Hong Kong's merchandise export performance in the first half of 2005 was above expectations, posting a remarkable 12% gain from the same period last year. In particular, the mainland's hearty appetite for industrial inputs for export production, notably electronics parts and components due to stronger-than-expected global demand for electronics products, and sustained consumer demand from the US and the EU, especially for garments amid quota removal, have underpinned Hong Kong exports.

In addition, firmer unit values of Hong Kong exports have further contributed to the robust sales performance. While sustained demand for Hong Kong exports has somewhat exerted upward pressures on prices, soaring prices of crude oil and certain other commodities have translated into more expensive prices of raw materials and semi-manufactures. Labour and electricity shortages on the mainland have further added to the production costs. During January-May 2005, the unit values of Hong Kong's total exports were up by 2.1%.

Looking ahead, Hong Kong exports should continue to do well in the second half of 2005. But the pace of expansion will likely slacken from the double-digit growth of the first half, given a softer world economy and higher energy costs. The recent revaluation of the RMB, which is expected to increase average prices of the mainland's outward processing exports by 0.6-1%, coupled with the rebound of the US dollar, also implies a relative loss in Hong Kong's export competitiveness, whereas overseas protectionism adds another uncertainty. But in view of the good showing in the first half, our forecast on the value growth of Hong Kong's total exports is maintained at 8.5% for the whole of 2005.

Product-wise, electronics and jewellery are again expected to be the star performers. For electronics, the largest export item which contributed to 68% of Hong Kong's total export growth in the first half of 2005, sales will continue to benefit from the popularity of digital products, as well as still-healthy demand for replacement and upgrading of computer equipment. Sales of parts and components to the mainland and other Asian economies will also be propped up by increases in the production of electronics and electrical products there. Regarding jewellery, sales will be revved up by sustained demand for luxury articles, although export growth is expected to slow, and intensified competition and recent price increases of diamonds, precious stones and materials pose further challenges.

With regard to clothing, strong overseas demand for mainland-made products following quota removal has evidently benefited Hong Kong exports. But the US and the EU's re-imposition of quotas on mainland products will put a damper on Hong Kong's clothing re-exports, although the slowdown in re-export growth will be partly offset by a better showing of domestic exports due to increasing outward processing arrangement (OPA). Afterall, Hong Kong's re-exports of textiles and clothing of mainland origin to the US and the EU constitute just 4% of Hong Kong's total exports, and hence the impact of quota re-imposition on Hong Kong exports as a whole should be rather contained.

Meanwhile, timepiece exports are expected to expand modestly amid a steady world consumer market. While sales of higher-priced items will likely fare better, demand for low-priced items will be hampered by intensified competition from local Chinese companies. Hong Kong toy exporters, for their part, should see their sales performance remain solid, despite rising production costs, notably prices of plastic raw materials. In the main, export growth will be underpinned by video games, electronic toys, as well as educational toys.

Latest Developments

Hong Kong's merchandise export performance during the first half of 2005 was again better than what had been widely anticipated. While total export growth moderated somewhat in line with earlier expectations, a commendable 12% expansion was still recorded. This splendid performance, driven principally by a solid 13% increase in re-exports, notwithstanding a 7% contraction of domestic exports, continued largely on the strong momentum of 2004 when Hong Kong's total exports grew remarkably by 16%, with re-exports and domestic exports rising by 17% and 4%, respectively.

This sturdy expansion of Hong Kong exports, in the main, has been buttressed by a largely sanguine world trade environment. The global economy has shown signs of moderation on entering 2005, following its strongest performance for almost three decades last year when growth exceeded 5%. Nonetheless, economic fundamentals have remained strong, as world economic growth is projected by the IMF to reach 4.3% in 2005. In particular, the US and the Chinese mainland, with a combined 60% share of Hong Kong's total exports, have been in good shape. In this context, sustained consumer demand from the US, as well as the mainland's healthy appetite for industrial inputs for export production, have underpinned Hong Kong exports. The earlier weakness of the US dollar has also facilitated sales to the EU and Japan, although its impact on bolstering the import absorption power of non-dollar-denominated markets is expected to ease gradually, due to the recent strengthening of the dollar, which has appreciated by some 10% against both the euro and the yen since the beginning of the year.

