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p. 10 of 81 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia People's Republic of China Hong Kong, China Republic of Korea Mongolia Taipei,China Southeast Asia South Asia Central Asian Republics The Pacific III. Preferential Trade Agreements in Asia and the Pacific

Asian Development Outlook 2002 : II. Economic Trends and Prospects in Developing Asia : East Asia

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Hong Kong, China

Hit by the slowdown in industrial countries, GDP growth collapsed to 0.1% in 2001. Assuming a modest recovery in the US and in other key trading partners, the economy is forecast to gradually strengthen over 2002. The effects of globalization and of accelerating integration with the mainland will require the economy to make changes in its institutional and production structures if it is to remain competitive in the long term.

Macroeconomic Assessment

The economy of Hong Kong, China suffered a sharp slowdown in 2001, with GDP growth decelerating to a virtually stagnant 0.1% from 10.5% in 2000. The major contributing factors were a drop in exports and a weakening of consumer and business sentiment, stemming from the difficult economic environment worldwide (Figure 2.2).

Domestic demand growth slumped to 0.2% in 2001 from 10% in 2000. Expansion in private consumption fell to 2% from 5.4% over this period, reflecting consumer sentiment that was undermined by a drop in asset prices and rising uncertainty over employment. Given the bleak business outlook, gross fixed capital formation averaged a 2.1% increase, compared with a 9.8% rise in 2000. Slower growth in capital expenditure was mainly due to a sharp slowdown in the growth of spending on new machinery and equipment in 2001 as corporations cut their investment in information and communications technology upgrades. Expenditure on building and construction declined further by 2.5%, the fourth year of contraction. Private sector developers remained cautious in view of the overhang of supply in the residential property market while residential public sector projects were also scaled back. With the weakening demand in the economy, inventories underwent a modest depletion in 2001 after a substantial buildup in 2000.

Labor market conditions deteriorated during the year. The seasonally adjusted unemployment rate, having trended downward from a peak of 6.4% at the beginning of 1999 to 4.4% in the fourth quarter of 2000, edged up to 6.1% by the fourth quarter of 2001. The rise was attributed to increased corporate downsizing and layoffs in the context of slowing aggregate demand and the skills mismatch caused by ongoing economic restructuring.

Partly as a result of a sustained fall in import prices, a depreciation of regional currencies against the US dollar, and a benign external inflationary environment, deflation took hold, as the consumer price index fell by 1.6% in 2001. Fierce retail price competition and a weak property market that resulted in falling property rentals also put downward pressure on prices.

Under the currency link to the US dollar, the Hong Kong dollar strengthened against most regional currencies in 2001. Money market interest rates fell, due to aggressive monetary easing by the US Federal Reserve and to excess liquidity in the domestic market. Notwithstanding the economic slowdown and difficult operating environment, the profitability of the retail banks (locally incorporated banks plus a number of the larger foreign banks which operate a branch network and which are active in retail banking) held up well, recording only a moderate decline. With low interest rates making debt servicing more affordable, the overall asset quality of the retail banks continued to improve. Preliminary figures indicate that the consolidated capital adequacy ratio of locally incorporated authorized institutions remained strong at 16.8% at end-2001.

The Hang Seng Index fell in 2001, on concern about the global economic outlook as the external environment deteriorated. Share prices plummeted to a near 3-year low of 8,934 in the wake of the September 11th events in the US, but recovered to over 10,000 in October, as anxieties surrounding the likelihood of future attacks subsided. Mirroring the strength of the US stock markets, the Index subsequently rose, to 11,397 at end-December, though this was still 24.5% below the level of a year earlier.

Amid the deterioration of global growth, total exports of goods and services dropped by 2.1%, reversing a 16.7% surge in 2000. Merchandise exports contracted by 3% from 17.1% expansion in 2000. Within this total, domestic exports tumbled by 11%, in contrast to a 7.5% rise in the previous year, and reexports registered a 2% decrease, after soaring by 18.5% a year earlier. Domestic exports of electronic components registered a marked fall, while reexports of consumer goods, raw materials, and semimanufactures also slumped. The growth in services exports moderated to 3.5% from 14.1% in 2000, largely on account of a fall in tourist arrivals and a deterioration of regional demand for trade-related and other business services. Total imports of goods and services likewise fell, by 2.2% from a robust 16.7% growth in 2000, in tandem with slower reexports and a worsening of domestic demand. The combined visible and invisible trade surplus, nevertheless, widened slightly by $0.8 billion to $8.6 billion in 2001, as the fall in imports outpaced the decrease in exports.

