• Hong Kong's merchandise exports will slow to a more moderate pace in 2007. Total exports are projected to rise by 6%¹, with re-exports up 6.5% but domestic exports down 10%.
  
  
• Dragged down by the US, the global economy though remaining fairly decent, is expected to slow. Yet this slowdown will not be in sync with the balance of growth tilting in favour of the emerging world.
  
  
• Developing Asia, led by China, will remain the most dynamic region. No wonder the mainland, which takes up almost half of Hong Kong's total exports, will be a buffer against the global slowdown.
  
  
• Meanwhile, certain risks and challenges exist, notably regulatory changes on the mainland, as well as overseas protectionism, a possible scenario of a dramatic US downturn and its knock-on effect on the global electronics cycle.
  
  
• Product-wise, despite peaking of the electronics cycle, demand for digital products should sustain sales. For clothing, more US and EU buyers will likely come back due to expected availability of quotas on the mainland.
  
  
• Consistent with the slower growth of merchandise exports, services exports should also moderate slightly, though the macro environment for exports of transportation, travel and trade-related services should stay largely constructive.
  
  
• Notably, financial services exports are expected to ease somewhat, as the record-breaking fund-raising activities fuelled by IPOs of many heavy-weight mainland banks and enterprises in 2006 are unlikely to repeat next year.

Reshaping and Rebalancing of World Growth

A paradigm shift in the global economic landscape is underway, characterised by the continued ascendance of emerging economies and transition of advanced economies to a slower lane of growth. In 2007, the world economy, though remaining fairly decent, is expected to moderate. The US, where inflation has trended upward to 2.4% in the third quarter this year against the 2% comfort level, will likely witness further moderation, as monetary uncertainties remain unabated, and a softening housing market continues to take its toll. Given the lacklustre housing market, disheartened consumers are finding it more difficult to tap the equity in their properties. According to Fed, the amount of cash that homeowners draw from their home equity has declined by over 40% since the third quarter of 2005 and, as a share of after-tax incomes, such amount has shrunk by nearly half to around 5%. Perhaps, as the housing decline deepens, the associated negative wealth effect will be a further beating for consumer spending. In view of this expected deceleration in consumption, holiday sales this year are widely forecast to moderate. For instance, the National Retail Federation predicts US holiday sales in 2006 to expand by 5%, compared with last year's 6.1% growth.

In the EU, the pace of economic revival should remain firm next year. But the tempo of expansion is unlikely to repeat itself to the extent of 2006, mainly because consumer demand will be capped by its ongoing efforts of fiscal consolidation, especially in Germany and Italy. Likewise in Japan, activity will likely take a breather, and consumers are expected to remain cautious amid anticipated tax increases and rising social contributions. Moreover, continued monetary tightening in Europe and Japan is on the cards, thus weighing further on domestic demand.

Interestingly, moderation of the global economy will not be in sync, with the balance of growth tilting in favour of the emerging world. While growth in the developed world slows, emerging economies tend to be able to take up some slack. Developing Asia, driven by the Chinese mainland, will continue to be the leading region in the global economic scene. Given its expanding significance, the Chinese mainland, currently the world's second biggest economy (on purchasing-power-parity basis) trailing the US and the third largest trading nation on the heels of the US and Germany, will be a spur to international trade in general, and intra-Asia trade in particular. Strong growth of the mainland economy is especially critical for Hong Kong, which has intimate trade relations with the mainland.

Mainland as a Buffer against Global Slowdown

The mainland, accounting for nearly half of Hong Kong's total exports, is projected to chalk up another healthy economic growth in 2007. While Chinese exports constitute about one third of the mainland economy, such exports have a high import content, with only around one quarter of their value being added locally. Therefore, the contribution of exports to China's economic growth will not decrease as much as the slowdown in exports. Indeed, domestic demand, which has been galloping by an annual 9% in recent years, is the bastion of economic growth on the mainland. Despite tightening measures to cool down an overheating economy, domestic demand should remain strong, as those measures will only affect the overheated sectors, and sturdy consumption will provide another stimulus to growth. In the first three quarters of 2006, retail sales were up 13.5%, vis-à-vis 12.9% in 2005.