Among major products, jewellery and electronics have continued to be the growth leaders. But while jewellery registered the biggest growth in the first half of 2005, its impact on overall export growth was dwarfed by its small share in Hong Kong's total exports. In contrast, electronics, the largest export item with a 46% share, contributed to 68% of export growth. In particular, stronger-than-expected global demand for electronics products has boosted sales of electronics parts and components to the mainland. Meanwhile, sales of clothing, accounting for another 9% of Hong Kong's total exports, also benefited from the elimination of quotas in the first half of the year, particularly to the US and the EU.

In addition, firmer unit values of Hong Kong exports have further contributed to the inspiring sales performance. To some extent, sustained demand for Hong Kong exports has continued to exert upward pressures on prices. Furthermore, soaring prices of crude oil and certain other commodities have translated into more expensive prices of raw materials and semi-manufactures. So far this year, oil prices have soared by almost 40%, whereas prices of plastic raw materials have risen by 15-20%. Labour and electricity shortages on the mainland have also added to the production costs. During January-May 2005, the unit values of Hong Kong's total exports were up by 2.1%. The unit values of re-exports rose by 1.9%, whereas those of domestic exports increased even by 4.6%.

In addition, the continued popularity of direct shipments from the mainland to overseas markets has served to depress Hong Kong's re-export growth, despite the narrowing cost differentials between Hong Kong and Shenzhen. While Hong Kong's main container terminals have recorded steady business, it has in part come at the expense of mid-stream and river trade operators amid rapid port development in the western part of the Pearl River Delta, especially Chiwan. In the first half of 2005, Hong Kong's total cargo throughput edged up by 1.3%, with Kwai Tsing container terminals showing an 11% increase but other container terminals recording a 12% decline. In the meantime, Shenzhen's cargo throughput rose by 23%, with Yantian and Chiwan registering increases of 20% and 30%, respectively.

Global Economic Outlook

Source: Hong Kong Trade Statistics, HKSAR Census and Statistics Department

Over the medium term, the world economy will continue to expand at a steady pace. Seemingly, economic activity is slowing. But the outlook for the rest of 2005 and 2006 remains decent, although high oil prices will take their toll. According to the IMF, world economic growth is projected to be 4.3% this year, and maintain a similar tempo next year. While world growth is cooling, a number of bright spots remain in the international economic landscape. In the industrialised world, the US, despite its moderating economy, continues to be the major hot spot. In the developing world, Asia, powered by the Chinese mainland, is still the most vibrant region. Within this context, world trade is poised to rise at a more moderate but steady pace. This slower trade expansion, however, is none too uninspiring for Hong Kong's exports, which are set to slow down and return to a more sustainable pace of growth in the second half of 2005 and in the coming year.

In the US, economic growth, after its fastest expansion in five years during 2004, has remained strong so far. But the US economy will ease back into a lower gear in the second half of 2005 and in 2006. While interest rates have remained at a low level, successive rate hikes, along with a less stimulatory fiscal policy and soaring energy prices, will increasingly affect business and consumer confidence. High interest rates may also put a damper on the buoyant housing market, and in turn weigh on consumption. Therefore, US demand for imports, including Hong Kong products, will likely be affected. Hong Kong exports will be further hampered by the protectionist sentiment in the US, particularly with the removal of textile quotas from January 2005.

Across the Atlantic, the EU's economic growth, which has further slackened on entering 2005, will remain hesitant over the medium term. Within the euro zone, subdued domestic spending still puts a drag on economic growth. Even in the UK, growth is slowing, although its economic performance will continue to outpace that of the euro zone. Triggered by higher interest rates, the UK housing market is cooling, while consumer confidence weakens. On the whole, the recent rejection of the EU constitution treaty in France and the Netherlands is having a further short-term impact on business and consumer confidence across Europe. This rejection, in tandem with the sluggishness of the EU economy, is exerting heavy pressures on the euro and other European currencies. While a favourable currency factor serves to facilitate EU exports, this will amplify the adverse impact of high crude oil prices. For Hong Kong exporters, this exchange rate movement will weaken the price competitiveness of their products in the EU market, as European consumers remain cautious, and protectionist sentiment is still widespread, despite the conclusion of the EU/China textiles agreement.