Policy Developments

The volatility of Hong Kong, China’s fiscal revenues and the faster growth of recurrent fiscal expenditures over recurrent revenues in the past decade have raised concerns about the tax system. The authorities have been running operating deficits since fiscal year (FY) 1998/99 (1 April 1998–31 March 1999). On the revenue side, while a significant amount of total revenue is derived from nontax sources, the tax base is narrow, with nearly 93% of income tax coming from 15.6% of the employed workforce and 60% of profit tax from 1% of the registered corporations. In addition, revenues have fallen, reflecting the slump in the property market. On the expenditure side, the growth in government spending has exceeded revenues at an average rate of 8% a year since 1998. Moreover, social expenditures, including social welfare, health, and education, are expected to grow over time, in response to an aging population and the need to upgrade human capital.

Against this background, in 1999 the authorities enacted the Civil Service Reform to enhance the efficiency and cost-effectiveness of the civil service. In 2001, a 3-year Training and Development Program was introduced, to upgrade staff capabilities in providing an effective service. Two reviews by the Task Force on Review of Public Finances and the Advisory Committee on New Broad-Based Taxes were conducted. The Task Force assessed the nature of the operating deficit and concluded that the public finances were confronted with structural problems. The Advisory Committee suggested that a goods and services tax be adopted over the longer term to broaden the tax base. To address the issues, the 2002 budget sets out a 5-year plan to restore the operating and consolidated accounts to balance and reduce public expenditures as a proportion of GDP to 20% or below by 2006. While the budget will be countercyclical, expansion in government expenditures over the medium term will be below GDP growth. In light of the economic slowdown, the authorities are unlikely to introduce any new taxes but will need to make good any shortfall by raising additional revenues or reducing expenditures in the medium term to sustain healthy public finances.

Against the backdrop of a worsening economic outlook, the authorities, in the Chief Executive’s October policy address, proposed HK$15 billion-worth of measures to relieve economic difficulties faced by the community. Enhancing human resources to support the transition to a full-fledged knowledge-based economy is at the top of the policy agenda. Aimed at improving labor flexibility and upgrading the labor skills required for technological development and application, reforms of basic and tertiary education will be continued. The measures include updating the school curriculum, strengthening the preservice training and professional development of teachers, and increasing the allocation of secondary school places to improve accessibility of educational resources. The authorities are pushing ahead with large-scale infrastructure projects, including both roads and railways linking with the Pearl River Delta, to enhance the transport network and economic cooperation between Hong Kong, China and neighboring provinces in the PRC.

Measures to improve the business environment were also emphasized in the policy address, involving financial assistance to SMEs and investing in the construction of a new exhibition center. Finally, the policy address emphasized both reinforcing the comparative advantage in tourism and in transport and logistics, and tapping the opportunities brought about by the new knowledge-based economy and economic growth in the PRC.

Outlook for 2002–2003

GDP is projected to grow by 2.1% in 2002. A moderate economic recovery by the second half of the year is forecast, following an anticipated gradual firming in external demand and some stabilization in domestic sentiment. Exports are expected to pick up, particularly in the second half of the year, as the world economy strengthens further. Imports are expected to grow at a modest rate in 2002. Private consumption will probably remain lackluster, dragged down by high unemployment rates and the uncertain outlook for the property market. Machinery and equipment investment by the private sector will stabilize and begin to improve in late 2002, along with the gradual upward trend of exports. The trade-related services sector is expected to register growth again in 2002, reflecting the recovery in exports, while the banking sector will continue to be weighed down by the supply overhang in real estate.

Over the near term, the economy will continue to suffer the restructuring pains of intensifying integration with lower-cost production centers in the PRC. While economic growth is expected to pick up in the second half of the year, structural unemployment will likely remain high as displacement of employees in traditional manufacturing and low-end services continues. Unemployment, coupled with subdued consumer sentiment and ongoing supply and demand integration with the Pearl River Delta, will exert a downward pressure on prices, maintaining deflation for yet another year in 2002. As global economic growth gathers momentum, the economy is forecast to strengthen by 4.8% in 2003.

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