• Given the lingering impact of the US-led global slowdown, Hong Kong exports are projected to grow by a modest 7% in 2008, unchanged from our previous forecast.
• The US economy is expected to pick up slightly in the latter half of 2008, on the back of fiscal stimulus, interest rate cuts and special measures to support the financial system.
• Yet intra-Asia trade, with the mainland in particular, will be the main engine for Hong Kong's export growth, while demand from the EU should remain firm.
• Product-wise, continued popularity of digital products should be conducive to electronics sales. But clothing exports will likely be impeded by shrinking orders from the US.
• Meanwhile, certain risks and challenges exist, notably a worse-than-expected US downturn, rising global inflation and a difficult production environment.

Hong Kong's export performance in the first quarter of 2008 was better than expected, as growth of total exports, at 9% last year, quickened to over 10% during the January-March period. This good showing, in spite of the US-led global slowdown, has been prompted by the sizzling intra-Asia trade, not least with the Chinese mainland. Yet exports to the developed markets have been less encouraging, featured mainly by declining sales to the US but firmer demand from the EU.

In the US, where the economy only showed marginal growth in both the final quarter of 2007 and the first quarter of 2008, demand has been particularly anaemic, reflecting continued corrections of the housing market as well as the ensuing sub-prime fallout, credit turmoil and deterioration of the labour market, in tandem with rising inflation due to high oil and commodity prices. By contrast, exports to the EU have been in better shape, thanks to its stronger economy and a firm euro.

Falling exports to the US but expanding sales to the EU have helped bring a setback in direct shipments from the mainland, and in turn served to lift Hong Kong's re-exports. For one thing, the impact of cargo diversion is particularly noticeable in exports bound for the US. Quite a few giant US buyers have set up warehouses in Shenzhen, and secured agreements with ship-liners to load their merchandise in Shenzhen ports. EU buyers, for their part, are more inclined to use Hong Kong as a consolidation centre. Separately, the solid export performance of electronics, mainly involving air shipment through Hong Kong, has likewise propped up Hong Kong's re-exports.

Firmer unit values of Hong Kong exports, spurred by rising input costs, have further contributed to the inspiring sales performance. Not surprisingly, given sustained demand from the EU and the strong euro, price rises for exports to Europe are more prevalent. Price increases for exports to the US, on the other hand, tend to be less significant amid the economic headwinds faced by American consumers and a weakening US dollar against the RMB. The depreciation of the US dollar has also galvanised Hong Kong exporters into shunning the currency to settle non-US transactions to reduce exchange risk.

Going forward, the tempo of Hong Kong's export growth is forecast to slow, as the contagious effect of the US economic downturn will probably linger on for a while. But the US economy, on account of the US$168 billion fiscal stimulus, aggressive interest rate cuts and a slew of special measures to support the financial system, is expected to pick up slightly in the latter half of 2008, thereby easing its drag on the world economy. Meanwhile, demand from the EU should remain fairly decent.

In any event, intra-regional trade, especially with the mainland, will provide the main impetus to Hong Kong's export growth. Outside emerging Asia, sales to other fledgling markets should remain relatively strong too. While non-commodity exporting economies will be impeded by the US-led global slowdown, commodity exporters, alongside countries with sustainable domestic demand, should continue to perform well. Taken together, the expected value growth of Hong Kong's total exports is maintained at 7% for the whole of this year.

In terms of product, sustained popularity of digital products should hold up Hong Kong's electronics exports. A still-healthy appetite for non-traditional toys and a stable demand for value-for-money timepieces should also facilitate sales. Clothing exports, in contrast, will likely be dragged by falling orders from the US, while jewellery exports in value terms will be inflated by stubbornly high prices of precious materials, stones and diamonds, but volume sales should fare less well.

Apparently, the biggest threat to the global trade environment comes from the still-unfolding adverse developments in the US. While the US economy is expected to bottom out in the second half of 2008, it cannot be ruled out that the prevailing downturn will be longer and deeper than anticipated. The consequences will not only hinder US growth, but also dampen the world economy, and Hong Kong exporters are unlikely to be left unhurt. Rising overseas protectionism is another concern, especially in the run-up to presidential election in the US.