Likewise in Japan, economic growth, which has stayed in the slow lane, is expected to be lacklustre in the rest of 2005 and in 2006, as exports, its main engine of expansion, will likely moderate amid softer demand from the Chinese mainland and higher costs stemming from spiralling oil prices. Although there are signs that corporate investment and consumer spending have expanded, lacklustre external performance will nonetheless feed back into the domestic front, thus limiting the expansion of business and consumer expenditure. Against this background, the outlook for Hong Kong exporters will be impaired by the continued cautiousness of Japanese consumers, while the recent depreciation of the yen will enfeeble the price competitiveness of Hong Kong products in the Japanese market.

Elsewhere in Asia, the Chinese mainland, as mentioned, will remain the region's growth leader over the medium term. Despite the macroeconomic tightening measures, the Chinese economy will largely remain in good shape, although domestic demand is expected to soften. To some extent, exports will also moderate, as demand from the mature markets is forecast to slow, aggravated by a less favourable exchange environment, including the 2.1% appreciation of the RMB against the US dollar, as well as pervasive protectionist sentiment in overseas markets. While the stronger RMB would undermine the mainland's export competitiveness, the impact would probably not be significant. A total of 55% of the mainland's exports relate to outward processing trade in which the local content is roughly estimated to be about 30%, mainly comprising labour costs. The 2.1% appreciation might increase average export prices by only 0.6-1%. On the other hand, the stronger RMB is expected to induce more imports into the mainland, and Hong Kong companies should have better chances to market their products in this lucrative market.

Talking of other Asian economies, the outlook for the rest of 2005 and next year is generally good. Sustained intra-regional trade, fuelled by continued demand from the Chinese mainland, should be able to cushion some of the negative impact engendered by a moderating world economy and high oil prices. Although slowing demand from the mainland will likely have a greater impact on Japan and, to a lesser extent, on South Korea, the overall impact of the mainland's tightening measures on the Southeast Asian economies should be limited, with the bulk of the mainland's imports from these Asian partners not much linked to the affected sectors of the mainland. Indeed, the steady world electronics market will provide a source of demand for the exports of electronics parts and components from other Asian economies to the mainland, and in turn benefit Hong Kong's re-exports.

Other than the mainland, India is another growth pole. With the fast growth of its services sector and industrial activity, the Indian economy should remain solid, which should bode well for Hong Kong's exports of capital goods, machinery and parts to the country. But while India holds medium and long-term market potential, unlike the mainland, a lack of integration with other Asian economies suggests that India's good showing will yet to have a substantial impact on the region.

While developing Asia will continue to lead growth in the emerging world, outlook for other fledging economies is still mainly favourable. In the Middle East, sustained oil prices will continue to boost the economic health of oil-exporting countries over the medium term, although growth among non-oil exporting economies will be increasingly affected by the slowdown in world demand. In Eastern Europe, business interest will continue to focus on Hungary, Poland and the Czech Republic, where economic growth will continue to cash in on foreign direct investment and their further integration with other EU members. Outside the EU, Russia, which will continue to benefit from lofty oil prices, is another potential market for Hong Kong exporters. Regarding Latin America, economic activity will largely retain its momentum. But growth will ease to a more sustainable pace, given rising financing costs, a slackening of external demand, as well as a likely moderation of commodity prices following drastic increases in the last couple of years.

All in all, Hong Kong exports should continue to fare well in the latter half of 2005. But the pace of expansion will likely slacken from the double-digit growth of the first half, given the moderation of the world economy against the background of sustained oil prices. The recent revaluation of the RMB, coupled with the weakening of the yen and the euro against the US dollar, also implies a relative loss in Hong Kong's export competitiveness, especially for labour-intensive industries like clothing, while prevailing protectionism in overseas markets adds another element of uncertainty. While export growth of the second half is expected to slow down, cushioned by the better-than-expected performance of the first half, no change in our overall annual projection is envisaged. Consequently, the expected value growth of Hong Kong's total exports is maintained at 8.5% for the whole of 2005. Looking further ahead, Hong Kong exports should remain robust in 2006, as the global trade environment will remain generally favourable.

Analysis by Industry Sectors