In comparison with the phenomenal double-digit (10.5%) growth in 2000, Hong Kong's economic performance in 2001 is somewhat disappointing. According to the Government's newly-released statistics, Hong Kong's GDP grew by 2.2% in the first quarter of 2001, and slackened to 0.8% in the second quarter, followed by a 0.3% contraction in the third quarter. To a great extent, Hong Kong's current economic downturn is a reflection of the weakening global economy. The precipitation of US economy, coupled with lingering recession in Japan, continued slowdown in Euroland, as well as the prolonged adjustment on the IT industry globally, has set in train a worldwide slump in demand. Moreover, the terrorist attacks on September 11 triggered off a confidence crisis, striking a head-on blow to the market sentiment. Hong Kong, being a small economy with high external-orientation, has found itself become a storm-tossed sampan.

Sailing against the Wind

Looking ahead, the global economy will continue to totter on the downside. On the one hand, it is much likely that the consolidation of IT industry will continue in the coming year and beyond. Following the evolutionary pattern of past technology revolutions, the IT Revolution is experiencing a boom and bust cycle, and it is doomed to go a longer way to absorb the over-capacity and financial excess, due mainly to IT products' shorter life cycle, escalated globlisation of production, and the higher leverage on financial market by new economy companies. Although IT sector represents a relatively insignificant share in Hong Kong's GDP, its indirect impacts on Hong Kong's economy should not be underestimated, as many of our major trade partners, namely, Mainland China and Southeast Asian countries, are world-class production bases of IT products. On average, IT products account for over 30% of the total exports of these Asia-pacific countries, equivalent to 10% of their GDP. In some degree, the performance of Hong Kong's re-exports, service exports, financial market, and especially the Growth Enterprises Stock Market, is predicated on the vicissitudes of global IT industry.

On the other hand, there signs that the international business cycle has resumed synchronization among the US, Japan and Western Europe, as a lead-up of the deepening trade linkages, increased cross-border diversification of portfolio and the interplay of business confidence between different markets. The synchronized, mutually reinforced slowdown in the major markets could render the global economy rudderless because of the very lack of a prime locomotive. Under the circumstance, the existing imbalances like the over-valuation of greenback and the hefty trade deficit run by the US would remain unaddressed, while the structural reforms in Euroland and Japan could be stalemated, all adding systemic risks and uncertainties to the world economy.

Moreover, although the immediate effects of the "September 11 Incident" have subdued, its spillovers would linger for some time, translating into higher business operating costs associated with security and insurance, setback in commercial confidence, widespread risk aversion sentiment, and the sharp shrinkage of some industries like aviation, insurance and tourism. Hong Kong may be significantly subject to such lingering effects, to the extent that it highly depends on international trade (with merchandise export to GDP ratio standing at 125% in 2000) and has a relatively large tourism industry (with tourism receipts accounting for 4.8% of GDP in 2000).

Uphill Battle

On the domestic front, Hong Kong is fighting an uphill battle to press ahead with structural transformation. After the Asian Financial Crisis, consensus has been reached among the local community that Hong Kong should broaden its economic base and move up along the value-added chain, so as to rectify the inherent fragility stemming from the exodus of manufacturing and over-dependence upon service sectors. In the past several years, the SAR Government has made attempts to foster a bevy of new industries, including IT, multi-media, modern Chinese medicine, biotech, environmental technology, tourism and logistics. Such efforts, though partially successful, are somewhat compromised by the elusiveness of policy orientation, which to a great extent has deterred the agglomeration of social resources and the commitments by the business community. Now that new industries are far from fledged and traditional sectors are diminishing, the up and down of Hong Kong economy is more likely to be driven by external factors rather than endogenous ones.

Structural unemployment, which often surfaces in tandem with the economic restructuring, is another big headache faced by Hong Kong. The situation has been acerbated by the retarded development of new industries and the acceleration of industrial relocation – which recently has been spread from manufacturing to other sectors like banking and professional services, making an increasing number of skilled labors redundant. It follows that the unemployment rate in Hong Kong will remain on the high side in several years to come, which would inevitably suppress domestic consumption and aggravate the deflationary spiral.