Mirroring the price surge in commodities and, to a lesser extent, manufactured products, risks associated with rising inflationary pressures have also increased. In view of the global economic slowdown, rising inflationary pressures pose a dilemma for policy makers worldwide, making it difficult to take a loose monetary stance if necessary. The resulting negative impact on global growth, along with rising raw material costs, will undoubtedly have a detrimental effect on Hong Kong exporters.

Hong Kong companies will be further confronted with immense cost pressures incited by soaring labour costs amid rapid wage increases, rising social security benefits, as well as the introduction of the new Labour Contract Law effective from January 2008, which also puts an extra administrative burden on Hong Kong manufacturers on the mainland. To compound problems, the sustained appreciation of the RMB, aggravated by higher safety compliance costs, will translate into even higher production costs.

Recent Performance of Hong Kong Exports

Hong Kong's merchandise export performance in the first quarter of 2008 was better than that which had been widely anticipated. On the back of a 9% increase last year, Hong Kong's total exports rose by more than 10% during the January-March period, driven principally by a solid 11% growth in re-exports, notwithstanding a stagnation in domestic exports. Yet there has been a trend of moderation. Hong Kong's total export growth stood at 16% in January, followed by a scant 8% in both February and March.

The sturdy performance of Hong Kong exports during January-March 2008, in the main, was buttressed by the burgeoning intra-Asia trade. In particular, sales to the Chinese mainland, which constituted 48% of Hong Kong exports, surged by 11% amid the mainland's hearty appetite for machinery and semi-manufactures for export production, while sustained export growth in the region has elicited greater demand for capital goods and production inputs. By contrast, sales have been less encouraging in the traditional markets, although exports to the EU have been in better shape, thanks to its stronger economy, as well as a firm euro, which has appreciated against the US dollar by 7% so far this year. Exports to the US, the centre of the prevailing global economic slowdown, have been particularly dreary. Sales to Japan have also remained weak, despite a 7% appreciation of the yen against the dollar.

Product-wise, electronics, which shared 51% of Hong Kong exports, continued to shore up overall growth with a 12% leap, given the sustained demand for digital products from overseas markets and parts and components from the mainland. Despite recent product recalls overseas, successive releases of electronics game consoles and the continued demand for electronics toys have further bolstered toy exports. Stubbornly high prices of precious materials, stones and diamonds, on the other hand, have magnified jewellery exports in terms of dollar value, but volume sales have been in the doldrums. Regarding watches and clocks, sales have been robust, against the backdrop of a sturdy world demand for value-for-money timepieces. As for clothing, sales have been hobbled by sluggish demand from the US, although exports to the EU were stable in the wake of its removal of textile quotas against the mainland.

Firmer unit values of Hong Kong exports, in the meantime, have contributed to the inspiring sales performance, as the juxtaposition of the mainland's processing trade policy changes, continued revaluation of the RMB, rising labour costs, higher product safety compliance costs, as well as skyrocketing prices of crude oil and certain other commodity prices, have exerted immense upward pressures on production costs. Partly reflecting the surging production costs, the unit value of Hong Kong's total exports increased by 2.6% during January-March 2008, quickening from a 2.3% rise for last year as a whole. Assuredly, the production environment has become increasingly formidable, and tended to weed out less efficient manufacturers. Yet this consolidation process has resulted in bigger orders for the surviving players, which also have stronger bargaining power over prices.

To no one's surprise, given sustained demand from the EU and the strong euro, price rises for exports to Europe are more prevalent. Price increases for exports to the US, on the other hand, tend to be less significant amid the economic hardships borne by American consumers and a weakening US dollar against the RMB. The depreciation of the US dollar has also prompted Hong Kong exporters to avoid using the currency to settle non-US transactions to reduce exchange risk.

In addition, a setback in direct shipments from the mainland, due in part to falling exports to the US but expanding sales to the EU, has served to lift Hong Kong's re-exports. For one thing, the impact of cargo diversion is particularly noticeable in exports bound for the US. Quite a few giant US buyers, including Wal-Mart, Target and Toys"R"Us, have set up warehouses in Shenzhen, and secured agreements with ship-liners to load their merchandise in Shenzhen ports. EU buyers, for their part, are more inclined to use Hong Kong as a consolidation centre. Indicative of the changing shipping arrangement, growth of Hong Kong's cargo throughput accelerated to almost 8% in the first quarter of 2008 from 2% last year, while Shenzhen's slowed to 9% from 14% in 2007.

