• According to Federal Reserve Chairman Alan Greenspan's latest comments in testimony on 13 February, the wobbling U.S. economy faced near-term risks to growth but was not in recession and should recover by year-end. Greenspan clearly implies lower rates by stressing that "downside risks predominate" for the economy this year, as businesses work off a pile-up of unsold inventories and consumer sentiment remains shaky.
  
  
• After advancing by a hefty 11.8% growth in the first three quarters of last year, the Hong Kong economic growth in the last quarter is expected to moderate to about 6% on the global economic slowdown, the slack consumption, and higher base for comparison.
  
  
• Given Greenspan's remarks to the Congress and recent economic evidence, it is expected that the U.S. will likely register 1%-2% growth on an annual basis for 2001 (against 5% growth in 2000). Under the linked rate system, we now expect Hong Kong interest rates will be closely in line with U.S. counterparts, lowering rates by a total of 1.75% this year, assuming U.S. economy will avoid recession.
  
  
• Looking ahead, Hong Kong economic growth in 2001 will be underpinned by lower real interest rates and strong internal demand in particular investment fuelled by China's entry into the WTO. To a certain extent, local stock and property markets will be supported and loan demand for investment and mortgage will benefit further, to be reinforced by the expected downward interest rate trend.
  
  
• Consumption will maintain moderate growth in the first half of 2001, restricting by ongoing corporate reform, negative equity on mortgage and the launch of the MPF scheme. However, rate cuts will improve consumer sentiment by relieving the burden of interest payments on mortgage. In anticipation of further rate cuts in the near future, the moderate wage increases and the emerging WTO effect, retail consumption is expected to gather more steam in the second half on better sentiment.
  
  
• We are concerned that the sharp slowdown in the U.S. will feed through into the global economy, thus dragging on external demand for Hong Kong exports. Meanwhile, the growth of exports of services will also be slowing on the easing trade volume and global economic downturn. We still expect the rise in internal demand with China's WTO entry factor will be strong enough to offset the downturn in external demand. Against this background, we maintain our forecast of 3.8% economic growth for Hong Kong in 2001 for the time being, assuming U.S. economy will revive in the second half.

Hong Kong Economic Outlook - Strong Domestic Demand

Background

According to Federal Reserve Chairman Alan Greenspan's latest comments in testimony on 13 February, the wobbling U.S. economy faced near-term risks to growth but was not in recession and should recover by year-end. Greenspan clearly implies even lower rates by stressing that "downside risks predominate" for the economy this year, as businesses work off a pile-up of unsold inventories and consumer sentiment remains shaky.

The Fed issued its forecasts for the year, predicting growth would rebound to a moderate 2% to 2.5% pace by year-end, down from a robust 5% in 2000. Following two half-percentage-point reductions in interest rates last month and subdued inflation, Greenspan's comments suggest the central bank is ready to cut rates again to encourage investment and shore up confidence.

Nevertheless, the slowdown in the U.S. economy appears to have come abruptly in the real sectors though how much this has been accentuated by the energy crisis in California remains impossible to judge. Given Greenspan's remarks to the Congress and recent economic evidence, it is expected that the U.S. will likely register 1%-2% growth on an annual basis for 2001 (against 5% growth in 2000). Under the linked rate system, we now expect Hong Kong interest rates will be closely in line with U.S. counterparts, lowering rates by a total of 1.75% this year, assuming U.S. economy will avoid recession.

Recent Economic Development of Hong Kong

After advancing by a hefty 11.8% growth in the first three quarters of last year, the Hong Kong economic growth in the last quarter is expected to moderate to about 6% mainly due to trade slowdown, slack consumption and higher base for comparison.

Locally, retail sales continued to lose steam, moving up 2.4% only in volume in the last quarter of 2000, much lower than the 5.9% growth recorded in the third quarter. Even with the widespread price discounts offered by retailers, consumers are cautious in spending. The slack consumption sentiment is mainly attributable to the negative equity on mortgage, sharp correction in stock prices especially for those dotcom companies, as well as the implementation of Mandatory Provident Fund with effect from early December 2000.

Nevertheless, with the transformation towards a knowledge-based economy, the growth momentum of investment demand in the private sector could probably sustain in the last quarter. More importantly, amidst China's expected entry into the WTO, large jump in direct investment inflows into China were reported in the last two months. As many foreign firms lack experience and knowledge in understanding the China market and its corporate structures and culture, Hong Kong, serving as a gateway and supporting base, can probably lure more foreign direct investment and boost domestic investment demand.

Externally, exports of goods increased by 12.3% in the last quarter of 2000 in real terms over a year earlier while imports also expanded but at a slower pace of 14.4%. However, after achieving a stronger-than-expected export growth in September and October, both domestic exports and re-exports started to slow sharply from double digits to single figures in both November and December. The near record high number of incoming visitors would help to cushion part of shortfalls in merchandise trade.

On the price front, thanks to slowing rental decline and the lower base effect, the deflationary pressure has continued to ease. Composite Consumer Price Index was down by 2.2% in the last quarter of 2000 from 2.8% decline in the third quarter.

Rate cut implications

Looking ahead, Hong Kong economic growth in 2001 will be underpinned by lower real interest rates and strong internal demand in particular investment fuelled by China's entry into the WTO. We expect Hong Kong interest rates will be in line with U.S. counterparts, thus pushing down real interest rates. Furthermore, China's WTO entry, as well as ongoing corporate restructuring towards high value added, could help to support the growth momentum of investment spending, as reflected in continued strength in retained imports of capital goods in recent months. To a certain extent, local stock and property markets will be supported and loan demand for investment and mortgage will benefit further, to be reinforced by the expected downward interest rate trend.

Consumption will maintain moderate growth in the first half of 2001, restricting by ongoing corporate reform, negative equity on mortgage and the launch of the MPF scheme. However, rate cuts will improve consumer sentiment by relieving the burden of interest payments on mortgage. In anticipation of further rate cuts in the near future, the moderate wage increases and the emerging WTO effect, retail consumption is expected to gather more steam in the second half on better sentiment. And mild inflation will result after the second quarter.

However, we are concerned that the sharp slowdown in the U.S. will feed through into the global economy, thus dragging on external demand for Hong Kong exports. Given the recent evidence of dramatic economic slowdown and the surprisingly low level of consumer confidence in U.S., the growth pace of external trade will continue to slow. Meanwhile, triggered by the U.S. rapid economic downturn, the growth momentum in E.U. and most Asian economies have also eased recently. Together with the worrisome economic outlook in Japan, the external trade performance will continue to deteriorate. Meanwhile, the growth of exports of services will also be slowing on the easing trade volume and global economic slowdown.

We still expect the rise in internal demand with positive China's WTO entry factor will be strong enough to offset the downturn in external demand. Against this background, we maintain our forecast of 3.8% economic growth for Hong Kong in 2001 for the time being, assuming U.S. economy will revive in the second half.

Concerns

If the U.S. economy continues to show signs of a significant downward spiral, the Fed with Bush's tax cut policy will probably lower interest rate much further to boost the economy. However, the market is worried about the fragile confidence and mounting risk that the U.S. will experience strong deceleration pressures and capital outflow as a result of high level of leverage and debt in the economy. Against this background, Hong Kong will be vulnerable to global downturn if U.S. recession emerges.

Projections of Main Hong Kong Economic Indicators