Sliver Lining

Judging from the external and internal conditions, the near-term prospects of Hong Kong economy looks bleak, but the likelihood is also slim for it to dive into a recession as serious as the crisis during year 1998-99. For the current recession, the root course lies in the international demand shock rather than internal problems, the source of weakness comes from trade sector rather than capital flow, and it took place against a backdrop of worldwide rather than regional cyclical slowdown. Moreover, every cloud has its silver lining. The fundamentals of the world economy are much sounder in comparison to 3 years ago and in Hong Kong, some favorable factors have arisen on the horizon:

Firstly, the real interest rate of Hong Kong dollar has dropped significantly. From the start of this year, the interest rate of Hong Kong Dollar has been reduced for ten times in tandem with the consecutive interest cut in the US. The prime interest rate has decreased to 5.25% currently from 9.0% early this year. Lower interest rate, together with ample liquidity in the banking system, could translate into an additional incentive for domestic investment as well consumption.

Secondly, in the recent years, local enterprises have been streamlining their operations through reducing redundancy, freezing wages, cutting expenses, and implementing value-adding programs. At the same time, Hong Kong's property prices have precipitated by more than 60% as compared with the peak in 1997. The latest figures have shown that the free fall in property market has subdued and the average wage rates for major sectors have registered moderate increase, indicating that the nerve-racking adjustments in Hong Kong's cost structure are drawing to consummation.

Thirdly, "China factor" will continue to buttress up Hong Kong economy. With the further implementation of proactive fiscal and monetary policies, the deepening of financial reform and SOE (State Owned Enterprises) restructuring, and the unfolding of "Go West" campaign, Mainland is expected to maintain a buoyant economic growth of over 7% per year in the medium term. In the wake of China's accession to WTO, a new tidal wave of economic liberalization is gaining momentum. Hong Kong companies, if not fail to re-position and enhance their traditional role as "middleman" for China-related business, will enjoy not only immense opportunities for trade and investment, but also favorable business environment characterized by increasing transparency, ameliorated regulatory framework, and better compliance with the international norm. In particular, the recent moves by the Central Government to open up domestic sales have paved the way for foreign investors to tap China's immense market, which would provide a new dimension for Hong Kong companies to diversify the geographical structure of their product outlets, thus mitigating the demand crunch in developed markets.

Fourthly, the economic integration between Hong Kong and Mainland China is gathering steam with the increasingly active involvement of governments on both sides. Since the 1980s, Hong Kong companies have extended their business frontier into Mainland land China, especially the adjacent Pearl River Delta, under the well-known "Front-end Shop in Hong Kong, Back-end Factory in Mainland" paradigm. More recently, "Consumption Northward" is coming into vogue with many Hong Kong citizens frequently flocking into Guangdong Province for shopping, pastime, even residence and employment. Although the cross-border movements of commodity, capital, people and information have been growing by bounds and leaps, they are thus far mostly confined to one-way pattern in the absence of proactive supports at the official level. This year has seen a significant shift in the governments' attitude. The SAR Government has been stepped up coordination with Guangdong provincial Government and the Central Government. Following striking agreements on relaxing the entry requirements for Mainland professionals to work in Hong Kong, extending the validity period of business visa, and opening up Hong Kong Tour, the SAR Government and its Chinese counterparts is currently discussing on crucial issues like extending the opening hours of Shenzhen checkpoints, improving the efficiency of customs clearance, and even setting up a Greater China Free Trade Area (FTA). Beyond doubt, the concerted efforts by the governments are becoming an additional driving force for the economic integration in South China, which in turn would broaden Hong Kong's economic hinterland on the one hand, and facilitate the adjustment in our cost structure through the factor price equalization on the other.

"W" Shape Recovery

In sum, the lingering consolidation in the global IT sector, coupled with worldwide slump in market demand, has short-circuited Hong Kong's recovery posterior to Asian Financial Crisis, posing an additional drag on the small island, which is plodding away at structural transformation. Nevertheless, as the other side of the coin, the synchronized slowdown in major markets has prompted developed countries to take orchestrated actions to cut interest consecutively, which has pump-primed great liquidity into Hong Kong economy through the transmission mechanism built in the linkage exchange regime. The relentless adjustments in cost structure in the past three years have also contributed to underpin our economic fundamentals, and an ever-buoyant Chinese economy will continue to provide a boost, given that Hong Kong is deepening its ties with this immense hinterland through brisk cross-border economic exchanges and more recently, pro-active coordination on the official level.

All in all, Hong Kong's economic outlook for 2002 warrants neither optimism nor over-pessimism. Barring further unexpected incidents, Hong Kong is likely to follow in the steps of world economy and be back on the track of recovery in the second half of 2002, resulting in a "W-shape" revival. It is anticipated that Hong Kong's economy could record a slight positive growth of 1.5% in 2002 as a whole, but unemployment rate would continue to stand at over 5%, and the lingering deflation will have less chance to let up until mid-2002.