In another development, the solid export performance of electronics, making up the bulk of intra-Asia trade, has further propped up Hong Kong's re-exports. For the most part, these were parts and components shipping from neighbouring economies to the Chinese mainland for assembly. As they were high in value, small in size and light in weight, transportation costs might be of little concern to shippers compared with the risk of delay or loss. As such, shipment by air through Hong Kong was preferred, given the efficiency of the Hong Kong International Airport and its unrivalled connections with mainland cities.

Medium-Term Global Economic Outlook

World economic activity, which showed a decent 4.9% growth last year, is losing momentum because of the uninspiring US economy, where the housing downturn has reverberated to other sectors and, worse still, to other economies worldwide. In this context, world growth is expected to decelerate to less than 4% in 2008, and only quicken slightly in 2009. No wonder the US will register the poorest showing in the developed world, as growth in the EU, though dragged by the US, should fare better. As regards the emerging economies, growth should remain relatively strong. While non-commodity exporting economies will be impeded by the US-led global slowdown, commodity exporters, alongside countries with sustainable domestic demand, should continue to fare well. But rising commodity prices, especially oil and food prices, will boost inflation worldwide, serving to further depress consumption and economic growth and limit the leeway for fixing monetary policies.

In the US, where the economy showed marginal growth in both the final quarter of 2007 and the first quarter of 2008, a recession is likely to have eventuated. Continued corrections of the housing market and the attendant sub-prime fallout have led to a credit crisis and deterioration of the labour market, aggravated by rising inflation due to high oil and commodity prices. Yet the economy is forecast to pick up modestly in the latter half of 2008 and into next year. The US$168 billion fiscal stimulus, which will likely lift economic growth by 1.5 percentage points in the second half, coupled with aggressive interest rate cuts and a slew of special measures to support the financial system, will inject the much-needed vitality into the economy. Robust exports, sound corporate positions and a relatively unscathed stock market are other positive developments. On balance, however, the US will likely remain a less promising market over the medium term, and even the higher-end segment is not immune.

Across the Atlantic, the EU economy is expected to continue to moderate amid the lacklustre US performance. But it should remain fairly decent, and could give some buffer to Hong Kong exporters facing softer demand from the US. Country-wise, Germany should benefit from sustained demand for capital goods from emerging markets, whereas Italy will continue to suffer from intense competition from emerging suppliers. In France, where structural reform will be the priority, consumption should remain quite stable. For its part, the UK, under the twin bite of a feeble housing market and credit crunch, consumer spending will likely become less strong. On the whole, continued economic expansion in the EU should lead to steady consumption and sustained demand for imports. A strong euro, which serves to maintain the price competitiveness of Hong Kong exports, is another favourable factor.

Likewise in Japan, economic growth should decelerate somewhat. While the exposure of Japan's financial sector to the US sub-prime market is limited, its merchandise export sector will likely be constrained by the US downturn, despite the growing importance of the mainland market. On the domestic front, a tightening in building standards, which has dampened residential investment and hence economic growth in the early part of 2008, should ease its drag in the latter part of the year. A sluggish job market and meagre wage increases, however, are not conducive to consumption. Although a firm yen may uphold Japan's power of absorbing consumer goods, this currency movement will not bode well for Japanese exports, thus suppressing the imports of semi-manufactures, parts and components.

Given the modest appetite in the traditional markets, Hong Kong exporters are advised to look to the emerging markets around the globe for sales expansion. In particular, developing Asia is expected to remain the most dynamic region on the world economic scene, although its medium-term economic performance will inevitably be constrained by the global slowdown. To some extent, sustained intra-regional trade, primarily driven by continued demand from the Chinese mainland, should be able to cushion some of the negative impact engendered by the slowing world economy in general and a dwindling US demand in particular. Over the medium- to long-term, the change in government in Taiwan should contribute further to economic integration and regional growth. Hong Kong is poised to benefit from growing trade between the mainland and Taiwan, despite a weakening of its intermediary role in the near term.