Evidently, a buoyant Chinese economy will augur well for Hong Kong exports. Yet the mainland's drive to foster the development of high-tech manufacturing industries and promotion of environmental protection will have a bearing on trade. In order to contain the expansion of pollution-prone and energy-intensive industries, the processing trade policies have been tightened recently. Changes in processing trade policies, along with the ongoing trend towards domestic sourcing on the mainland, will pose a challenge for Hong Kong traders. Nonetheless, the sustained shift in overseas sourcing to the mainland should shore up the export processing trade, which will remain the lifeblood of Hong Kong exporters. In addition, the mainland's emphasis on hi-tech industries, including environmental protection and green manufacturing, will also unfold new dimensions to Hong Kong exporters.

Major Factors Affecting Hong Kong's Merchandise Exports

Although prospects of the global trade environment, buttressed by the mainland juggernaut, are mainly favourable, Hong Kong exporters will find themselves no lack of risks and challenges. In spite of the mainland cushion, they will remain susceptible to the vagaries of the US, and look unlikely to be left untouched by a faster-than-expected downturn of the US economy. In particular, a collapse of the US economy may have serious knock-on effect on the global electronics cycle, which has a close link to Hong Kong's export performance. Hong Kong's export outlook is further blemished by the undercurrent of protectionism in overseas markets, especially the US and the EU. In the US, changes in Congress following the mid-term elections may lead to mounting protectionist pressures. In the EU, record-breaking trade deficits with the mainland have also intensified protectionist sentiment, and induced a tougher stance against the mainland. The ongoing regulatory changes on the mainland, however, may herald a bigger poser to Hong Kong exporters, if the processing trade policies are tautened further.

Likely Performance of Selected Hong Kong Exports

In terms of products, electronics, which take up nearly half of Hong Kong's total overseas sales, will continue to boost export performance. While there are signs that the global electronics cycle has peaked, the popularity of digital products should presage continued, albeit slower, demand for a comprehensive range of electronic products. For clothing, certain mainland exports will remain under quotas imposed by the US and the EU. But if the quota utilisation this year is any guide, quota availability in 2007 will unlikely to be tight, and hence a growing number of US and EU buyers will likely be lured back to Hong Kong and the mainland for sourcing, offsetting in part the moderation in overall overseas demand. It should be noted that in many cases, since Hong Kong's trade in garments and, to some degree, electronics involves processing operations on the mainland, relevant shipments may pass through Hong Kong more than one time, so magnifying the ebb and flow of related import and export statistics.

Strategic Implications for Hong Kong's Merchandise Exports

Hong Kong exporters must take note of the likely developments of the global trade environment, as well as the potential risks and challenges, when drawing up their business strategies. In the US, many consumers will look for value-for-money luxury items, although lower-income buyers will become more conservative, and competitively priced products are sought after. Meanwhile, European and Japanese consumers will largely remain in favour of quality but competitively priced products, with value-for-money still the tenet. Hong Kong exporters should therefore appreciate the trends in different markets, and formulate their product and pricing strategies properly. Moreover, as protectionism is unlikely to abate, while consciousness on environmental protection will become more popular, what Hong Kong exporters should do is to keep a close eye on regulatory developments and respond accordingly, covering not only quotas and anti-dumping actions, but also environmental laws and the related green manufacturing requirements.

In addition to traditional markets, which are already highly competitive and only expand slowly, Hong Kong exporters are advised to diversify into emerging markets, spanning from Southeast Asia, South Asia and the Middle East to Eastern Europe and Latin America. In any event, the Chinese mainland holds particular promise for Hong Kong firms. Rapid urbanisation, estimated at a level of almost 43%, as well as growth of the prosperous middle class, consisting of over 200 million inhabitants, continue apace, eliciting mammoth demand for a comprehensive array of sophisticated consumer goods. Of interest to Hong Kong companies, Hong Kong's domestic exports to the mainland will be further facilitated by CEPA, under which all products of Hong Kong origin have become tariff-free, whereas revaluation of the RMB will enable products produced in Hong Kong, as well as other countries, to be sold to the mainland more easily.

For Hong Kong companies producing on the mainland, however, a stronger RMB will mean less competitive prices in international markets. Since the exchange reform in July 2005, the RMB has strengthened by some 5% against the US dollar, raising the average cost of outward processing exports by an estimated 1.5-2%. While this stronger RBM has appeared to exert only modest impact on production costs, rising labour costs in the PRD, which have increased by 15%-30% since the beginning of the year, have made exports more expensive. But given intensified competition and increased consumer cautiousness, most Hong Kong exporters are unable to fully shift the burden of higher costs to their customers. To compound the problem, changes in processing trade policies may even have a greater impact on Hong Kong exporters. Apart from the initiatives introduced recently, it is reported that further changes are in the pipeline. Hong Kong companies need to be aware of any possible changes in processing policies and exchange rate movements, which may affect their mode of operations, production costs, profit margins and sources of raw materials.

