Weakness in 1Q02 might be overrated

Hong Kong's 1Q real GDP fell by 0.9% on year, worse than the market's flat expectation. The disappointing economic performance stemmed from easing consumption and plummeting investment; even exports of services were stronger-than-expected. By components, private consumption recorded 0.6% year-on-year decline in real terms, the first decline recorded since 1Q99. Meanwhile, contraction in investment increased to 16.5% in 1Q02 from 6.1% decline in 4Q01.

On a seasonally adjusted quarter-to-quarter basis, the headline figures, however, painted a more encouraging picture. GDP growth rose back by 0.3% in real terms, from a 0.1% decline in 4Q01. By components, all the figures recorded positive quarter-to-quarter growth, suggesting that the territory is bottoming out. In particular, private consumption growth rose back to 0.4% in 1Q02 after contracting for two consecutive quarters in 2H01.

More important, the export recovery is faster-than-expected, thanks to an improving global economic environment and the pick-up in intra-regional trade. Likewise, exports of services accentuated further, mainly supported by booming tourism, rising offshore trade and a marked rebound in transportation services.

Outlook

Purchasing Manager's Index is up

The Hong Kong Purchasing Managers' Index, which gives an overall view of local business activity in manufacturing, services, retail and construction, rose to 52.7 in May from 52.1 in April, suggesting that the economy is accelerating. Through January, the index had been below 50 for 15 consecutive months. The volume of new orders increased to 54.3 in May from 54.1 in April, a pace not seen for almost two years.

Besides, recent economic figures suggest that export outlook looks brighter, thanks to the revival in external demand. However, the recovery of domestic demand will continue to be hindered by cautious consumer sentiment amidst job insecurity and income uncertainty. We are also concerned that investment spending will remain slack on uncertain business outlook and weakened profit margins.

External-oriented sectors - gathering momentum

On the external front, the booming tourism and a pick up in exports should help the economy pull out of the doldrums. In April, a record 1.4mn people visited Hong Kong, up 19% on-year, against 12.4% growth in 1Q02 (Chart 2). Although the astonishing growth rate was driven by a surge in the number of visitors from Mainland China, improvement was witnessed across all major markets.

Meanwhile, total exports rose for the second consecutive month in April, indicating that external demand is picking up. Some are wary that improvement cannot be sustained as it was mainly driven by re-export growth and ports in Guangdong have successfully lured away part of Hong Kong shipping business. However, Guangdong is reaching capacity at its main ports and Hong Kong remains relatively attractive on its better soft infrastructure, deep-water port facilities with frequent shipping schedule, and located at the mouth of the Pearl River Delta region. Re-exports from China through Hong Kong will gather more steam if trade volume continues to expand. For instance, the volume of trade moving through Hong Kong's main terminals bounced back in April after a 12-month slump. Meanwhile, recovery was particularly notable on cargo exports which grew by nearly 30% to 117,000 tonnes in April, against 17.1% on-year growth in March (Chart 3). Looking ahead, we expect that US economy has recovered, albeit with some easing recently. The EU and Japan economies will pick-up in the coming future and that the Mainland economy has held up well. Besides, the export-dependent economies also benefit from the revival in export orders in toys, jewellery and watches, garments and electronics. In the face of better external economic prospects and very low base effect, export demand is expected to gather more steam in 2H02. Meanwhile, the strong rebound in China's exports will also fuel demand for trade-related services, especially logistics.

Further, a weaker US dollar means that HKD and CNY depreciate against regional currencies, such as Korean won, Taiwan dollar and Singapore dollar. Consequently, Hong Kong manufacturers will benefit from a weaker CNY as most of them have relocated their production bases in China, while service providers, particularly tourism, could enhance their competitiveness with a weaker HKD.

Domestic sectors - Recovery quarters away

On the domestic front, we expect that unemployment will peak soon in the wake of the recovery of trade-related sectors. However, as some jobs in the low-value added service sectors are moving north, we do not expect the local jobless rate will drop significantly in the period ahead. Consumption, therefore, is unlikely to have any strong rebound in the coming quarters, as consumers are still cautious amidst rising unemployment and wage cut. Fortunately, the wholesale and retail sector will benefit with visitors from Mainland having strong demand for electrical goods, jewellery and watches.

For the property sector, it is encouraging to see an increase in turnover in the primary residential property market and signs of stabilization in property prices and rents. After its 10-month moratorium, the government plans to sell a total of 4,900 subsidised flats only between September 2002 and April 2003, against the original cap of 9,000 units annually. Further, the restriction to sell no more than 2,000 Home Ownership Scheme (HOS) flat sales per year after 2005/06 would help the property market by easing the competition between the public and private sectors. However, the secondary market will remain depressed on ample supply in the primary market and more than 67,500 mortgage borrowers facing negative equity. We expect property investment (about 25% of total investment) will remain sluggish. However, investment in machinery and equipment (about 60% of total investment) might improve again later this year on a better business outlook.

More importantly, amidst improving stock market sentiment, the financial and business service sectors should revive as a number of enterprises are tipped to be listed in Hong Kong later this year. According to investment bankers, at least nine companies are likely to be listed in 2H02, aiming to raise between US$ 13bn and US$ 15.7bn. Looking ahead, 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 after its WTO accession.

In sum, the recovery road will be rocky. Fortunately, the Fed is likely to defer raising interest rates until the US economy is on a firmer footing, especially while inflation is still in check. We expect that the Fed will hike its key rates by 75 basis points this year. The low interest rate environment should help the domestic sector to gradually recover in the quarters ahead.

Implications

The better-than-expected global economic performance will help revive the external-oriented sectors and pull the economy out of the doldrums. However, it might take a bit longer to spill over to the beleaguered domestic sector, as sentiment remains fragile. The recovery path will be similar to that in 1999. We, therefore, maintain our forecast of Hong Kong's real GDP growth this year to be 1%. As the domestic sector is still struggling, we expect that the local banks in Hong Kong will initially raise interest rates a little smaller than the US Fed's moves.

Daniel Chan, Dr.
Senior Economist
Head of Economic Research