In developing Asia, the Chinese mainland will continue to be the axis of growth. In spite of the temporary impact of natural disasters and policy curbs in response to signs of overheating, the mainland's economic growth will remain solid over the medium term. Consumption, now sought by the government as the driver of growth, will stay strong. While mainland exports will moderate amid policy changes, currency appreciation, rising production costs and cooling US demand, such impact will unlikely be substantial, as sales to markets outside the US, not least other emerging markets, are expected to be sturdy. If anything, the central government may ease its policy curbs in view of any drastic fall in domestic and overseas demand. The mainland's appetite for finished goods for local consumption and capital goods for export production will therefore remain relatively healthy.

Elsewhere in developing Asia, sound economic fundamentals should be largely in place too. Within ASEAN, Vietnam, spurred by the continued positive impact of WTO membership, is expected to lead the pack in economic growth, while Indonesia, with sustained efforts to encourage investment, will likely maintain its robust expansion. Being potential markets aside, Vietnam and Indonesia are also viable alternative production bases for Hong Kong. Meanwhile, domestic demand should remain the mainstay of growth in Malaysia, and a stabilising political outlook will facilitate an improvement in business and consumer sentiment in Thailand. Outside ASEAN, the economic prospects for India are again decent. Its services sector, fuelled by buoyant IT outsourcing activity, should stay in good shape, although slower exports are expected to dampen overall growth.

While developing Asia will lead growth in the emerging world, the medium-term outlook for other fledging economies is likely favourable. In Central and Eastern Europe, economic growth, to a certain extent, will benefit from the continued expansion of Western Europe, although Hungary will be hit by fiscal consolidation. Outside the EU, Russia will once again take advantage of sustained oil and commodity prices and, likewise in the Middle East, lofty crude prices will boost the economic health of oil-exporting countries, notwithstanding a moderation in growth among non-oil exporting economies. As regards Latin America, economic activity should retain its momentum amid sustained commodity prices. Yet the pace will ease, as mundane demand from the US will cap regional growth, particularly affecting nations with closer links with the US, notably Mexico.

In all, Hong Kong exports should continue to expand in the rest of 2008. Yet the rate of growth is forecast to slow. The repercussion of the US-led global slowdown on Hong Kong exports will probably linger on for a while, although the US is expected to emerge, in the second half of 2008, from the recession in the first half, thereby easing its drag on the world economy. Given the likely stronger-than-expected sales performance in the first quarter, however, the expected value growth of Hong Kong's total exports is maintained at 7% for the whole of 2008. Looking further ahead, the growth of Hong Kong exports should only be steady next year, as the world economy, albeit expected to pick up a tad, will need some time to get rid of the residual impact of the US economic woe. But while the medium-term prospects for the global trade environment will likely be stable, Hong Kong exporters will find themselves no lack of risks and challenges.

Risks and Challenges

Worse-than-Expected Downturn of the US Economy

Seemingly, the biggest threat to the global economy stems from the still-unfolding adverse developments in the US. While the US economy is expected to pick up in the latter half of 2008, it cannot be ruled out that housing corrections and, more importantly, the credit crisis will be longer and deeper than that which is widely anticipated. The unfavourable consequences of housing and financial turmoil will not only hamper US growth, but also dampen the world economy, especially countries more vulnerable to housing and financial market turbulence, such as the UK, as well as nations more dependent on the US market like Mexico. In this context, there could be a serious effect on global trade, and Hong Kong exporters are unlikely to emerge unscathed from such developments.

In particular, a worse-than-expected downturn of the US economy may reverberate globally through a sell-off in the financial markets worldwide. Under the worst-case scenario, consumer confidence and business sentiment in the US will be badly hurt by a prolonged recession. US financial markets will then be seriously undermined, and plunges in US asset prices will have strong contagious effects worldwide, compelling consumers and businesses to hold back consumption and investment harshly. Indeed, recent vagaries of the US stock market, in spite of their rather limited extent, serve as a reminder of the potential financial risks. Even though the stock market has become more stable for now, it still trembles over data showing troubles in US corporations and indications of any economic weaknesses, especially signs that inflation might be out of control.

