During the past year, Hong Kong's economy was dominated by various negative factors, resulting in a second economic downturn within four years. Nevertheless, although the situation is still quite mixed, it is expected to see some improvements in the coming year, and H.K's economy will also improve slightly. In the first half of this year, recession will continue, but there will be slight recovery during the latter half. GDP for the year may grow by 1%, but deflation will possibly worsen.

Year 2001 - Second Downturn in Four Years

According to the latest government forecast, GDP would record zero growth in 2001, with negative growth during the last two quarters. The main GDP components would either contract or slow down drastically.

In 2001, the general public suffered even greater hardship than during the last financial turmoil. Since there was no growth in the value of overall economic activity and deflation persisted, Hong Kong's nominal GDP was lower compared to the previous year and even to that of 1997. With increased population, the decline in per capita GDP was even larger. Amid sliding property prices, the number of negative asset households also increased. Unemployment rate soared to 5.8%, the highest in 20 months. Employees were confronted with greater pressure of increased workload and job uncertainty.

Nevertheless, compared with other economies across Asia, Hong Kong was in fact doing relatively well. Hong Kong ranked second after Korea in economic growth and registered the smallest fall in exports.

Hong Kong's economic performance is affected by a number of key factors.

The first is global economic deterioration. The terrorist attacks on September 11 happened at a time when the U.S. economy was on the brink of recession. The economic repercussions of the 9.11 attacks had not only sent a wave of shocks through financial markets worldwide, but also seriously jeopardized consumption and investor confidence. Hong Kong suffered from drastic decline in exports and in the number of incoming visitors, as well as shrinkage of investor and consumer confidence.

On the other hand, the positive impact of the mainland factor has obviously strengthened. During the year, China's rapid economic growth, its increase in import and export, coupled with the Central Government's responsive measures to support Hong Kong, have formed an important counteracting force to balance the negative influence from worldwide. For instance, the continuous growth in Hong Kong's exports to the mainland has moderated the decline in total exports; increase in the number of tourists from the mainland has, to a certain extent, offset the decrease of tourists from Europe and the U.S. Indeed, the mainland factor is a unique advantage of Hong Kong and is vital to its relatively favorable economic and trade performance.

Impacts from the internal factors are quite mixed. While the SAR government is striving for economic restructuring, the financial authorities and the banking sector have followed the U.S. in reducing interest rates substantially. The persistently high U.S. dollar exchange rate and the currency devaluation in many East Asian countries added to Hong Kong's pressure to adjust asset values and labor costs. As a result, Hong Kong's property market plunged. While the SAR is still undergoing economic restructuring, the long-rooted 'speculative culture' has driven down local competitiveness in many traditional industries, thereby impairing Hong Kong's basic strengths as well as people's confidence.

Developments of Major Factors

In spite of the inherent uncertainties in the international arena, barring unforeseen circumstances, the global environment should improve slightly in 2002.

The U.S. economy is still in recession. Although there are some similarities with those of Japan ten years ago, the U.S. provides a good environment for innovative technological development that guarantees the availability of abundant supply of scientific knowledge - the key engine for economic development. Therefore, U.S. is unlikely to experience economic depression. We expect that following consolidation in the first quarter, the US economy should be able to recover in the second half of the coming year. Factors contributing to recovery include a loose monetary policy, expansionary fiscal policy, sustained productivity growth and low oil prices. On the other hand, factors hindering recovery in the U.S. are present. These include high household and corporate debts, excessive manufacturing capacity, weaker motivation after the burst of the information technology bubble, development in new industries still in an early stage, after-effects of the 9.11 attacks on consumption, resources allocation and economic globalization. Worldwide economic recession has made export-led recovery more difficult. Continuing rise in jobless claims and deflation will restrain consumption and investment. As a result, only a modest recovery is expected. Economic growth for the latter half of the year will probably reach 3% while the annual growth rate will be 2%, far behind the pre-recession level.

Although the EU is nearing recession, chances of a worsening economy are slim. Lower oil prices will reduce inflationary pressure, leaving more room for the ECB to lower interest rates. Further considering the liberalization measures and labor market reforms, the European Commission forecast growth will reach 1.3% in 2002 while IMF's forecast is 1.4%, slightly lower than those of last year. Japan is at the midst of its third economic recession in 10 years. The outlook is still grim. BOJ expects recovery will not take place before 2003. The IMF also anticipates the GDP decline in 2002 to extend to 1.3% from 0.9% in 2001. The economic development modes in the active East Asian economies are all export-oriented, primarily electronic product exports. Since last November, there have been signs of increasing demand for semi-conductor products in the world market. If the trend continues, these economies may prosper.

