2002: On the Road to Recovery

Amid recession and a host of uncertainties, the Hong Kong economic scene looked rather pessimistic in early 2002. In fact, Hong Kong's GDP still registered year-on-year decline during the first quarter. Gradual improvement started from the second quarter. Growth for the fourth quarter is now expected to reach about 4%, lifting the growth for the whole year to 2%.

During 2002, Hong Kong's economy can be described as "strong externally but weak internally". The former refers to the relatively strong recovery in some economic activities stimulated by external demand. Hong Kong's external trade started to grow again in March. Growth in real terms for the whole year is expected to reach 7.1%, a significant improvement from last year's -3.3%. Exports of services, which maintained growth throughout the recession period, performed even better. It is expected to grow by 11% in 2002, being the single economic activity to register double-digit growth. Strong growth in merchandise exports and exports of services should help boost Hong Kong's net exports for the year, making it the strongest driving force for growth. The contribution to GDP growth from net exports is expected to reach 2.8 percentage points.

Internal weakness relates to the slack domestic demand, with consumption and investment still contracting. Private consumption fell by 1.4% in real terms during the first 3quarters. As for investment, real domestic fixed capital formation declined by 6% for the same period. For the whole year, the forecast decline is 4.1%. Among the sub-items, investment in machinery, equipment and computer software fell for the first time in two years. For the whole year, decreases in private consumption and investment are forecast to trim GDP growth by 0.6 and 1.1 percentage points respectively. Overall domestic demand, which also includes inventories, would lower the growth rate by 0.8 percentage point.

Such performance of the Hong Kong economy has been a mixed result of cyclical and structural factors. Being a highly outward-oriented economy, Hong Kong's economic boom and bust correlates closely with the external economy. As the global economy recovered this year, demand from Hong Kong's major export markets - East Asia and North America - bounced back and offered opportunities for Hong Kong. Another favourable factor for Hong Kong's exports was the fall of the USD exchange rate. As the USD softened in the second quarter, the Hong Kong dollar followed suit, with the trade-weighted real exchange rate index down by 1.4% and 3.2% in the second and third quarters respectively. This has raised Hong Kong's export competitiveness. Moreover, the China factor has contributed even more to Hong Kong's external momentum. China's economic growth further accelerated. The WTO impact brought additional stimulus to trade and foreign investment in the Mainland. Hong Kong's trade with the Mainland also prospered. Besides, as China's imports from East Asia grew dramatically, Hong Kong's exports to East Asia also gained impetus. Furthermore, the state government's policy has favoured Hong Kong's exports of services, particularly in tourism. Visitor arrivals from the Mainland rose to 5.37 million in the first 10 months, growing by 49.9% year-on-year.

However, structural factors continued to restrain Hong Kong's economic growth and brought along pain. While the restructuring of the domestic economy is inevitably a long-term process, adjustment in manpower and wages has caused unemployment to rise and income to fall. The highest unemployment rate this year was 7.8% and the average for the year may reach 7.3%, 2.2 percentage points higher than that of the previous year. These further dampened consumption and investment, and added downward pressure to property prices. Deflation has also become more serious.

Compared with the previous year, during which growth fell for two consecutive quarters and annual GDP only grew by 0.6%, the Hong Kong economy has undoubtedly improved this year. However, judging from the partial nature of the recovery, aggravated deflation, fall of nominal and per capita GDP, the Hong Kong economy has not been able to overcome all the difficulties.

A Mixed Environment

In 2003, Hong Kong will be under a mixed environment.

Similar to the previous year, the international front is clouded with uncertainties. Obviously, these mainly concerns the possible war between the U.S. and Iraq as well as terrorist attacks. They are hard to predict. Assuming no warfare or a quick victory by the U.S. and no catastrophic events, the international environment should continue to improve. Firstly, interest rates will remain low, with inflation continued to be checked by globalisation, worldwide excess capacity and growth in productivity. Under these circumstances, any rate hike in response to economic recovery would probably be small. Secondly, oil prices are expected to fall slightly. Should the Middle East tension subside and oil supply increase, oil prices may fall by 10%. These two factors are the basis for a more optimistic outlook. Nonetheless, global recovery will only gather momentum gradually. Growth will still be lackluster in the first half of 2003, given the recent economic weakness and uncertainties associated with Iraq. As uncertainties gradually disappear, faster growth will follow. While performance of major industrial economies may still synchronise, varied economic structures and policies will likely result in a wider gap.

U.S. economic recovery is still fragile, but the possibility of a double-dip recession is extremely low. Growth will likely accelerate, reaching 2.8% in 2003. Factors favourable for recovery include: the recession and adjustment undergone in 2001 and 2002 with a large number of bankruptcies, corporate scandals and weak stock prices should help remove growth deterrents; the administration will face fewer hurdles in launching pro-growth measures with the Republicans gaining control over the parliament and the reshuffle of the economic team; recovering corporate profitability and smooth capital market functioning will help foster capital investment. Constraints on U.S. growth, however, still exist. They include the possible moderation of private consumption amid high household debts, low employment creation under high productivity growth and keen competition, limited public spending power under poor fiscal conditions. As for the USD exchange rate, no drastic upward or downward movement is envisaged. Hence, its impact on the economy may not be significant.

