Economic Update

After receiving a surprisingly depressing report with the second quarter's real GDP growth further slowed to 0.5%, the third quarter's economic data releases still point to economic slowdown. The territory in fact is on the brink of a recession after contracting by 1.7% quarter-on-quarter in the second quarter. Hurt by prolonged global slump, total export and import growth continued to fall by 9.1% and 9.3% year-on-year respectively in August. Meanwhile, following improvement for two consecutive months, July retail sales growth did not sustain and further slowed to 1.5% in volume on the back of fragile consumer confidence and job insecurity. On the price front, deflation is still in sight with CPI falling by 1.1% in August, showing cautious consumption sentiment, soft rentals, stable food prices and persistent large price discounts in retail business. Over the job market, unemployment rate climbed to a high of 4.9% for the period of June to August on skill mismatch, economic restructuring, and more importantly, the ongoing downturn in external trade.

US economic outlook

The 911 tragedy has prompted fears of postponed US recovery and the possibility of a global recession. The already struggling US economy gets worsened and is heading for recession. Household wealth further hurt by a deep plunge in the stock market. Investment spending would suffer on higher cost of equity capital and grim outlook. The consequences of the attacks are feeding through the economy in the deteriorating labor market at once. The collapse in airline companies brought up thousands of layoffs. Tourism and other affected or related industries are following through. Consumption spending which accounts for two-third of the US GDP has been the key sector supporting the economy would tumble further. Consumers would have a higher propensity to save from spending on job insecurity and economic uncertainties. Import demand would continue to decline, further destabilize those export-oriented economies.

Given inflation remains low, we see there is still more room for the Federal Reserve to trim rates further by 0.5%-0.75% in order to bolster the economy by the end of this year. So far, the Fed has lowered the Fed funds rate by a total of 4% since the beginning of this year. Additionally, it is reported that the US government and the Congress plan to seek more stimulus measures (amounting to USD100 billion) to boost the flagging economy.

We expect the US economy will rebound in the second half of 2002 on anticipation of a restricted US military retaliation against terrorism. A large rebound would come in view not only on low base effect. Preparations for the retaliation would engage public investment in armaments and security equipment. Postwar infrastructure projects and public investment in defense would generate enormous economic activity and create job openings. In addition, the combination of monetary and fiscal stimulus would have an effect eventually while both the oil and gold prices remain steady. Yet, given a view of mild recession that would last for a few quarters, we expect a mild US economic growth in 2002. However, should the war last for a longer span, not only recovery will be delayed, economic conditions would get worse with unstable oil price and deepening uncertainty. The ultimate scale and damage from the retaliation as well as possible terrorist response would be impossible to judge.

Hong Kong economic outlook

As an export-oriented economy, Hong Kong is negatively affected by the US recession. Meanwhile, Hong Kong would succumb to fragile market sentiment, weak business and consumer confidence and volatile financial flows. Import demand in US is unlikely to recover this year and domestic demand remains sluggish, it seems that Hong Kong would suffer from the slumping equity market, as well as contracting exports and most likely mire into economic recession in the last two quarters of this year. Therefore, we expect an economic contraction of 0.5% for 2001 as a whole.

Hong Kong would see lower interest rates and follow the path of the US counterpart with a rebound in mid-2002. China's entry into the WTO would further lift up the local economy. Hong Kong private sector investment and foreign direct investment, arising from the China's WTO entry, would revive. Hong Kong would be greatly benefit from increased trade between the world's most populated country and the rest of the world. Against this background and supported by the expected recovery of US economy, Hong Kong economic growth would likely be about 2% in 2002.

On the inflation front, rental and food prices remains soft but we are concerned that accelerating economic restructuring, cross-border consumption and higher propensity to save would hamper the general price recovery in the fourth quarter. We therefore revise our deflation forecast downwards to 1.5% from 1.3% deflation this year and inflation to be remained flat in 2002. With an expectation of gradual improvement in deflation, real interest rates are expected to fall in 2002, supporting steady consumption and private capital investment, when external demand conditions would also improve.

On the job market, unemployment rate remained at 4.5% for the first half but surged to 4.9% in June-August on more fresh graduates entering the market, skill mismatch and economic restructuring. Going ahead, the downswing in the global economy after the hijack attacks on the US would drag on Hong Kong's trade-related sectors and consumer sentiment. Large companies have accelerated layoffs, putting renewed pressure on the labor market and the deteriorating economy. We expect unemployment rate will exceed 5.5% by the year-end.

Fiscal stimulus is expected in the forthcoming policy speech

As global recession is in the cards, we expect the local government to follow other major Asian economies to slash corporate and personal-income taxes, grant rate rebate, strengthen the welfare safety net, create short-term employment by accelerating infrastructure projects and freeze government charges, etc., to alleviate pains arising from the rapid downturn. However, we doubt the effectiveness of any government stimulus to bolster the trade-oriented economy. The market is increasingly concerned on whether the government would bow to pressure to create low value-added jobs and increase government spending with an anticipation of about HKD40-50 billion fiscal deficits at the end of the current fiscal year.

Market Implications

The local interest rates would continuously be in line with the US counterparts. Despite an easing rate trend, the economy is hardly benefited as negative mortgage equity, deteriorating job market and grim business outlook have dragged on consumption and bank loan growth. The government's suspension of subsidized public house sales did not have much effect on property prices over deteriorating economic conditions. Hong Kong dollar forward premiums and equity market would remain volatile amid the uncertainty of the US retaliatory response.

Daniel Chan, Dr.
Senior Economist
Head of Economic Research