• The Financial Secretary unveiled a prudent and friendly budget, with a view to maintaining confidence. The most drastic surprise from the budget speech was the news that Hong Kong economic growth rocketed to 8.7% in the fourth quarter of last year. Buoyed by the turnaround in the economy and the surge in stock market, the Hong Kong government announced no new tax or tax increases, despite a projected budget deficit of HK$ 6.2 billion for FY2000/2001.

The Implications of the 2000/2001 Budget Report

Background

The Financial Secretary Donald Tsang Yam-kuen delivered his fifth budgetary speech for 2000/01 on 8 March, proposing the government's revenue and expenditure. The most drastic surprise from the budget speech was the news that Hong Kong economic growth rocketed to 8.7% in the fourth quarter of last year. Buoyed by the turnaround in the economy and the surge in stock market, the Hong Kong government announced no new tax or tax increases, despite a projected deficit of HK$ 6.2 billion for 2000/2001. In spite of the robust economic growth, fiscal prudence is sill emphasized. Nevertheless, the recovering HK economy does not give the government any excuses to hike existing tax rates and impose new tax in the election year.

Overview of the prudent but friendly budget

Delivering his budget for the fiscal year beginning April to the Legislative Council, Mr. Tsang has vowed to return to balanced budgets beginning from 2001/02 and a modest surplus is estimated for 2003/04. Deficit in 1999/00 is projected to be HK$ 1.6 billion, better than the deficit of HK$ 36.5 billion originally estimated, whilst 2000/01 will post HK$ 6.2 billion deficit without any new taxes. However, proposals for increasing fees and charges not directly linked to livelihood will be put to legislators after the budget is approved.

The big decline in budget deficit was attributable to the windfall revenue from stocks the government bought during a controversial market intervention in 1998 which earned HK$ 44 billion, double the original estimate. Also, given the booming stock market, the large trading volume further boosted collections from the stamp duty on securities transactions.

Given the surprisingly small deficit in 1999/2000, the Financial Secretary decided not to raise existing taxes or seek any new source of recurring revenue in 2000/2001 budget even with a projected deficit of HK$ 6.2 billion. However, the Financial Secretary warned that this windfall in investment earnings would not be repeated and reiterated the need for Hong Kong to move towards a broader tax base.

The recurrent public sector spending is still projected to be around 21.9% of GDP, much higher than about 16% in early 1990s. More important, public sector recurrent expenditure for 2000/01 will total HK$ 209 billion, rising by 4.8% in real terms over the revised estimate for 1999/2000. This includes HK$ 194 billion for the recurrent government expenses of existing and new services. Capital expenditure including major infrastructural works and various loan assistance schemes amounts to HK$ 50 billion.

Of all major categories, the recurrent spending on social welfare would rise by 9.2% and to nearly HK$ 30 billion in 2000/01, over the revised estimate for 1999/2000. The recurrent spending on education will grow by 4.2% in real terms to over HK$ 45 billion while the health category will grow modestly by 2.8%.

Besides, the government expected that the robust economic growth would be sustained, with 5% GDP growth forecast in 2000. The medium-term growth trend has picked up by 0.5% from last year to 4% annually. Meanwhile, the consumer prices fell by an average of 4% in 1999 and expected to fall by 1% in 2000. (Please see the appendix for detailed figures on public finance and government forecasts.)

Implications

In the budget, the market is still concerned about the large size of the public sector which amounts to 21.9% of GDP, compared with 16% in early 1990s. To finance the public sector spending, some of the new revenue (about HK$ 30 billion) is supposed to be raised through privatisation of the MTR within the coming two fiscal years. Meanwhile, the government reveals the voluntary retirement scheme for civil, citing that 10,000 staff, such as those whose jobs had been replaced by technology, would be affected. The ongoing privatisation and the bureaucracy cost cut programs are welcome by the community and are regarded as the first step to increase efficiency. However, further bold action is urged to avoid large increase in government charges and taxes in the future.

Given the broad-based recovery, the budget does not surprise us without any major stimulative policies. Relying on market mechanism, the government has refrained from assuming an excessive interventionist role. In view of a more buoyant economy ahead, the government's salary and corporate tax receipts will be boosted, despite no hikes in the existing tax rates. Most taxpayers will reap some benefits as no tax rises have been implemented. The budget will benefit consumers and corporations, given the plight of economic restructuring in Hong Kong.

