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An International Monetary Fund (IMF) Staff Mission to Hong Kong affirms that the Hong Kong economy is showing clear signs of recovery.
The Mission forecast a 1.25% GDP growth for 1999, supported by further strengthening of exports, improved private consumption and high public investment. The forecast was made before the third quarter GDP figures were released. It projected a 3.5% growth in 2000, based on the assumption of positive impact of China's impending entry to WTO, easing of monetary conditions as deflation declines, and continued strengthening of global economy.
The assessment was made by the IMF Mission in their Concluding Statement following the completion of the Article IV Consultation mission with China in respect of Hong Kong SAR, which involves a review of Hong Kong's exchange rate, fiscal and economic policies.
Mr David Robinson, Assistant Director of the Asia Pacific Department of the IMF, who was leading the Mission, said, "We expect a solid recovery of the Hong Kong economy into year 2000, assuming a continued favourable external environment."
The Financial Secretary, Mr. Donald Tsang, said, "We welcome the Article IV Consultation as a useful external audit exercise. Generally speaking, the Mission has made a fair and balanced assessment of the economy and the policy framework in place. We welcome the IMF's endorsement of the government's policy approach in mitigating the effects of the Asian crisis on the domestic economy and restoring economic growth."
The Mission noted that Hong Kong has pursued an appropriately supportive fiscal policy during the economic recession experienced over the past two years. It projected a deficit for 1999/2000 of 1.5% of GDP, against the government's original forecast deficit equivalent to 3% of GDP. For 2000/01, the Mission noted that a small deficit, as projected in government's medium range forecast, would be acceptable and achievable, provided the privatisation of MTRC goes ahead as planned.
The Chief Executive of the Hong Kong Monetary Authority, Mr Joseph Yam, said, "It is encouraging to note their continued and steadfast support for the linked exchange rate regime and for our efforts in strengthening the rules-based system of the currency board. We welcome their recognition that the seven technical measures introduced in September 1998 have worked well."
The Mission noted that the banking sector has demonstrated its strength and resilience to external shocks over the past year, owing much to the high quality of the regulatory and supervisory framework in place. The Mission believed that the wide-ranging series of banking reforms planned for the next two years would increase competition. This, along with technological advances, would result in increased pressures on a number of smaller banks, making consolidation of the domestic banking system necessary.
The Mission envisaged that the Mainland's entry into WTO would bring new opportunities for Hong Kong, which is well placed to assist the ongoing restructuring of the Mainland's financial and enterprise sectors. The Mission commended Hong Kong for being "one of the most transparent, well governed and least interventionist places to do business" and stressed that the policy of positive non-intervention should remain.
The Mission regarded the launch of the Tracker Fund as a very good start and called for continued divestment of the authorities' equity holdings in an orderly and transparent manner.
The Mission noted that Y2K risks in Hong Kong appear very modest, with both the government and the private sector exceptionally well prepared.
The Mission considered that the Government's job creation, retraining and youth pre-employment training programmes, combined with the appropriate fiscal policy, have contributed importantly to the improving economic outlook and the strengthening in confidence. The Mission noted that there may be some downward rigidity in nominal wages in some sectors. They observed that while this is the result of private sector decisions, and the labour market is exceptionally free by international standards, it could have a negative impact on the speed of recovery, and the rate at which unemployment declines. The Mission also stressed need for continued attention to domestic competition issues.
The IMF Mission was in Hong Kong from 8 November to 22 November for the annual Article IV Consultation visit on Hong Kong SAR. It held discussions with the private sector and government officials.
The Mission's Concluding Statement for the Consultation is enclosed in annex.
Annex
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INTERNATIONAL MONETARY FUND
HONG KONG SPECIAL ADMINISTRATIVE REGION
Concluding Statement for the Article IV Consultation
with the People's Republic of China
in respect of the Hong Kong Special Administrative Region
November 18, 1999
1. After enduring one of the most severe recessions in its modern economic history, the Hong Kong SAR economy is now showing clear signs of recovery. Initially, these were seen primarily in financial markets, including a sharp rise in equity prices driven by foreign capital inflows, and a marked decline in the risk premium. However, from the second quarter of 1999 the recovery has spread to the real economy, driven largely by a sharp rise in private consumption, and strengthening re-export activity. As a result, output jumped sharply in the second quarter, and year-on-year GDP growth has moved into positive territory sooner than expected, causing many observers - including ourselves - to revise their forecasts significantly upward.
