• After surging by 14.3% in the first quarter, the Hong Kong's economy remained on the road of strong recovery, growing by 10.8% year-on-year in the second quarter of 2000, slightly higher than our 10% growth forecast.

• Impressive real GDP growth in the second quarter was due to the low base effect, booming offshore financial activities and the rapid growth in domestic tourism industry. More importantly, strong import intake from the vigorous economies of US and Euroland, resurgence in intra-regional trade, as well as the robust export expansion in China ascribed to Hong Kong's remarkable external trade performance and hence also lifted demand for trade-related services. Meanwhile, moderate gains in consumption and steady rise in investment also reinforced the recovery momentum.

• Despite the impressive economic growth recorded in the first half, the consumer price figures revealed that Hong Kong was still caught in a deflationary spiral, with Composite Consumer Price Index declining by 4.6% in the first seven months, mainly on cheap food from China, lower rentals and large price discounts offered by retailers. Deflation will gradually ease in the second half while high level of real interest rates and negative equity on mortgage continue to drag on the recovery momentum of consumption.

• Looking forward, the Hong Kong economy would slow down in the second half (likely to 5% growth), in anticipation of rate cycle peaking and the soft landing in the US economy, as well as the dissipation of the low base effect. Nevertheless, external trade is still an important driving force (export momentum likely to be sustained at about 10% growth) due to the impressive recovery in the intra-regional trade and Euroland. Amidst the rapid development of 'knowledge-based' economic activities and the pending approval of China's WTO entry, real investment spending in the private sector could probably maintain moderate gain even on the still high level of the real interest rates. The China's entry into the WTO will also lure more foreign direct investment flow in 2001 and afterwards. In addition, the gearing up of the public infrastructural projects in the second half could help to support moderate economic growth.

• Despite the government's upward revision to 8.5% economic growth from 6%, we maintain our 8.8% economic growth forecast and 3.5% deflation for the whole 2000 year as the second quarter's figures are already within our expectation in July's report. Due to the distortion of the higher base effect, real economic growth will decline to 3.8% next year. However, on the China's WTO entry and the easing of real interest rates, the Hong Kong economy will continue to improve in 2001 as inflation will emerge, likely in the second half of next year.

According to the latest economic figures, the Hong Kong economy continued to experience robust growth in the second quarter. The economy grew by an impressive 10.8 percent year-on-year, slightly higher than our 10% growth forecast. On a seasonally adjusted quarter-to-quarter basis, GDP had a modest decline of 0.8% in real terms in the second quarter, after expanding for five consecutive quarters and rising by 5.3% in the first quarter.

In the second quarter, double-digit economic growth was sustained on the back of booming offshore financial activities and the growing tourism industry. More importantly, the robust growth in US economy, continued economic upturn in Euroland, fast recovery in Asian economies as well as strong China's export trade helped to spur the growth of Hong Kong merchandise trade. Meanwhile, moderate gains in consumption and rise in investment (including inventories) also maintained the Hong Kong's recovery momentum.

Locally, in spite of the surging tourist arrivals and the stabilized employment situation (with the seasonally adjusted unemployment rate easing to 5.0%), consumer spending moderated to 5.2% growth in the second quarter from the first quarter's 8.8%, partly due to interest rate hikes and the stock market correction. Amidst the prevalence of large price discounts offered by the retailers, the double-digit growth in retail sales volume was sustained, but slowed to 10.6% in the second quarter from 14% in the previous quarter.

More importantly, fuelled by the widespread corporate restructuring towards high-value added and the setup of large number of new economy-related firms, the domestic investment in the private sector continued to gather steam in the second quarter. The growth in capital formation in the private sector hovered at 5.1% year-on-year in the second quarter (against a 5.0% rise in Q1 2000) with the main impetus coming from the sharp rebound in machinery and equipment. Meanwhile, total investment (including inventories) was up 23.6% over a year earlier.

Externally, helped by strong rebound in China's export trade, resurgent intra-regional trade, as well as the vigorous import demand from US and EU economies, export performance continued to paint a rosy picture in the second quarter. Exports of goods rose impressively by 17.7% in real terms (against a 20.7% growth in the previous quarter). Meanwhile, on the back of sustained revival in inbound tourism, offshore financial activities and trade-related services, exports of services continued to gather momentum and recorded 16.3% growth in the second quarter. With the strengthening in domestic demand, which had already reflected in the rapid rise of retained imports in capital goods, raw materials and intermediate goods, imports of goods accentuated remarkably, up 18.8% in real terms over a year earlier.

