Key Points

• The financial secretary has vowed to restore fiscal balance in four years through tighter spending control
  
  
• To achieve the target, the government will need to further reduce civil service payrolls through pay cuts and layoffs. On the revenue side, apart from the introduction of a departure tax in 2003/04, the government will need to levy a consumption tax and sell more assets
  
  
• To avoid hitting Hong Kong's conomic recovery, the financial secretary has cut rates and some government fees. This will help to ease the household and businesses financial burden
  
  
• We view the budget's near-term impact on economic growth as neutral. The reduction in rates and fees should, however, increase deflation. In the medium term, the government's efforts to cut the fiscal deficit will likely have a contraction effect on the economy. The reduction of civil service salaries also will help lower Hong Kong's labor cost
  
  
• "Moving up the value chain" is now the slogan of the government's economic policy, which has been changed from "positive non-intervention" in the past to the present "proactive market enabler"

Balance the budget again in 4 years

Source: Hong Kong SAR Government

Hong Kong 2002-03 Budget Breakdown

Discussion

In the Budget 2002-03, the financial secretary, Antony Leung, balanced the need to cut the fiscal deficit and support economic recovery. He has vowed to balance the budget in four years but avoided sharply increasing taxes this year.

Revenues and spending for 2002-03

On the revenue side, as we expected, Leung rejected the introduction of a Goods and Services Tax to avoid hitting economic recovery and arousing massive political opposition. A Boundary Facilities Improvement Tax (previously called the Land and Sea Departure Tax) will, however, be levied in 2003-04 to bring in HK$ 1bn. In addition, duty on wine will be raised from 60% to 80%.

The major surprise in the budget is the reduction of rates and some government fees to ease the financial burden on households and businesses. The maximum reduction of rates in 2002 will be increased from HK$ 2,000 to HK$ 5,000 for each rateable property. Water fees, sewage charges, the trade effluent surcharge and business registration fee will also be cut or waived in 2002-03.

To contain the fiscal deficit without hiking taxes, the government has resorted to tighter spending control. The financial secretary has assumed a 4.75% civil service pay cut in 2002-03. Thanks to an expected rebound in investment income, land revenues and privatization proceeds, the government expects the fiscal deficit to narrow to HK$ 45.2bn (3.6% of GDP) in 2002-03 from a record HK$ 65.6bn (5.2% of GDP) in 2001-02.

Medium-term strategy on public finances

Apart from the introduction of the Boundary Facilities Improvement Tax in 2003-04, Leung did not elaborate on his plan to return the consolidated and operating fiscal balances to surplus in 2005-06 and 2006-07, respectively. A closer look at the medium-range forecast of the Budget reveals the government is likely to:

Revenue rises more than GDP, while spending grows much less rapidly

Source: The 2002-03 Budget Speech by Antony Leung on March 6, 2002.

Impact on the economy

In the near term, the budget is likely to have a neutral effect on Hong Kong's economy as the government spending growth will fall only moderately to 6.2% in 2002E-03E from 6.5% in 2001-02. While the reduction of rates and fees will ease the financial burden of households and businesses by HK$ 6.4bn, the forthcoming civil service pay cut may prompt 174,500 civil servants and their families to reduce spending. The government expects a 4.75% pay cut with effect from October 2002 would reduce civil service payrolls by HK$ 3bn in 2002-03. As a result, the budget should have only negligible impact on consumer spending.

Meanwhile, the reduction of rates and government fees will accelerate the decline of consumer prices, which fell 3.5% yoy in January 2002. After adopting these revenue concessions, the government expects deflation to increase to 2.8% this year from 1.6% last year, slightly higher than our forecast of 2.5%.

In the medium term, the government's effort to cut the fiscal deficit will likely have a contraction effect on the economy. This is the price Hong Kong must pay to avoid the fate of Argentina. In its medium-range forecast, the government assumed the local economy would grow by only 3.5% a year between 2003-04 and 2006-07, similar to our estimate of Hong Kong's growth at 3-4%. In addition, a civil service pay cut could help lower Hong Kong's labor cost and make the economy more competitive.

Government's economic strategy : "Moving up the value chain"

Equally important to Hong Kong's medium-term prospects is the government's economic strategy. In the budget speech, the financial secretary reiterated that the government would not unpeg the Hong Kong dollar. Without devaluation, prices and costs in Hong Kong will remain higher than neighboring economies. The government's strategy is to shift the focus of Hong Kong's economic development to high value-added sectors, namely financial services, logistics, tourism and production and professional services. This strategy seems to make sense as Hong Kong has already shown competitive advantage in these sectors. "Moving up the value chain" has now become the slogan of the government's economic policy.

The economic strategy outlined in the budget also means a change in the government's role in Hong Kong. Over the past few decades, the government adopted a "positive non-intervention" policy in Hong Kong's economic development. This policy has served Hong Kong well in its restructuring in the 1980s from an industrial city to a regional service center. In Leung's budget speech, the government's role has become that of a "proactive market enabler." The government will become more actively involved in promoting the high value-added sectors through cooperation with the business sector to secure market access for local companies. In addition, the government will prepare "to take appropriate measures to secure projects beneficial to Hong Kong when the private sector is not ready to invest in them." It remains to be seen whether this change in government's role will help Hong Kong find new sources of growth to sustain its long-term economic development.

A well-balanced budget to cater short- and long-term needs

In conclusion, the 2002-03 budget is well balanced to serve Hong Kong's short- and long-term needs. The reduction of rates and fees will ease the financial burden on households and businesses during the current economic downturn. Although Leung has begun to take action to cut the fiscal deficit, he limited the near-term impact to civil servants to avoid derailing Hong Kong's economic recovery. To enhance Hong Kong's long-term growth prospects, the budget also outlined the government's strategy to help the economy move up the value chain.

Joe Lo