The terrorist attacks on the US have aggravated economic downturn. We believe that the contraction in the fourth quarter of this year will deepen to 3.6%, as the full economic fallout from the terror attacks begins to be felt. Nonetheless, in light of much better-than-expected economic performance in 3Q, we technically revise our full-year contraction from 0.5% to 0.2% in 2001. Going forward, with growing business opportunities after China's WTO entry, we see the territory recovering in 2H of next year and look for an economic growth of 1.0% in 2002 given the resilient US economy.

Economic review

Battered by the global economic downswing, real gross domestic product (GDP) shrank 0.3% in the third quarter, the first year-on-year decline since the first quarter of 1999. However, thanks to the accelerated investment spending on aircraft, the contraction was much smaller than our expectation of a 1.2% decline or the market expectation of a 2.07% decline. Further, on a seasonally adjusted quarter-on-quarter basis, the economy surprisingly rose by 0.4%, meaning that the beleaguered economy escaped from slipping into a technical recession.

On the domestic front, with job security concerns and prolonged weakness in asset markets, consumer spending remained subdued. Growth momentum of domestic consumption eased to 1.3% year-on-year in the third quarter, from 3.6% in the second quarter. In contrast, buoyed by strong spending on machinery and equipment, due to the delivery of planes ordered by Cathay Pacific, the gross domestic fixed capital formation surprisingly expanded further, rising by 3.7% year-on-year in the third quarter, from 1.3% in the second quarter.

On the external front, amidst global economic downswing, contraction of merchandise exports widened from the second quarter's 1.9% to 4.0% in the third quarter. In the meantime, sluggish domestic demand and decline in re-exports also dragged down imports, which dropped by 3.4% from a 0.7% contraction in the second quarter. Likewise, growth in exports of services also slowed to 1.5% and imports of services declined by 2% in the third quarter.

Along with economic downturn, the deflationary problem has worsened since August. Deflation was particularly problematic among items of durable goods, clothing, and footwear. On the job market, the terrorist attacks on the US dampened hopes of US economic recovery this year and prompted widespread layoffs in September. Twined with skill mismatch caused by economic restructuring, unemployment rate climbed to 5.5% in August-October, from 4.9% in June-August.

Hong Kong's Gross Domestic Product

Hong Kong economic outlook

Near-term gloomier economic picture

The terror attacks, coming on top of an already weakening global economy, have aggravated global economic downturn. As Hong Kong is an export-oriented economy, the slowdown in its major markets will undoubtedly have a negative impact on various sectors, especially those services sectors related to trade and tourism.

Unlike South Korea, Malaysia, and Thailand where private sector spending is the buffer to offset the effects of slumping exports, consumer spending in Hong Kong has been weighed down by the negative equity in mortgages, rising cross-border spending, and worsening unemployment situation. Meanwhile, business continues to restrict investment spending in the midst of uncertain economic outlook. As the full economic fallout of terrorist attacks begins to be felt, we expect the economic contraction in Hong Kong will deepen to 3.6% in the fourth quarter. Nonetheless, in light of much better-than-expected economic performance in the third quarter, our projection for full-year real GDP contraction is technically revised from 0.5% to 0.2% in 2001.

Economic recovery to be seen in 2H of 2002

The Chinese government has allowed more people to visit Hong Kong to boost the territory's tourism. Key measures include extending multi-entry business visas for Mainland business people from present six months to a maximum of 3 years and scrapping the quota system for Hong Kong Group Tour Scheme from 2002.

Further, falling oil prices and the rapid progress of the military action in Afghanistan have significantly reduced downside risks to the US economy. Equally important, the combination of the Federal Reserve's aggressive monetary policy and substantial fiscal stimulus in the pipeline for next year will help the US economy pull out of the doldrums and pick up down the road. Our in-house US growth forecast was revised from -1.4% to -0.4% for 2002. Hong Kong exports of goods and services will, therefore, gradually pick up next year.

More importantly, with its geographic and cultural proximity and well-developed legal and financial systems, Hong Kong will be a natural gateway for companies wishing to do business in China. Indeed, the number of regional operations of foreign companies in Hong Kong increased by 7.9% in the 12 months to June to a record 3,237. Thus, we expect private sector investment and foreign direct investment will revive in the second half of 2002 as the lucrative Chinese market gradually opens. Meanwhile, the high-end service sector will also benefit from the increased demand for financial, accounting, and legal expertise as the pace of bank and enterprise restructuring quickens in the Mainland.

While the low interest rate environment helps to relieve the debt services burden on corporations and homeowners with mortgage financing, consumer market will remain lackluster on job insecurity and negative equity in mortgages. Going forward, we remain cautiously optimistic on Hong Kong economy. Against this background, Hong Kong economic growth is projected to be 1.0% in 2002.

Slow improvement in unemployment and deflation

The downswing in the global economy and economic restructuring will continue to put a drag on the job market, especially that related to trade, travel, and financial services. Responding to rising unemployment, the Chief Executive unveiled a plan for creating an estimated 30,000 new jobs in his Policy Address. However, the measures could be of little immediate help as only 7,900 new jobs will be created before April of 2002. We expect unemployment rate to exceed 6% by year-end and likely to peak at 6.3-6.5% by the Lunar New Year. Unemployment is projected to average 5.7% in 2002.

On the price front, with sluggish domestic spending, soft food prices, and low rentals, inflation is unlikely to emerge next year. General consumer price level is projected to ease by 1.5% in 2001 and 1.0% in 2002.

Expenditure weight of the 1999/2000-based Composite CPI

A total of 425 basis points cut in prime rate this year has prompted some investors to enter the property market and revitalized market transactions recently. Nonetheless, we are concerned that poor job security and uncertain economic outlook will induce renewed deflationary pressure on property prices. Meanwhile, the gloomier near term economic environment and lacklustre corporate earnings prospects will hamper a strong price rebound in blue chips. However, the uptrend could be sustained in anticipation of a US recovery next year.

Revised projections of main economic indicators

Daniel Chan, Dr.
Senior Economist
Head of Economic Research