The mass residential property market remained stagnant in the second quarter of 2000, as another rise in mortgage rate by 0.5 percent on 22 May 2000, correction in stock market and the anticipation of ample supply in the near future have prevented people from buying property. Compared with the previous quarter, flat prices on average dropped up by 8% quarter-to-quarter, while flat rentals on average held steady in the second quarter. On commercial property, the rental market for office space continued to pick up in the second quarter of 2000, benefiting from a strong rebound in economic activity generally and a surge in demand for space from foreign firms amid the pending approval of China's WTO entry.

Despite the impressive economic growth recorded in the first half, the consumer price figures revealed that Hong Kong was still caught in a deflationary spiral mainly on cheap food from China, lower rentals and large price discounts offered by retailers. Composite Consumer Price Index declined by 4.6% in the first seven months. However, deflation has gradually eased to 4.5% in the second quarter from 5.1% in the previous quarter due to lesser declines in rentals and the prices of many non-food items, such as fuel, clothing and footwear and durable goods.

Growth is expected to slow down

After rebounding by 12.6% in the first half, the Hong Kong economy would slow down in the second half (likely to 5% growth), in anticipation of rate cycle peaking and the soft landing in the US economy, as well as the dissipation of the low base effect. However, external trade is still an important driving force (export momentum likely to be sustained at 10% growth) due to the still robust US economy, impressive recovery in the North Asia, economic upturn in Euroland economies, as well as resurgence in intra-regional trade.

Amidst the pending approval of China's WTO entry and ongoing corporate restructuring as well as the setup of a large number of new economy-related firms, Hong Kong real investment spending in the private sector could probably maintain moderate gain even on the still high level of the real interest rates. As a springboard, the China's entry into the WTO will also help to lure short-term capital flow into Hong Kong in late 2000 and more related investment flow in 2001 and afterwards. These will help Hong Kong's asset markets and the overall economy in the medium term. In addition, public sector investment spending, particularly on the reclamation project for the Disney theme park, plans of railway construction, Cyberport and other infrastructure projects should continue to gear up in the second half.

Some Concerns

There still exist concerns about the US inflation and economic fragility in Japan which will overshadow Hong Kong's recovery pace. In addition, there is anxiety about Hong Kong's labour market and income inequality as corporate restructuring and slow wage growth will drastically change the livelihood of most people, thus affecting domestic demand revival and casting a shadow over the budding consumption recovery. Meanwhile, the sharp rebound in external trade has not yet fed through to the retail sector.

Despite improving economic environment, strong deflationary pressure still existed in the first seven months. Deflation is expected to ease gradually in the second half as slow recovery in property rentals, high real interest rates environment and negative equity on mortgage in the reminder of 2000 will continue to be the major drags on price level revival. However, deflation may fade next year on better sentiment and continued economic improvement to help reduce real interest rates.

Projection

As deflation had still made very slow improvement in the second quarter, the government forecast on the Composite CPI for the whole year is now lowered further, from the earlier forecast of a 2.5% fall to a 3.5% decline which is same as our forecast.

As expected, the government raised its forecast of full-year real GDP growth from a conservative 6% to 8.5% on the achievement of remarkable trade performance in the first half and the prevailing favourable external environment (Please see the appendix for official forecasts). However, we maintain our 8.8% economic growth forecast and 3.5% deflation for the whole 2000 year as the second quarter's figures are already within our expectation in July's report.

Due to distortion of the higher base effect, real economic growth will decline to 3.8% next year. However, on the China's WTO entry and the easing of real interest rates, the Hong Kong economy will continue to improve in 2001 as inflation will emerge, likely in the second half of next year.

ERD's Projections of Main HK Economic Indicators

Appendix

Offical Forecast growth rates of the Gross Domestic Product and its main expenditure components and forecast rates of change in the main price indicators for 2000

Daniel Chan (Senior Economist, Economic Research, DaoHengBank)

Tel: (852) 2218 8230
E-mail: Danielch@guoco.com