed policies to remove unnecessary market entry restrictions, improve transparency, and deregulate the rules for setting interest rates. The first phase of interest rate deregulation for short-term time deposits was implemented in 2000, while the restrictions on savings deposit interest rates will be lifted in 2001, depending on the economic and financial conditions at the time. This will encourage efficiency in pricing and provide incentives for bank mergers and acquisitions to enhance competitiveness. Measures to enhance stability were also undertaken. The Hong Kong Monetary Authority clarified its role as lender of last resort. A study to improve depositor protection was completed in 2000. Although a depositor protection scheme would provide a safety net for the banking system, the financial costs and the risk of moral hazard associated with the scheme would need to be carefully considered.

A three-pronged reform to enhance competitiveness and strengthen risk-based supervisory regime in securities and futures markets was announced by the authorities in 1999 in the face of global changes. The reform includes (i) enhancing market infrastructure, (ii) modernizing the market structure through the demutualization and merger of the two exchanges and three clearinghouses, and (iii) modernizing and rationalizing the legal framework for the regulatory regime. On market infrastructure enhancement, a number of short-term measures have already been completed, which among other things, enable the electronic submission of returns by intermediaries to the regulator. The Steering Committee on the Enhancement of the Financial Infrastructure is considering the possibility of introducing straight-through processing, scripless trading, and a single clearing system for securities transactions. In terms of market structure modernization, the exchanges and clearinghouses were demutualized and merged under the name of Hong Kong Exchanges and Clearing Limited on 6 March 2000. The merged entity was listed on the stock exchange on 27 June 2000. The merger has produced a new market structure that should achieve greater efficiency, cost reduction, and better risk management, and facilitate development of new products and services. As regards regulatory reform, the Securities and Futures Bill that consolidates and modernizes 10 existing pieces of legislation governing the securities and futures market was introduced into the legislature in November 2000. The Bill seeks to provide a more transparent and coherent regulatory regime in line with international standards and practice.

A US dollar clearing system was developed in 2000. It is expected to promote the issuance and trading of US dollar-denominated stock and debt securities in Hong Kong, China and to support its position as an international financial center.

All these structural changes are expected to deepen liquidity and investor participation in the market, reinforcing Hong Kong, China’s position as the PRC’s main window for international capital raising. Continued policy initiatives that enhance effective management by the banks themselves as well as careful monitoring by banking supervisors will also be needed. The financial sector reforms, which aim at enhancing competitiveness and tapping the enormous opportunities brought about by globalization and the knowledge-based economy, will further support Hong Kong, China’s long-term vision of itself as a global financial center.

Policy and Development Issues

The economy began its transition in the 1980s when manufacturing activities moved across the border after the PRC opened to foreign investment. The share of manufacturing employment in total employment fell from 38 percent in 1982 to only 7 percent in the first three quarters of 2000. In contrast, the proportion of employment in the services sector went up from 51 percent to 82 percent of the total over the same period, mirroring both the accelerated trade flow between the PRC and the rest of the world, and the continued orientation of the economy toward services.

The impact on employment of these structural adjustments was aggravated by the financial crisis. Weaker reexports caused by lower regional trade volumes, falling property values, and slowing private consumption raised unemployment in the services and construction sectors. In more recent years, as the economy underwent restructuring toward services- and knowledge-based activities, unemployment for low-income workers stayed at relatively high levels. As part of this restructuring, deregulation in banking and telecommunications initiated competition, that led to an increasing emphasis on efficiency and high value-added economic activities performed by high-skilled labor. The rapid rise of the knowledge-based economy, especially ICT, has led to great demand for well-trained talent with specialized skills required for technological development and application. However, the majority of the low-income workforce lack the skills and educational background to adapt to the new economy. Statistics show that the lowest paid 20 percent of the employed population suffered a fall in employment earnings of 18 percent in real terms between 1990 and 1999, with much of this decrease occurring in the late 1990s during the financial crisis. The top 10 percent (in earnings terms) of the employed population, however, enjoyed a 43 percent increase in earnings in real terms during 1990–1999, partly because they appeared relatively less affected by the crisis due to consistently strong demand for workers with greater skills and a better education.

To relieve the shortage of ICT talent in the short run, the authorities may need to formulate a policy for importing professionals. The attraction and maintenance of a concentration of highly skilled and motivated immigrants from all parts of the world could be a crucial component of a comprehensive strategy to maintain a dynamic economy. If the economy is to emerge as one of the world’s technology centers, existing entry barriers in immigration policy need to be removed.

However, the long-term policy strategy to address these problems at the source should include reform of the education system and curriculum to enhance labor flexibility and skill levels. The Education Commission proposed a comprehensive reform package in 2000, covering education from early childhood to continuing level. The proposed measures include broadening the spectrum by updating the school curriculum, improving the format and content of public examinations, and revising the systems of admission for primary and secondary schools. In addition, the Government has set a target of enabling 60 percent of senior secondary graduates to have access to higher education opportunities, including degree and subdegree programs.

The long-term development of the economy and its competitiveness will depend critically on the success of these education reforms and the adoption of a proper set of educational priorities and strategies. The authorities should consider the involvement of more private initiatives in the provision of education facilities to supplement those supported by public funding. The Education Department should decentralize decision making further to individual educational institutions, including selection of students, choice of instructional medium, and specific subject curricula. These measures are essential for the ongoing transformation of Hong Kong, China into a knowledge-based economy.

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