Despite growing overseas protectionism and rising local production costs, the mainland, sustained by its cutting edge in manufacturing, will remain the factory of the world. To enhance competitiveness, however, it is striving to shift from labour-intensive to high value-added industries. Just across the border in the PRD, where growth will stay strong, a major transformation is taking place as the region now focuses on the development of high value-added industries. In view of the industrial restructuring in the PRD, coupled with high wages and labour shortages in the region, Hong Kong exporters could shift part of their manufacturing activities beyond the PRD and further into other provinces. More importantly, they should continue to move up the value chain, particularly with respect to Hong Kong's emerging role as a technology marketplace. With the PRD's current emphasis on hi-tech industries and green manufacturing, the proximity of the region to Hong Kong will offer a plethora of new business opportunities. In any case, Hong Kong companies must be proactive about changes across the boundary, and ready to step out of their comfort zone to avoid being "crowded out".

Developments of Hong Kong's Service Exports

Despite solid growth in 2006, services exports should post less remarkable growth in 2007. First of all, Hong Kong's merchandise exports are anticipated to slow from the high single-digit growth estimated for 2006 to a projected growth of 6% for 2007 in light of an anticipated slowdown of the global economy. Trade prospects for the Greater PRD region, which immensely affect Hong Kong's exports of cargo transportation services as well as trade-related services, could be clouded slightly by the expected slowdown in the developed markets. Fortunately, developing Asia should pick up some of the economic slack to provide a cushion to the demand for Hong Kong's transportation and trade-related services.

Also affecting the transportation receipts is direct shipment, which has evidently become more popular over the past few years. Nonetheless, recent administrative measures to facilitate more cost-effective trucking to Hong Kong, plus the expected opening of the Hong Kong-Shenzhen Western Corridor and co-located customs arrangements in July 2007, are improving land connectivity and enhancing the attractiveness of using Hong Kong ports. Measures targeting barge and river-trade operators, such as the cut in barge anchorage fees, should also enhance the appeal of Hong Kong ports amid the continued expansion of the PRD cargo base. In any event, cargo diversion notwithstanding, Hong Kong still derives very substantial income from the trade-related services, which are predominantly offshore trade transactions.

Regarding aircargo transportation, Hong Kong continues to command a solid lead with positive prospects for 2007. Competition from nearby airports, especially the new Guangzhou Baiyun International Airport (GBIA), can hardly rival Hong Kong as an international airfreight hub in the region in the near term. Further, mainland aircargo handled by Hong Kong International Airport (HKIA) in 2007 will likely be helped by the new Hong Kong-mainland air services arrangement (ASA) signed in July 2006, with the ASA adding 11 new air routes as well as relaxing air passenger and cargo capacity constraints. Specifically, the cargo capacity limits for Beijing and Shanghai will be increased, while the limits for all the other new routes will be completely removed by the summer of 2007.

On the other hand, the strength of inbound tourism is losing some momentum from the middle of 2006. After easing from the robust growth of 2005, inbound tourism will likely moderate further in 2007 to affect overall tourism-related service receipts. Yet further relaxation of the mainland's Individual Visit Scheme (IVS), amid a steady appreciation of the RMB, will have a continual stimulating effect on Hong Kong's tourism income, as IVS travellers now account for close to half of inbound mainland visitors. Further promotion, plus expansion of measures to attract overseas tourists to visit Hong Kong, especially many non-mainland tourist source markets, may prove essential to ensure continually healthy growth in Hong Kong's inbound tourism.

Services other than transportation, travel and trade-related activities, representing about 20% of Hong Kong's total service exports, grew substantially in 2006, thanks to enormous fund-raising activities by mainland enterprises in Hong Kong. In 2007, receipts of financial service exports should moderate somewhat in the wake of the record-breaking IPO activities of many heavy weight mainland enterprises in 2006, though the number of mainland enterprise-related IPOs will remain high.

CEPA is to enter its fourth year of implementation in January 2007, with the latest package announced in June 2006 comprising 15 measures spreading across 10 sectors, CEPA is expected to create more employment opportunities over the longer term for Hong Kong, many of which will be found across the boundary. According to an estimate by the Hong Kong government, the first two phases of CEPA implementation contributed to the creation of about 30,000 jobs for Hong Kong.

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