HK still faces crucial challenges in reforming its existing fiscal structure. The tax base remains far too narrow. The operating deficit needs to be reined in. Government spending must be reduced to less than 20% of GDP (17% is the official target). All these are underlying structural weaknesses, which cannot be papered over by a cyclical rebound in HK's economy. Mr. Tang must not lose sight of that. That is why the downward revision in the overall deficit for 2003/04 (from the initial official forecast of HKD78bn to HKD49bn) should not be viewed as a policy triumph but more, perhaps, the luck of the 'economic' bounce.

The key debate over what core fiscal solutions need to be implemented was only briefly addressed in this Budget. For example, the much discussed 3% GST is still being studied, and at best another year or two away from being policy. Mr. Tang flagged the GST issue in order to deepen consumer expectations and broaden public discussion of the technicalities of a sales tax. Elsewhere, there was no hike in major taxes. Given HK's position in the current economic upswing, that is wise. On this and the introduction of a GST will, once more, require good economic timing. The HK consumer is looking healthier. But arguably, not healthy enough to stomach such new measures in the coming fiscal year.

Issuing government bonds to finance infrastructure projects is not a bad idea given current conditions. Local interest rates are at record lows onshore, allowing the government to issue debt at relatively low yields. The large crowd of HKD savers earning next to zero interest in HKD bank accounts should also benefit from an alternative conservative asset. Recent retail bond offers have also been well received, such as Cheung Kong and Hutchison. HK has little by way of public debt so adding a little here should not alarm credit agencies. As long the capital raised is invested in worthwhile projects that boosts HK's infrastructure, the arguments for bond issuance are favourable.

Key points from the Financial Secretary's (FS's) Budget speech for 2004/5

Economic performance and prospects

• Real GDP grew 3.3% in 2003 and it is expected to grow 6% in 2004 (same as SCB's forecast).
• Consumer price index fell 2.6% in 2003 and forecast to fall by another 1% in 2004 (vs SCB's forecast of -0.5%).
• Medium term growth forecast is revised up to 3.8% from 3% with trend increase in GDP price deflator at 0.7%, implying nominal growth rate of 4.5%.

Public Finances (all in HK$ unless otherwise stated)

• 2003/4 total govt spending is estimated to be $252.9bn and deficit of $49bn. The deficit number is much lower than market consensus ($50-60bn) and FS's first estimation of $78bn in October. Deficit forecast for 2004/5 is $42.6bn.
• The FS is planning to reduce operating expenditure from $212.2bn in 2004/5 to $200bn in 2008/9. The FS agrees with the ideology of cutting expenditure first before hiking taxes.
• The government will reduce the size of the civil service to 166 500 by March 2005 from the current 172 000, or a decline of 3.2%.
• Capital expenditure for 2004/5 is estimated to be $46.5bn and average $42bn in the next five years.
• In terms of revenue, tax hikes announced by the previous FS will continue and this could add $13bn in revenue.
• No new tax hikes in this Budget, and salaries tax deduction for home loan interest will be extended to 7 years from 5 years.
• Encourages the "Users pay" principle when considering government fees and charges. Government fees and charges freeze will end but people's livelihood should be considered first.
• Goods and Services Tax (GST): Feasibility study will be available by the end of 2004 and the FS expects to take at least 3 years to implement. Rough estimate suggests every 1 percentage point of GST will add $6bn to govt revenue, assuming no exemption.
• $21bn of govt assets was planned to be sold or securitised in 2003/4 and so far $15.5bn of housing loans have been sold to the HKMC. Airport privatisation and rail merger are expected to take place in 2005/6.

Issuance of government bonds

• FS proposes to issue govt bonds to fund infrastructure and investment projects. This will also help the development of the local bond market.
• The amount proposed is less than $20bn in 2004/5.
• Fund raised by bond issuance will not be used to meet operating expenditure.

Fiscal reserves

• The FS will aim to maintain a fiscal reserve of $150bn to $220bn to maintain market confidence.
  

Global Research Team
Standard Chartered Bank