Considering the global financial and trading environment, US interest rate is expected to stay low and high volatility in the dollar exchange rate is unlikely. Trade protectionism may be curbed as a result of the progress made in the WTO meeting in Doha. Nevertheless, impacts of the 9.11 attacks on world trade should not be ignored. More stringent security inspection measures have been implemented, which would affect the efficiency on commuting system and logistics flow. Changes in trading pattern would also occur, owing to more political consideration.

The mainland factor shall continue to forge ahead in a way beneficial to Hong Kong. As China insists on expanding domestic demand and implementing its open door policy, the nation has also put forward supporting measures to ensure an economic growth of 7%. Besides, China's accession to the WTO would mean lower custom duty and firm WTO commitments. All these will boost trade and foreign investment. Within China, policies encouraging "go abroad" will be introduced. Relationship between Hong Kong and the mainland will also be reframed. Policies encouraging economic integration and cooperation between the two regions are expected to be introduced, bringing a closer relationship and benefiting Hong Kong.

Internal factors are expected to improve, though the pressure is still there. The first Chief Executive of the SAR has successfully implemented "one country, two systems" during his term, laying the foundation for stability and prosperity. Starting from the second term, the Chief Executive will implement the accountability system for principal government officials, enhancing the efficiency of the administration, and will continue to enforce the long-term economic development strategy and foster the existing industries to move towards higher value-added ones. It is expected to generate faster results. As for the housing market, healthy development can be expected after the gradual decline of public sector participation. However, if the HK dollar exchange rate remains high, the pressure for asset price and labor cost adjustments will remain. During the past year, Hong Kong has been confronted with not only a substantial fiscal deficit, but also a structural problem in public finance resulting from the change in economic structure. As this problem cannot be resolved in the short run, the SAR Government will not be able to implement expansionary fiscal policy, but have to trim its expenses and seek new sources of revenue.

Year 2002 - Recovering Slowly

2002 will still be a difficult year for Hong Kong. During the first half of the year, the economy may continue to contract, in spite of the support from China. Nevertheless, with larger impact from the mainland factor and improvement in the global economy, the situation may improve, with possibly 1% growth for the entire year. Global deflationary pressure and weak demand will make it difficult for Hong Kong to bring the 3-year-long deflation to an end. The Composite CPI will fall by an average of 2% for the whole year. Excessive production capacity and falling nominal income will persist.

Export growth for the whole year should improve from a decline of 2.6% to an increase of 1.7%. However, domestic exports will continue to fall due to the decline of competitiveness. Re-exports may increase by 2.5%. Demand from major western markets will continue to weaken, but goods originating from China and re-exported through Hong Kong should remain competitive. In addition, U.S. buyers may continue to shift their orders from the Middle East to East Asia. As a result, Hong Kong may benefit. Following China's WTO accession, import and export trade is expected to grow substantially, again to the benefit of Hong Kong. Export of service-oriented industries will rise along with export of goods. But tourism may still suffer due to the impact of the 9.11 attacks. Decline in the number of visitors from Europe and America will probably continue for a while. On the other hand, there is great potential for visitors from the mainland to increase after the abolition of quota restrictions and simplification of application procedures. Above all, higher quality services will attract more tourists.

Domestic consumption demand will continue to grow, although at a pace lower than that of 2001. Under the pressure of cost adjustment, many corporations are forced to streamline and reallocate their manpower resources. It is expected that unemployment may even exceed the 6.4% level experienced during the financial turmoil. Improvement will not be expected until late 2002. With salary reduction and persistent deflation, personal consumption is expected to increase only slightly by 1.8%.

Investment demand is also expected to slow down, but with a more even performance among different investment activities. Property and construction expenditure is expected to remain stable. More reasonable property prices, unprecedented low interest rates and higher return on real estate investment should all contribute to a more stable property market. In addition, real estate developers are actively pursuing for new investment projects since the peak housing supply period will soon be over. Expenditure on private construction therefore should no longer fall. Decline in public housing construction will be compensated by railway development. The rapid increase of machinery and equipment investment since the second quarter of last year have slowed down, but hopefully can be improved upon the arrival of foreign investors using Hong Kong as their base for entry into China after her WTO accession.

To conclude, Hong Kong's real economic growth in 2002 should improve moderately. However, due to worsening deflation and rising unemployment, the hardship experienced by the general public cannot be easily relieved. This is the unavoidable ill consequence caused by people's chase for superficial prosperity before 1997, as well as the necessary cost for economic restructuring. One thing for sure: Once we have endured this difficult period, tomorrow will be much better!

Forecast on Hong Kong's Real Gross Domestic Product and Consumer Prices for 2002
(changes in per cent)