In Europe, positive export outlook and the maintenance of a loose monetary policy made possible by low inflation will boost economic growth moderately in 2003. According to the OECD, growth of the E.U. and Euroland will rise to 1.9% and 1.8% respectively. Nevertheless, the European economy is facing a number of constraints. Limited progress in labour market reform in Western Europe is the major hindrance to faster growth. In spite of their weak economies, Germany and France will have to conduct contractionary fiscal policies, with their fiscal deficits exceeding the limit set by the Stability and Growth Pact. There is also little room for lower interest rates, which should benefit Germany, with higher inflation in some Euroland members and maintenance of price stability as ECB's major objective.

Better global economic environment may help Japan maintain export growth and avoid a recession in 2003. Growth forecasts for Japan range between 0.8 and 1.1%. Implementation of domestic reform is by no means certain, with strong opposition against the recently proposed anti-deflationary measures. Failure to implement thorough reform would render the structural problems unresolved. Short-term pain, however, has to be borne should reform be implemented.

The China factor will offer more opportunities for Hong Kong. The WTO effect, including the lowering of tariffs, implementation of national treatment, further market liberalisation and revision of laws according to WTO principles favourable for trade and investment, has significantly boosted trade and foreign investment. In the coming year, China may pursue its reform ahead of schedule. Together with its cheap labour and large domestic market, attraction of the China market to foreign investors will be enhanced. More rapid growth in trade and foreign investment in China can be expected in 2003. Besides, the WTO effect will also foster overseas development of Mainland enterprises. Hong Kong, being the major intermediary of China's external economic activities, should be in a good position to solicit more business.

Considering Hong Kong's domestic situation, the crucial factors affecting growth should be the budget, property market stabilisation policies and progress of economic restructuring. The budget is anticipated to be contractionary, with large spending cuts and moderate taxes increase. This will be in stark contrast to previous budgets. Yet, a low tax increment should limit the negative impact on consumption and investment. The government's property market policies are favourable for the long-term healthy development of the property market. In the coming year, it may generate a mixed impact on the economy. While property transactions are expected to increase, government revenue will be affected by the freeze of land sale. Construction activities will also fall. As for economic restructuring, the government's effort to foster the upgrade of finance, logistics, tourism, industrial and commercial support services should bring along progress in the long-term. But as restructuring is still running its course, pressure to streamline and cut pay will remain. The average unemployment rate is expected to remain at a high level of 6.8%.

2003: Further Recovery and Hardship Reduction

Economic recovery in Hong Kong is expected to gather momentum in 2003, with GDP growth forecast to reach 2.8%. External demand will continue to be the major impetus. Deflation is expected to moderate as no further relief measures are expected from the budget. Nominal GDP will record positive growth as a result. Together with improved employment and stabilised property prices, people's hardship can be reduced to some extent.

Improved international environment and more favourable impact from the Mainland will benefit Hong Kong's merchandise exports and exports of services. Faster growth in East Asia, North America and the European Union, which occupy around 90% of Hong Kong's export markets, will generate higher import demand. Particularly worthy of mention is the fact that as multinational companies increase their investment in the Mainland, expansion of production activities will generate more exports as well as imports of raw materials and semi-finished components. Consumption demand will also be boosted, producing even more import demand. Hong Kong should benefit from the resultant increase in trade in China and the East Asia region. Total exports are expected to register a real growth of 7.8%, with re-export growth of 9.5%. While little progress is expected from the effort to attract the relocation of domestic manufacturing industries back to Hong Kong, domestic exports will continue to dwindle. Growth in exports of services will accelerate, with expansion of trade in East Asia generating more transport and trade related services activities. Hong Kong's tourist industry will continue to receive support from the state government. Hence, growth in exports of services is expected to increase from 11% to 12.5%. Being one of the most secured places in the world, Hong Kong should be attractive to tourists. As a smaller increase in imports of merchandise and services is expected, net exports of merchandise and services should increase, contributing about 3 percentage points to GDP growth.

Domestic demand will still be weak, though some bright spots are expected. Investment in machinery, equipment and computer software is forecast to rebound by 3.5% after falling substantially in 2002. External demand will be the key driving force, including the demand from multinationals targeting the Mainland market. A slim growth of 0.5% is expected for private consumption, with a slight retreat in the unemployment rate and stabilised property prices. Property transactions should increase. Private construction activities will proceed and there will be no interruption to public non-real estate construction activities. Public real estate construction will slow down, amid the government's retreat from the residential market and freeze of land sale. Together with lower government consumption, overall domestic demand will still contract and may trim GDP growth by 0.2 percentage point.

Deflation will persist, albeit moderate. The larger decline in prices in 2002 has been mainly the result of the implementation of relief measures proposed by the budget. In 2003, no further relief measures are anticipated and charges may even increase. But apart from these, factors bringing about deflation still exist, such as imported deflationary pressure, price-cut pressure amid weak demand, cost adjustment etc. Rent may continue to fall despite stabilised property prices. Hence, deflation will still be quite significant.

It should be emphasised that the above forecasts are made under the assumptions that war between the U.S. and Iraq can be avoided or resolved quickly as well as no further disastrous terrorist event will occur. Should actual situation differ considerably, economic performance will certainly deviate from the forecasts.

Hui Wing Fu