Heightening Global Inflationary Pressures

Risks related to rising global inflationary pressures have evidently increased, despite the moderating world economy. Surging commodity prices, driven by strong demand from emerging economies, supply constraints and a weak US dollar, are the major source of inflationary pressures. In particular, the global oil market remains worryingly tight. Given limited production capacity, any supply disturbance or rising geopolitical concern will likely push up crude prices to increase further from the prevailing high levels. In the meantime, food prices, already bolstered by unfavourable weather conditions, may continue to rise amid sustained demand from emerging economies and increased biofuel production. To make matters worse, the deflationary price pressures on manufactured products have waned, exemplified by a 3.6% rise in prices of US imports from China in the first quarter of 2008, reflecting the unabated rise in production costs on the mainland.

In view of the global economic slowdown, rising inflationary pressures, while further hurting consumption, pose a dilemma for policy makers worldwide. In the US, accelerating inflation may make it difficult for the Federal Reserve to lower interest rates further, while necessitating a hike if the economy stabilises. Other economies, such as the EU, may also be unable to lower interest rates as an offset to slackening US demand, or even need to raise interest rates to stem inflation. Evidently, while higher commodity prices are a boon to commodity-exporting economies, their negative impact on global growth and inflation is a concern for policy makers, as well as Hong Kong exporters, who are increasingly faced with a softer overseas demand and rising production costs.

Intensifying Overseas Protectionism

Hong Kong's medium-term export outlook is further overshadowed by the undercurrent of protectionism in overseas markets. Especially in the US, Hong Kong exports will be affected by trade relations between the US and the mainland, in particular in the run-up to the presidential election. While the US administration is not expected to deviate significantly from its general policy of co-operative engagement with the mainland, calls for a tougher stance have increased, and the US government has, for instance, initiated countervailing (CV) actions against a number of products from China. In addition, given the expiry of its quotas against mainland textile products by end-2008, the US will likely resort to a variety of measures to restrict clothing imports from the mainland. Likewise, Hong Kong exports will be affected by regulatory developments in the EU, which is expected to take a tougher stance on trade issues with the mainland, although the reform of its trade defence instruments will be postponed.

A Challenging Production Environment

An increasingly difficult production environment on the mainland will pose another big challenge for Hong Kong exporters. Now that promoting the transformation and upgrade of processing trade and restricting the development of high energy-consumption, heavily polluting and resource-intensive industries are the mainland's long-term development objectives, it will continue to make adjustments to the processing trade policies. Such policy changes, covering VAT rebate adjustment, expansion of the restricted/prohibited category and access threshold for processing trade enterprises, could have a significant impact on Hong Kong manufacturers, perhaps in terms of the mode of operations, use of technologies, sources of raw materials, manufacturing localities as well as production costs.

Hong Kong companies will be further confronted with immense cost pressures incited by soaring labour costs, against the background of rapid wage increases, associated rising social security benefits, as well as the introduction of the new Labour Contract Law effective from January 2008, which also puts an extra administrative burden on Hong Kong manufacturers on the mainland. Furthermore, the sustained appreciation of the RMB, which has appreciated against the US dollar by over 4% so far this year, will translate into even higher production costs. To compound problems, the recent product recalls, dominated by toys, will also elevate safety compliance costs, whereas soaring commodity prices will jack up input costs, especially for precious metals and stones, as well as plastic raw materials due to skyrocketing oil prices.

Analysis by Industry Sectors

Electronics and Household Electrical Appliances

After an 11% growth in 2007, Hong Kong's exports of electronics products, which accounted for over half of Hong Kong's total overseas sales in the first three months of 2008, expanded by 12% during the period, aided by the continued popularity of digital products in overseas markets, sustained demand for parts and components from the mainland, as well as a weak US dollar. Yet sales of household electrical appliances, in the wake of a 4% fall last year, declined further by 7% in the first quarter of 2008, given intense competition in the global market.

For the rest of 2008 and 2009, electronics exports will moderate amid the US-led slowdown of the world economy, notwithstanding a still-healthy appetite for digital products, not least in the emerging markets. To be sure, exports will be constrained by weaker consumer sentiment, particularly in the US, along with intensified price competition sparked by the slower world economy. Meanwhile, sales of electrical appliances will remain lacklustre over the medium term, dragged again by the sluggish demand in the global market.

Market-wise, sales to the US and the EU will continue to benefit from the popularity of digital products like DVD recorders, digital cameras, flash memory products (e.g. MP3 and MP4 players) and flat-panel TV sets. In particular, demand for digital TVs and set-top boxes will boosted by the digitisation of TV broadcasting in the US, which has set a timetable to require all commercial TV broadcasters to phase out analogue TV broadcasting by early 2009. Exports of IT and telecom products, for their part, will become soft in view of the sluggish economy, despite ongoing computer replacement and a steady appetite for price-competitive and user-friendly mobile phones.

