In Hong Kong the generally held view is that the budget deficit is structural - and not cyclical - and this will need significant action at some stage. Outside of Hong Kong the view on this is mixed. Perhaps the most interesting aspect today is the common sense approach the Financial Secretary has taken by not tightening policy prematurely. The short-term aim is growth and the medium-term objective is a return to fiscal stability. In that respect, this is a good Budget.

Key points from the 2002/03 Hong Kong Budget

• The authorities remain cautious about economic prospects. The Budget outlined that Hong Kong GDP growth is expected to be 0.1% in 2001 and 1.0% in 2002. The GDP price deflator is expected to fall 1.5% in 2002, with the consumer price index (CPI) falling 2.8%. This growth forecast is exactly in line with our views, but perhaps surprisingly the government expects deflation to be even worse than we have been anticipating - and we were already relatively pessimistic. Medium-term trend economic growth rate is estimated to be 3%.
  
  
• The government will aim to cut public spending to 20% of GDP or below by FY2006/07 as well as balancing the budget in the same year.
  
  
• Financial Secretary Leung expressed no intention of changing the currency peg to the USD.

• Total spending for FY 2001/02 is estimated to be HK$ 203.9bn and FY2002/03 public expenditure is seen at HK$ 218.47bn, up by 7.25%. Financial Secretary Leung outlined a budget deficit of HK$ 66bn for FY 2001/02 and HK$ 45bn for FY 2002/03.
  
  
• Salary of civil servants will be cut by 4.75% in the medium term and the number of government employees will also be reduced, albeit by a small amount. The cut in civil service pay announced today was not a surprise, having already been widely talked about, but it highlights the negative impact of deflation on households' purchasing power and these pressures are also evident across the private sector in Hong Kong.
  
  
• No increase in taxes except wine duty. Meanwhile government will study the possibility of a GST and land departure tax, with possible introduction of the latter in FY2003/04.

No major tax changes

Faced with a still weak economy and recent concerns about the budget outlook, there was little in the way of immediate radical initiatives to stir market sentiment. If the Budget contains any surprises, it is the lack of new taxes or substantial expenditure cuts. In truth there was little expected given the uncomfortable fiscal and economic circumstances that the Financial Secretary finds himself in this year. But what is clear is that Mr Leung is very cautious about economic prospects. He has chosen to wait for a hoped for pickup in the global economy to do most of the work in repairing the fiscal deficit, rather than pursuing an extensive overhaul of the current tax system. With the economy still floundering and the deficit at a record HK$ 66bn, the Finance Secretary is looking to take the "safety first" approach rather than endanger the economy with any bold or mistimed changes in the government's current fiscal stance. Despite speculation of a new sales tax (GST), reductions in salaries tax allowances and increases in tax rates, nothing of that sort is included in the Budget. Anthony Leung's hint that a GST will be introduced "as and when necessary", while suitably vague, does suggest it could become reality when consumer confidence recovers and if the deficit persists. This makes sense. There is nothing to be gained from tightening fiscal policy prematurely, if private demand is still weak. Apart from this, there are no major plans to change the existing tax structure. There are minor increases in wine duty and a land departure tax is likely to come into force in 2003-4, which could fetch up to HK$ 1bn in revenues per annum. In short, Mr Leung has decided not to take any risks with the economy for now and to wait, at least until business conditions become palpably more favourable, before he begins the task of addressing Hong Kong's structural deficit.

Concessions, concessions

The Financial Secretary's caution is also evidenced in a number of concessions, including raising property waiver rates and the freezing of various government fees and charges that could reduce revenues in 2002/03 by as much as HK$ 6.4bn. Nevertheless, the bulk of the spending cuts saved will likely come from the civil service salaries which accounts for some 70% of recurrent government expenditure. The Financial Secretary has assumed that civil service salaries would be cut by 4.75% in October 2002, although the actual adjustment would have to wait for the results of the pay trend survey currently going on.

Balancing the Budget in the medium term

Mr Leung put a lot of emphasis on balancing the budget in the medium term. His projections show a balanced budget in 2005/06 with the public sector expenditure to GDP ratio falling to 20% (from the current level of 21.6%). Apart from waiting for an economic recovery, the Financial Secretary will have to work hard in the coming years in controlling public expenditure growth. The reality is that public expenditure is forecast to grow by 5.1% in 2002/03 when the economy is expected to shrink by 0.5% (both numbers are in nominal terms), so that public sector expenditure as a proportion of GDP will actually rise to 22.9% in the coming year.

Pro-active market enabler

Real GDP growth is expected to be 1% this year. Mr Leung also gave a rather clear idea of what his economic philosophy is - instead of "positive non-intervention", he says he sees the government's role as a "proactive market enabler". And instead of putting a lot of emphasis on technology (which was the emphasis a few years ago), Mr Leung puts his emphasis on "moving up the value chain". To achieve his much more market oriented vision for the economy, he focused on promoting Hong Kong financial services, logistics, tourism, and producer and professional services. Another new dimension he has introduced is the promotion of what he calls "the local community economy".

Summary

The Finance Secretary's decision to resist the temptation to tighten fiscal policy too much, whilst highlighting his medium-term desire for fiscal stability is justified, given the weakness in the domestic economy and only tentative signs that global conditions are improving. His vision of a market-enabled economy makes sense. The core concerns over Hong Kong's structural deficit remain for now, so some hard choices have effectively been set aside by another fiscal year. The key focus in the coming year will be growth and the need for private sector demand to recover.