Highlights

Dragged by a slump in exports and sluggish investment growth, Hong Kong's economy grew only 0.5% year-on-year in the second quarter. As a weakening of business and consumer confidence is expected to further dampen domestic demand, the pace of economic growth is likely to moderate further in the coming months. Whether Hong Kong can avert a recession will hinge on exports. In the US, consumption may increase after consumers receive their tax rebates in the third quarter. Assuming a modest pick up of exports towards the year-end as demand in the US slowly recovers, Hong Kong's real GDP growth may inch back to 0.7% in the fourth quarter from -1.3% in the third quarter. This will bring full year real GDP growth down to 0.5% in 2001. However, if the US economy fails to turn around in the fourth quarter, the local economy would contract further and the full year economic growth will plunge into the negative region in 2001.

Hong Kong's economy grew at a lower than expected rate of only 0.5% year-on-year in the second quarter, down from 2.3% in the first three months. The sharp slowdown is mainly due to a 1.9% contraction in exports and a plunge in investment growth to only 0.4%, which more than offset a robust 4% increase in consumer spending. With domestic demand expected to remain weak, the pace of economic growth is likely to moderate further in the coming months, and the risk of Hong Kong slipping into a recession has sharply increased.

A weakening of business and consumer confidence is expected to further dampen domestic demand in the near term. Against growing concerns over a prolonged global economic downturn, businesses would continue to defer investment in machinery and equipment. Private developers will also hold off new property projects to avoid piling up large inventory of unsold housing units. Meanwhile, hit by waning investor confidence, local stock and property prices are likely to face further downward pressure. The negative wealth effect of falling asset prices and rising unemployment would partly offset the stimulating impact of the 300-basis-point cut in local interest rates so far this year and put a drag on consumer spending.

Despite the looming risk of recession, the government could do little to bolster domestic demand. As the weakening local stock market and lackluster land sales will hit the government's investment income and slash the revenue from land transactions, the fiscal deficit could surge to near HK$ 10 billion this year. To prevent a further worsening of its fiscal position, the government is unlikely to sharply increase spending or cut tax to boost the economy.

Given the prospects of subdued domestic demand, whether Hong Kong can avert a recession will hinge on exports. In the US, consumer spending has remained steady thanks to the Federal Reserve's aggressive monetary easing this year. Consumer demand may increase further after US consumers receive their tax rebates in the third quarter. Assuming a modest pick up of exports towards the year-end as demand in the US slowly recovers, Hong Kong's real GDP growth may inch back to 0.7% in the fourth quarter from -1.3% in the third quarter. This will bring full year real GDP growth down to 0.5% in 2001, from 10.5% in 2000. With sluggish domestic spending, deflation is likely to persist and would average about 1.2% in 2001. Meanwhile, as businesses trim their workforce to cut costs, unemployment rate would edge up to 5.2% by year-end.

After suffering a downturn this year, Hong Kong's economy is projected to grow more rapidly by 3.5% in 2002. A recovery of the world economy thanks to continued low interest rates in the US and Europe will boost Hong Kong's exports. Domestically, the rebound of the global economy and continued low interest rates will also help consumers and businesses regain confidence and increase spending. The recovery of the local economy should help to lower unemployment rate gradually to 4.5% by the end of 2002. With stronger domestic demand, deflation is also expected to end in mid-2002.

However, if contrary to expectation, the US economy fails to turn around in the fourth quarter despite aggressive monetary easing and generous tax rebates, the risk of Hong Kong slipping into recession would become real. Hit by continued weakness in exports and faltering domestic demand, real GDP may contract further in the fourth quarter, bringing full year growth down into the negative region in 2001. Depending on the timing of the US recovery, the outlook in 2002 could remain depressed.

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Jason Kwok
North Asia Chief Economist

Joe Lo
Senior Economist

Ellen Cheuk
Economist

Alice Chan
Senior Information Officer