While the medium-term prospects of the EU market look more promising than the US's, Hong Kong exporters are required to acquaint themselves with the increasingly stringent EU regulations relating to environmental protection. On the heels of the WEEE Directive and RoHS Directive, the EU's new Directive on the Eco-design of Energy-using Products (EuP) is now in place. The EuP Directive does not set out substantive standards for product design, but rather sets up a framework within which standards will be promoted for specific groups of products through implementing measures, probably necessitating manufacturers to consider altering their product design processes.

For the Chinese mainland and ASEAN, sales of parts and components, which dominate Hong Kong's electronics exports to the region, will be affected by slower production of electronics and electrical products for exports to overseas markets. Regarding exports to Japan, however, sales will benefit from sustained consumer preference for value-for-money products, although exports of parts and components to the market will become soft over the medium term.

Clothing

After edging up by 2% last year, Hong Kong's clothing exports saw a 3% decline during January-March 2008, with sales to the US and the EU taking up more than 70% of Hong Kong's total clothing exports. While sales to the EU rose by 5% in the first quarter, those to the US fell by 11%. Amid continued worry of the slowdown of the US economy and the resultant spillover across the globe, expenditure on clothing during the rest of 2008 is expected to be unassuming, and so is the performance of Hong Kong's total clothing exports.

In the US, utilisation of safeguard quotas on Chinese textile and apparel articles has increased at a very modest pace since the beginning of 2008, and no limit is currently in any real danger of embargo. Evidently, the retrenchment in clothing expenditure amid economic slowdown plays no small part in this subdued quota utilisation, especially considering that these restraints will expire in a few months' time. The relatively high utilisation of the 2007 limits on Chinese apparel, the 14-17% increase in 2008 quota limits, and the fact that some of the orders that used to be filled in China have migrated to other Asian locations, most notably Vietnam, are other possible factors leading to the subdued quota utilisation. In this context, it is likely that Hong Kong's total clothing exports to the US will remain lacklustre in 2008.

EU's textile quotas, on the other hand, expired by the end of 2007. Thenceforth, a joint system with China has been established to monitor EU imports of Chinese textiles and apparel. This system, which will operate for one year, covers eight out of the 10 previously restricted categories. Following the expiry of EU's textile quotas and introduction of the surveillance system, Hong Kong's clothing exports to the EU have been able to sustain the growth trend prevailing in the past years. Looking ahead, relatively decent economic performance in the EU and a strong euro will help lure more EU buyers to Hong Kong and the mainland for sourcing, and therefore lend support to Hong Kong's total clothing exports in the rest of 2008 amid the slowdown in exports to the US.

As for 2009, the outlook for Hong Kong's clothing exports will remain lacklustre, given the tentative prospects of a global economic revival. In addition, the impending elimination of US safeguard quotas on Chinese textiles and apparel is expected to lead to calls for increased protection for US and regional manufacturers. While US textile manufacturers are expected to seriously consider the possibility of filing anti-dumping and/or countervailing duty actions against Chinese products, the anti-dumping monitoring system in place on imports from Vietnam could possibly be extended to cover China as well. These will certainly pose challenges to Hong Kong's clothing exports, especially if the US economy cannot regain growth momentum by the end of 2008 or on entering 2009.

Toys

Hong Kong's toy exports expanded robustly by 20% in the first quarter of 2008 after the tremendous growth of 23% in 2007, with non-traditional toys, such as video games and electronic toys, being the main driver of the growth. In contrast, traditional toys, such as dolls, construction sets and wheeled toys, have experienced a period of stagnation. Among mature markets, sales to the EU, which has benefited from a strong euro, have outperformed the US and Japan. Emerging markets, such as the Chinese mainland and ASEAN, were also in good shape.

For the rest of 2008 and 2009, Hong Kong's toy exports should continue to expand, albeit at a slower pace. Growth will still be underpinned by non-traditional toys, given the sustained popularity of video games and electronic toys. However, the craze for the latest generation of video game consoles like Wii and PS3 should start to fade later this year, as they have been on the shelf for more than a year already. The outlook for traditional toys is less promising amid keen competition and a shift in consumer preference towards more sophisticated products.

