3Q real GDP accelerated

Hong Kong's 3Q02 real GDP growth accelerated to 3.3% yoy, from 2Q02's 0.8% gains, slightly better than our expectation of 3.2% and market forecast of 3.0%. On a seasonally adjusted quarter-to-quarter comparison, real GDP growth picked up, rising by 2.5% in 3Q02, against market expectation of 1.2% growth.

Export of services was still the growth driver, expanding by 14.1% yoy in 3Q02, against 8.6% in 2Q02. Equally important, exports of goods surged by 11.4% on year, the first double-digit growth recorded since 4Q00. On the local front, as expected, domestic demand stayed subdued. Contraction of gross domestic fixed capital formation enlarged to 5.0%, from 2Q02's 0.6% fall. Private consumption contracted by 1.5% yoy in light of a slackened labour market and deepening deflationary pressure. Nonetheless, retained imports firmed up to a growth of 5.2% in 3Q02 and consumption rose by 0.2% qoq, suggesting that domestic demand might be bottoming out.

Outlook

Key on war threats

The economy in 2003 will be vulnerable to some event risks, such as any large-scale terrorist attacks in US or any escalation of tensions in the Middle East. Meanwhile, a possible US-led war against Iraq is keeping business and consumer confidence at bay. If the war breaks out in Mid-East in early 2003, the territory's stealthy growth could dampen in 1H03 on its heavy reliance on export recovery. Growth could be resumed in 2H03 if the war is short-lived and US economy improves. For the whole year of 2003, we expect Hong Kong's real GDP to grow by 1.8%.

Exports of goods and services still the growth drivers

Strong export of goods and services would still be the principal growth driver. On the visible trade, although there are emerging signs of weakening in the global economy, the upsurge in intra-regional trade and strong demand for China's exports would help support moderate export growth.

A medium-term concern is that if direct links between Taiwan and mainland resume, Hong Kong would lose some re-export business. According to the information from Hong Kong Trade Development Council, Taiwan-Mainland trade via Hong Kong amounts to some one million containers, or 6% of Hong Kong's total container throughput (equivalent to 1.4% of GDP). With direct links, present Taiwan-related transshipment cargo from Xiamen, Fuzhou and Shantao may ship directly to Taiwan where terminal handling charges are lower.

On the invisible trade, Nov's tourist arrivals grew by 37.5% yoy (Chart 2). Figures showed that aside from 71.8% yoy surge in visitors from mainland China, all other markets also showed substantial year-on-year growth, suggesting that the recovery in tourism is broad-based. Taking account of the remarkable performance attained, we expect the tourism sector could stay robust. Added to the revival in trade-related services, the upturn of exports of services would remain intact.

Modest improvement in domestic demand is likely

On the local front, import growth continued to pick up in Nov (Chart 3). It might suggest that demand for raw materials and capital goods turns around. Retail sales figures in Oct-Nov also reflected that contraction in consumer spending might be stabilizing. However, recovery in the local economic activities will be slow, as the economic uncertainty in the global economy would weigh on investment sentiment. Further, job insecurity and negative wealth effect are still eroding consumer sentiment.

Deflation to persist

On the price front, as the effects of government relief measures (rate payment concession and water and sewage charges waived) dissipate and low base effect emerges, we expect deflation to diminish gradually in magnitude in the period ahead. However, mild deflation is likely to persist in 2003, driven by weak domestic demand, the downward pressure on rentals (30% weight of CPI) and cheaper food prices from the mainland (27% weight of CPI). Against this background, we forecast rate of change in the Composite CPI in 2002 is maintained at -3.0% but 2003's CPI change will improve to -1.0%.

Uncertainty persists in the labor market

Unemployment may ease slightly in the final quarter as trade will rise albeit at a moderate rate. Meanwhile, 4Q is the peak season for tourism which will help lower unemployment on more demand for temporary workers to the range of 7.0%-7.2% by the year-end. However, job creation will be affected early next year, as war fears will cast shadow on export orders and tourism. Meanwhile, huge job creation over the last two months could be attributable to government programs such as "One Company One Job" and Youth Pre-employment Training. We are concerned that these jobs created are temporary in nature and unemployment rate could pick up again early this year. Nonetheless, unemployment rate in 2H03 is expected to drift lower to below 7%, along with economic recovery. We project unemployment rate to average at 7.0% as economic restructuring and hollowing out will go on.