Highlights

Thanks to the linked exchange rate system, Hong Kong's interest rates will follow closely the falling trend of their US counterparts. The decline of local interest rates will boost household disposable income, and prompt consumers to increase spending. Lower funding cost will also bolster business confidence and stimulate more equipment investment. Increased consumer and business spending will offset the impact of a plunge in export growth due to a US economic downturn, and help Hong Kong sustain a 4% real GDP growth this year. Stronger domestic demand will also help to ease deflation, as continued recovery of consumer spending will ease the pressure on retailers to cut prices. A strengthening of domestic demand will, however, increase imports at a time when exports are moderating. Hong Kong's trade deficit is, therefore, expected to widen, and the current account would turn into a small deficit in 2002.

ECONOMIC OUTLOOK

Thanks to the linked exchange rate system, local interest rates will follow closely the falling trend of their US counterparts. After cutting interest rates twice by a total of 100 basis points (bps) in January 2001, the Federal Reserve is likely to lower its federal funds target rate by another 50 bps in March to arrest the decline of the US economy. Accordingly, local prime rate is expected to fall to 8% in March, or an average of 8.2% this year, from 9.5% at end-2000.

The decline of prime rate will lower household interest payment on Hong Kong's HK$ 620 billion home mortgage loans by HK$ 8.1 billion a year (1.6% of real private consumption) and support a stronger recovery of consumption. Consumers' purchasing power will be further boosted by an expected 3-4% increase in salaries this year, which should partly offset a maximum 5% contribution of employee's salary to the newly introduced Mandatory Provident Fund. Meanwhile, stable home prices will boost consumer confidence. To prevent a further decline in home prices from hitting the large number of homeowners who are suffering negative net worth on their mortgaged flats, the government has recently tightened the supply of subsidized flats and scaled down land sales. With stronger purchasing power and improved consumer sentiment, private consumption should continue to recover and become a main growth engine for the local economy.

The outlook on investment is, however, mixed. Although falling interest rates will bolster business confidence, the growth of investment is likely to pick up only modestly due to sluggish housing construction. To avoid increasing the large inventory of unsold residential units, private property developers may delay their housing projects. Moreover, the government will reduce the construction of subsidized flats to support the housing market.

Externally, exports will suffer from a steeper US economic downturn. As the US directly accounted for 24% of Hong Kong's exports and a large part of local trade with mainland China is also related to the US market, the current weakening US consumer and business spending will hit local exports. As a result, the growth of exports is likely to plunge to 5% this year from 16.2% in 2000. Export growth should pick up again in 2002, as the US economy is expected to recover thanks to the monetary easing this year.

Despite the weakening of exports, the pick up of domestic demand will help Hong Kong sustain a 4% real GDP growth this year. The pace of growth should edge up to 4.5% in 2002, as exports increase more rapidly due to a US economic recovery. Stronger domestic demand will also help to ease deflation. With continued recovery of consumer spending, retailers will be under less pressure to cut prices. Meanwhile, after having declined for 11 consecutive quarters, housing rental finally edged up again in the third quarter of 2000 and is expected to continue to trend upward as property prices stabilize. As a result, consumer price would begin to edge up in the second quarter of this year, and reach an average of 0.8% and 2.5% in 2001 and 2002 respectively.

Although a strengthening of domestic demand will help absorb the impact of the current US economic downturn on the local economy, it will increase imports at a time when exports are moderating. Hong Kong's trade deficit is, therefore, projected to surge from US$ 11 billion last year to US$ 23.7 billion in 2002. Accordingly, the current account surplus would decline from 5% of GDP last year to 1.1% in 2001 and turn into a deficit of 0.3% in 2002. Despite the worsening current account balance, the Hong Kong dollar will remain stable thanks to continued inflow of foreign capital as Hong Kong's economy recovers further from the Asia financial crisis.

HONG KONG MAJOR ECONOMIC FORECASTS

Jason Kwok
North Asia Chief Economist

Joe Lo
Senior Economist

Ellen Cheuk
Economist

Alice Chan
Senior Information Officer

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