With the global economy expected to enter a period of adjustment triggered by the US subprime loan crisis, demand from most developed economies should slow. But emerging markets, particularly the Chinese mainland, will be less affected because of a strong appetite for quality toys on the back of higher purchasing power. Meanwhile, the coming Beijing Summer Olympic Games 2008, which is expected to cheer up a buying spree for souvenirs, festive items and related goods, will provide added opportunities for Hong Kong exporters.

Increasing product safety awareness in overseas markets, on the other hand, will remain a major challenge for Hong Kong exporters. As a result of the high-profile toy recalls last year, Hong Kong's major toy exporting markets, especially the US and the EU, have tightened up the enforcement of their existing product safety regulations. While tougher regulatory regimes are in the pipeline, a number of retailers, notably Wal-Mart and Toys 'R' Us, have already responded to consumer demand for safer products by adopting more stringent sourcing requirements. In any event, Hong Kong companies, which excel in production experience and quality compliance, should be able to adjust to tighter testing and inspection imposed by overseas buyers, as well as increasingly stringent safety standards.

Watches and Clocks

On top of a 6% increase in 2007, Hong Kong's watches and clocks exports grew by 16% during January-March 2008. Sales to most major markets, including not only the EU, but also the US and Japan, managed to record increases, whereas those to the Chinese mainland exhibited even stronger expansion. In the medium term, however, exports are expected to become slower against the background of a slackening global demand for timepieces.

Not surprisingly, sales to the US will be affected by the sluggish consumer market. Given a deteriorating economy and subdued sentiment, demand for timepieces is expected to become uninspiring, especially for opening-price-point luxury watches, although the top-end segment will likely remain promising. Yet in view of growing consumer cautiousness, the appetite for competitively priced items will remain stable. Hong Kong's exports of low-priced timepieces will continue to be hampered by intensified competition from local Chinese companies, however.

The EU, for its part, is a fairly mature market characterised by a penchant for watches with fashionable designs for formal as well as casual occasions. In all likelihood, there will still be potential in the middle- to high-end segment, focusing on quality but value-for-money timepieces. In addition, the price competitiveness of Hong Kong's timepieces will continue to be facilitated by stronger European currencies. Spurred by the continued strength of the European currencies, sales to the EU would remain steady over the medium term.

As regards the Chinese mainland, sales of timepieces, apart from the positive effect of the imminent Beijing Summer Olympic Games 2008, will be well supported by its growing purchasing power. Now that mainland consumers are increasingly looking for higher quality items amid the improvement in income levels, watches bearing Hong Kong labels should enjoy a premium in the market. Regarding Japan, sales to the country will only remain steady, as the market is already saturated, although the stronger Japanese yen will enhance the price competitiveness of Hong Kong timepieces.

Jewellery

On top of a 17% rise last year, Hong Kong's exports of fine jewellery grew by 27% in value terms in January-March 2008. However, the surging prices of precious materials for jewellery fabrication, such as gold, silver and diamonds, have in fact hit jewellery sales. In volume terms, for example, after dropping by 14% in 2007, Hong Kong's exports of jewellery items of precious metals further declined by 6% in the first three months of 2008. Marketwise, supported by the appreciation of the euro, sales to the EU managed to register strong growth, while those to the US and Japan dropped on their weaker demand.

For the rest of 2008 and 2009, the overall business sentiment will be clouded by softer global demand brought by the US slowdown. In mature markets, notably the US, even better-off consumers are tightening their budgets. Consumers, in general, will tend to shift away from luxury jewellery articles towards lower-priced items, although very affluent customers tend to be less price-sensitive. Emerging markets, such as Russia and the Chinese mainland, should outpace the developed ones because of their higher purchasing power due to their stronger currencies or rising disposable incomes. Yet some of these exports may be semi-finished products for further processing.

With high global inflation and an expansionary monetary stance in most developed economies, the prices of precious materials, stones and diamonds will likely remain at high levels. Therefore, usage of karat gold and other metals, especially silver, is expected to increase. The industry is also tackling the rising precious metal costs through exploring new markets, developing innovative technologies, adjusting product designs and providing better services.

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