2. At the same time, the necessary adjustment in prices under the linked exchange rate system is well under way. Property prices and rentals have fallen very sharply, and - while the market remains fragile - may be beginning to stabilize, especially in the residential sector. Consumer prices are deflating rapidly, which - together with the appreciation of the yen and other regional currencies - has returned the real effective exchange rate to close to its pre-crisis level. Adjustment in labor costs has been somewhat slower, with real payroll per employee only just starting to stabilize (although, as discussed below, the degree of adjustment may be partly obscured by statistical problems).
3. During the second half of 1999 we expect the economic recovery to continue. While private investment is likely to remain weak, higher public investment, as well as a further strengthening of exports will support activity. Against this background, GDP growth of 1.25 percent appears achievable. As the adjustment in prices continues, the CPI is projected to decline by 4 percent for the year as a whole. Unemployment will remain at about the present level, with the growth in the labor force offsetting rising employment in small scale enterprises and the informal sector.
4. Turning to 2000, we expect global and regional economic growth to strengthen further, and output and export growth in the Mainland to remain robust; the prospective entry of the Mainland into the WTO will also have an important positive effect. Domestically, the rate of deflation should slow to close to zero as price adjustment is completed; thus, notwithstanding the recent increase in U.S. interest rates, monetary conditions should steadily ease. As business confidence improves, and real interest rates decline, private investment should begin to pick up, while private consumption and external demand will continue to support growth. For the year as a whole, GDP growth could reach 3.5 percent, allowing unemployment to fall modestly. The speed of recovery will, however, depend critically on developments in the United States - not least the equity market - and the region, as well as the speed with which domestic price adjustment is completed and corporate profitability improves. Y2K risks in Hong Kong SAR appear very modest, with both the government and the private sector exceptionally well prepared.
5. During the Asian crisis, Hong Kong SAR has undergone a very painful period of adjustment, with periods of intense pressure on the linked exchange rate. In the face of these difficulties, the authorities - notwithstanding some unorthodox measures - have maintained and even strengthened the rules-based system, which is a major achievement. At the same time, an appropriately supportive fiscal policy, combined with job creation and retraining programs, has helped mitigate the effect of the crisis on the domestic economy (although, given the SAR's small size and openness, the impact has inevitably been substantial). We believe this policy approach has been the right one, and has contributed importantly to the improving economic outlook and the strengthening in confidence. In the remainder of our remarks, we would like to comment on some key policy issues facing the authorities over the short and medium term.
A. The linked exchange rate system
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6. As on previous occasions, we continue to strongly support the linked exchange rate system, which is the centerpiece of the rules-based approach to policymaking in Hong Kong. The seven technical measures introduced in the fall of 1998, while not yet substantively tested, have clearly worked well to date and the gradual shift of the convertibility undertaking rate toward the linked rate of $1=HK$7.8 is proceeding smoothly. Once the two rates have been unified, there may be merit in revisiting the technical measures to strengthen convertibility and transferability within the system discussed in recent meetings of the Exchange Fund Advisory Committee Sub-Committee on Currency Board Operations.
7. The smooth functioning of the linked exchange rate system depends importantly on the underlying flexibility of the economy. In this context, while prices have generally adjusted quite rapidly, the increasing level of real payroll per person (until recently) is a potential source of concern. In this connection, it should be noted that the payroll statistics likely understate the degree of pay adjustment taking place (Note); and that in larger establishments much adjustment has taken place through labor shedding. Nevertheless, some of our interlocutors have noted that there may be some downward rigidity in nominal wages in some sectors. While this is the result of private sector decisions, and the labor market is exceptionally free by international standards, it could have a negative impact on the speed of recovery, and the rate at which unemployment declines.
B. Fiscal Policy
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8. Over the past two years, the overall fiscal balance has been allowed to move into significant deficit, providing appropriate support to aggregate demand. Against this background, the FY 1999 budget targeted an overall deficit of 3 percent of GDP, set in a medium term framework incorporating a further small deficit in FY2000, and a return to budget surplus thereafter. Given the strengthening in economic activity, and relatively encouraging performance of land revenues and the appreciation in value of the Exchange Fund's equity holdings, we project that the final outturn in FY 1999 could be closer to a deficit of 1.5 percent of GDP; however, much will depend on developments in asset markets.
9. For FY2000, fiscal policy will need to balance the need to provide support for the nascent recovery and the provisions of the Basic Law (especially the injunction to strive to avoid deficits). Given the cyclical improvement in revenues as activity strengthens, the target set out in last year's medium term forecast should be achievable, provided that the MTRC privatization goes ahead as planned. In our view, this would be an acceptable result from the perspective of the Basic Law; with the economic recovery not yet broadly based, a tightening of the underlying fiscal policy stance would not appear desirable at this point.
