Economic review

A further down-drift in the final quarter

4Q01 real GDP declined by 1.6% in real terms over a year earlier, versus 0.4% decline in 3Q01. Due to weak external demand, slack consumption and declining investment, real GDP increased by a mere 0.1% in 2001, much lower than the robust 10.5% growth in 2000. The government revised earlier results, stating that real GDP contracted by 0.5% and 1.4% qoq in the first two quarters of 2001. The revision indicated that the territory fell into recession in 1H01 by technical definition. The economy posted positive qoq growth of 0.3% in Q301 but shrank again by 0.2% in the final quarter.

On the domestic front, with job loss concerns and prolonged weakness in asset markets, consumer spending remained subdued. Private consumption growth eased further to 0.3% yoy in 4Q01, from 1.2% in 3Q01. Meanwhile, investment fell by 6.4% in contrast to the 3.2% expansion in the previous quarter.

Externally, global demand deteriorated further after the terrorist attack on the US in September 2001. Contraction of merchandise exports widened from the third quarter's 4.0% to 8.8% in the fourth quarter. In the meantime, sluggish domestic demand also dragged down imports, which dropped by 9.1% in the fourth quarter from a 3.4% contraction in the third quarter. Exports of services posted a modest growth of 0.5% in 4Q01.

Taking 2001 as a whole, gross investment rose moderately by 2.1% while private consumption posted a 2% rise. Total exports of goods dropped 3.0% in real terms while exports of services increased by 3.5%. Deflation continued, with the composite CPI falling by 1.6% in 2001 while the latest figure dropped 2.3% in February 2002. Unemployment rate jumped to its high of 6.8% in the quarter ended 28 February 2002.

Hong Kong economic outlook

Still under the cloud in near term

Hong Kong is an export-oriented economy, therefore its economic outlook will be underpinned by the revival of its trading partners, particularly the US. The US Fed's aggressive expansionary monetary policy will help the US economy pull out of the doldrums. In light of recent upbeat US economic data, the Fed Chairman Alan Greenspan at his speech confirmed that US is on its road to recovery.

As the US economy is turning around, HK exports will start to benefit in the first half of 2002. However, consumption will remain slack, restricting by ongoing layoffs and rate hike concerns. January's retail sales volume plunged sharply by 10.3% with poor performance in clothing, food, alcoholic drinks and tobacco. However, the figure is not indicative yet as retail sales was highly distorted by the Lunar New Year timing effect. We believe Hong Kong will continue to have sluggish economic growth in 1H02.

Better picture for the second half

The government projected 2.8% deflation and 1% economic growth for 2002 with unemployment rate increasing further in the short term. We agree with the government's view that the EU and US economies will recover in the coming future and that the Mainland will keep up its high economic growth. In face of a better external economic prospect, export demand is expected to gather more steam in 2H02.

However, a faster-than-expected US economic recovery will also prove a double-edge sword for Hong Kong as interest rate hikes may be sooner than expected. After the terrorist attack on the US, the Fed has slashed its key federal-funds rate by 125 basis points, lowering it to a 40-year-low of 1.75% to help support the economy. Given a stream of US economic indicators that have been surprised on the positive side over the past few weeks, it is expected that future rate increases will be on the way in 2H02. We are concerned that consumer spending will be discouraged as most mortgage borrowers in Hong Kong are carrying floating rate loans. We expect that outlook will be similar to the situation in 2000 when the economy experienced strong rebound on the back of export recovery but local demand recovered slowly in a high real interest rates environment.

Unemployment is expected to reach its peak between 7-8% in April-May with improvement starting in the second half. However, owing to a structural problem, the local jobless rate will likely to stay above 7% for the rest of the year. Although consumption will remain slack due to rate hike worry and mounting unemployment, the boost to inbound tourism should help relieve some of the pain.

Private sector investment and foreign direct investment will revive in 2H02 as China market gradually opens up following its accession into the WTO. However, improvement will focus on machinery and equipment acquisition. Property investment on the other hand, will remain sluggish. Meanwhile, the high-end service sector will also benefit from the increased demand for financial, accounting, and legal expertise as the pace of restructuring of banks and enterprises quickens in China.

Against a more optimistic US prospect in 2H02, we maintain our forecast of 1% economic growth for Hong Kong in 2002 on weak consumption concerns for the time being. Given the fragile consumption sentiment on high unemployment rate, yen weakness, rates concession, restraint in government charges, and deflation in China, we revise our deflation projection of 1% to 3% for 2002.

Implications

The large cut in prime rate last year induced some investors to enter the property market. However, with a large overhang of supply in the property market and the concern on poor job prospect, any significant upswing in property prices is unlikely. In view of a US economic recovery, the local stock market has been reacting positively recently and the uptrend should be sustained through the year. Recent speculative moves, structural budget deficit issue and rate rise expectation put the HKD forward premiums in a volatile range but HKD peg is expected to be resilient, supported by anticipated export recovery.

Daniel Chan, Dr.
Senior Economist
Head of Economic Research