On the financial market, more new initiatives, including an open and secure electronic network in the stock market and a multi-currency clearing system in the capital markets, are being developed to enhance Hong Kong' international financial center status. 10% reduction in stamp duties on equity transactions from 0.25% to 0.225% will benefit the newly merged stock exchange and enhance its competitiveness to meet challenges from other regional centers, in particular Singapore.

The government continues to invest in areas to support innovation and technology as well as basic infrastructure which is vital to Hong Kong's long term growth, especially in the development of a "knowledge-based" economy. Meanwhile, the government established a new dedicated agency to attract long-term investment into Hong Kong. This will lure foreign direct investment in the coming years, making use of the opportunities arising from China's impending entry into the WTO.

Nevertheless, the budget does not show any urgency to accelerate the privatisation pace to lower the size of public sector. It is also somewhat disappointing that the government has not introduced more specific measures to lower Hong Kong's cost of doing business. The Financial Secretary has cited that, in the near term, he will seek to widen the revenue base through some options such as increase in government charges and business levy which will lead to more business cost.

Chronic deficit issue

It is still arguable that the budget deficit, which ended up being smaller than first expected, is merely cyclical or structural. Cyclical deficits can ride the ups and downs whereas structural deficits cannot be reversed.

Given the ongoing economic restructuring, the structural unemployment and corporate bad debt provision have resulted in narrowing of tax revenue base. The development of e-business and gambling over the Internet will also erode tax bases. Meanwhile, in the wake of the Asian currency crisis, revenue from land sales and property-related duties which accounted for more than 40 per cent of total tax revenue becomes unstable. Against this background, the government has repeatedly claimed that the revenue base in Hong Kong is too narrow and that it should explore various alternative income options. Getting legislative approval for increased taxes is a challenge at any time. During an election year, in a period of cutbacks and wage restraint, the Financial Secretary has acknowledged that it is a near impossibility.

On the other hand, the government has difficulties in cutting welfare, health and education recurrent spending during an election year. In addition, the commitment to infrastructure spending and investment in the Disney theme park will boost recurrent public expenditure which may exceed the revenue growth.

Less urgency in implementing unpopular sales tax

Fortunately, with the mainland's supposed imminent membership of the World Trade Organisation expected to give the SAR's economy a hefty lift in coming years, the book-balancing takes on a decidedly less-urgent appearance. In the budget, the Financial Secretary has excised restraints not to put forward the sales tax scheme and proposed to set up an independent committee to look at the suitability and implications.

In fact, even though the deficit does reflect structural problems, it will not do simply to rely on an uptick in consumption to fix the problem. As yet, the recovery is shaky. Consumption is picking up slowly because of lower prices rather than a resurgence of disposable income while the threat of factors such as the introduction of the coming MPF scheme and US interest-rate movements will weigh heavily on the Hong Kong economy. The contagion effect of the immediate introduction of sales tax will be disastrous. As a result, we agree with the Financial Secretary that a whole review of tax structure with caution is needed. The government will set up an internal task force to review the viability of the existing regime.

In the final quarter of 1999, Hong Kong's economy unexpectedly surged by 8.7% year-on-year. While the lower base effect was a factor behind the strong figure, the red-hot US economy and economic resurgence of major Asian economies contributed to drastic expansion in Hong Kong net exports of goods. Meanwhile, exports of services improved further, partly shown by the continued pick-up in inbound tourism and offshore financial activities. More important, there exist signs that the self-sustaining domestic demand has gathered recovery momentum. Gross investment rose strongly by 9.5% while consumption posted a mild 4.5% rise.

Looking ahead, external demand will remain the key driving force in 2000. Meanwhile, the restoration of investment sentiment and abundant liquidity has helped to boost the economy. Given the friendly budget, an anticipation of stronger growth momentum in investment and consumption, as well as deepening corporate reform with advanced technology, Hong Kong's economy will likely gear up, rising further by 5.7% (higher than our previous forecast of 4.8% and the government's 5% projection) this year. However, we are still cautious about whether consumption and investment spending will be affected especially in the first half under high real interest rates (pressured by US rate hikes).

Appendix

Following are key features of Hong Kong's 2000/01 budget and the government's economic forecasts:

Public finances

* Includes the Land Fund

2000/01 spending estimates

Percent increase (decrease) in sector spending in 1999/2000

NOTES:
* GDP was calculated by applying trend growth to the latest 1999 estimate.

Government economic forecasts in 2000:
(% growth)

Daniel Chan (Senior Economist, Economic Research, DaoHengBank)