10. With unemployment still at very high levels, we strongly support your efforts to strengthen employment and training programs, especially for youth unemployed; it is encouraging to note that job training programs in particular have maintained very high placement rates. The CSSA continues to provide an adequate safety net for the neediest, while limiting adverse effects on work incentives.
C. Financial Market Issues
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11. Over the past year, the banking system has demonstrated its strength and resilience to external shocks. While the share of non-performing loans has risen to 10 percent, and concerns about the quality of some Mainland-related loans remain, there are signs that the situation is now stabilizing. At the same time, capital adequacy ratios remain at very high levels. This owes much to the high quality of the regulatory and supervisory framework, which is widely acknowledged to be among the best in the region. The corporate sector also appears to have weathered the crisis relatively well, aided by its high pre-crisis profitability, relatively modest gearing, and determined efforts to restructure.
12. Over the coming two years, a wide-ranging series of reforms of the banking system is planned, including the elimination of the remaining interest rate rules, and reduction of restrictions on the activities of foreign banks. This will increase competition in the banking sector, but - along with ongoing technological changes - it will also result in intensified pressures on a number of smaller banks. Thus, as you - and a wide variety of private sector interlocutors - have noted, consolidation of the domestic banking system will be necessary. The HKMA has published a clear timetable for the implementation of the reforms, which will provide an important window of opportunity for the institutions concerned to assess their options and to take appropriate action.
13. Following the intervention in the stock market last year, the Exchange Fund Investment Limited was set up to divest the bulk of the authorities' equity holdings. The Tracker Fund launch represented a very good start in this process; further divestment should continue as market conditions permit, to eliminate the overhang of shares in an orderly and transparent fashion. We welcome the Government's initiatives to strengthen the securities markets and legislation, which will be central to help ensure that Hong Kong SAR remains a world class financial center in an increasingly competitive global environment. The Growth Enterprise Market will also play an important role in financing small innovative enterprises in the SAR and the Mainland, supporting the adjustment underway in each.
D. "Reinventing" Hong Kong SAR
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14. Over the coming years, the Hong Kong SAR economy is likely to undergo major structural changes. Technological advances are already forcing major adjustments in a variety of services sectors; the SAR's role as an entrepot is likely to decline as competition from Mainland ports increases; and the importance of the property sector in the economy is likely to shrink. The Mainland's entry into the WTO may, as some have noted, reduce Hong Kong SAR's role as the main window to China over the long run. However, and in our view more importantly, it will bring with it a host of new opportunities; the SAR is also well placed to assist in the ongoing restructuring of the Mainland's financial and enterprise sectors.
15. Hong Kong SAR has in the past adapted to such changes swiftly and flexibly. This has been aided by its well deserved reputation - confirmed in many surveys - as one of the most transparent, well governed, and least interventionist places in the world to do business, a reputation which is itself one of the SAR's most valuable assets. The government clearly has an important role to play in facilitating adjustment, especially - as stressed in the Chief Executive's policy address - in the areas of infrastructure, education, language training and the environment. However, the central responsibility for adaptation must lie with the private sector, and the policy of positive non-intervention - which has been the watchword of economic development in the SAR for many years - remains appropriate.
16. In recent years, a number of observers have raised questions about the extent of domestic competition in Hong Kong SAR, including the extent to which activity in certain sectors is dominated by a relatively small number of participants. A degree of market concentration is inevitable in a small market such as Hong Kong SAR, especially in sectors which have increasing returns to scale; the question is whether in practice this leads to abuses. In this connection, we have been impressed by the work of the Hong Kong Consumer Council, and by the Government's generally prompt and comprehensive responses to its recommendations (as well as its efforts to strengthen competition in a variety of other areas). Domestic competition issues continue to merit close attention, especially since - except in sectors which are subject to specific regulations or ordinances - there are no substantive penalties if firms engage in anti competitive behavior.
E. Statistics
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17. We welcome the progress that has been made toward meeting Hong Kong SAR's obligations under the Special Data Dissemination Standard. The release of the first ever set of balance of payments accounts covering transactions in 1997, and the scheduled publication of quarterly data from early 2000, are important steps. However, there remains room for improvement in certain areas, including publishing domestic and foreign assets and liabilities of the banking system on a residency basis, as a precursor toward a monetary survey, and more detailed and timely fiscal data.
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Note: The growth in nominal and real payrolls per person engaged has likely been biased upwards for two reasons. First, redundancies have been concentrated on lower paid workers, thus resulting in an increase in measured average payrolls per person with no rise in labor cost for remaining employees. Second, part time workers, who have likely been laid off first, are counted in the definition of "persons engaged", biasing the measure upward for a similar reason.
End/Tuesday, November 30, 1999
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