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An International Monetary Fund (IMF) Staff Mission to Hong Kong affirms that Hong Kong's economy has recovered strongly.
The Mission is upbeat about the performance of the Hong Kong economy this year. It forecasts a 9.5% GDP growth for 2000, based on strong external demand. Growth is projected to moderate to 4% in 2001, reflecting partly the dissipation of the low-base effect and partly the relatively modest growth in consumption and weak investment. Nevertheless, external demand is projected to remain strong next year, especially in light of the better prospects for China. The Mission said the prolonged decline in domestic prices may now be coming to an end, and projects a return to 1% inflation next year.
The assessment was made by the IMF Mission in their Concluding Statement following the annual Article IV Consultation with China in respect of Hong Kong SAR, which involves a review of Hong Kong's exchange rate, fiscal and economic policies.
The Mission considered that the greatest challenge facing Hong Kong is adjusting to the Mainland's prospective entry into the World Trade Organisation. A key task for Hong Kong is to ensure that the economy builds on its current advantages, including flexible markets, a more competitive cost structure and strong legal and regulatory institutions. Mr. Ranjit Teja, Division Chief of the Asia & Pacific Department of the IMF, who was leading the Mission, said, "We are optimistic that these challenges will be met."
The Mission is supportive of the existing monetary and financial policy framework, including the linked exchange rate regime, the fiscal policy and the financial supervisory framework. The Mission noted that Hong Kong's prudent bank practice, strong legal institutions, and effective supervision had enabled the banking system to weather the turbulence of the Asian crisis. The Mission also supported the upgrading of the securities regulation and financial infrastructure, including the recent merger of the exchanges and clearing houses, the proposed introduction of deposit insurance and the move to more risk-based supervision of banks. It commended the authorities' recent efforts to raise corporate transparency and catalyse the establishment of a commercial credit reference agency.
The Mission also suggested a number of structural issues that Hong Kong would need to tackle in the longer run. More specifically, the Mission called for consideration to develop long-term fiscal policy to cope with a potential rise in health and education spending, and to develop a legal framework to investigate anti-competitive behaviour.
The Acting Financial Secretary, Mr Stephen Ip, said, "We welcome the IMF Mission's assessment of the Hong Kong economy and endorsement of our monetary and fiscal policy framework."
Mr Ip went on to say, "Hong Kong is committed to promoting competition in the local markets. An all-embracing competition legislation could have profound implications for our market efficiency and flexibility, particularly given that Hong Kong is a small and open economy. A pragmatic and practical approach that we are now taking is to closely monitor competition-related issues, and to adopt appropriate sector specific measures where necessary. For example, the Government has taken effective measures in recent years to open up the telecommunications and broadcasting markets and to promote competition in these sectors. We welcome the Mission's recognition of Hong Kong as one of the most open economies of the world."
The Acting Chief Executive of the Hong Kong Monetary Authority, Mr David Carse, said, "It is encouraging to note the Mission's continued and steadfast support for the linked exchange rate regime and their support of our initiatives to enhance the banking supervisory framework and safeguard financial stability in Hong Kong."
The IMF Mission was in Hong Kong from 23 October to 3 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 of the Consultation is enclosed.
Annex
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INTERNATIONAL MONETARY FUND
Concluding Statement For The 2000 Article IV Consultation
With the People's Republic of China
in respect of Hong Kong SAR
November 3, 2000
1. The economy has recovered strongly since last year's review. Led by strong external demand, especially the regional trade that Hong Kong SAR intermediates, output bounced up by some 121/2 percent during the first half of 2000. Prices have adjusted downwards, demonstrating the flexibility of goods and factor markets, and unemployment too has started to fall off from the high levels reached in the wake of the Asian crisis.
2. In the near-term, economic growth is likely to moderate. Going forward, the slowdown partly reflects the end to the catch up from the low base in previous years. However, there are also signs of underlying weakness in domestic demand. Thus, we anticipate relatively modest growth in consumption, given apparently soft consumer confidence and the dampening effect that the new Mandatory Provident Fund may have. Similarly, investment is likely to be weak, reflecting recent asset market volatility and concerns about the impact of higher oil prices. Nevertheless, with external demand projected to remain strong, especially in light of the prospects for China, we project growth in 2001 to be around 4 percent (compared to about 91/2 percent this year).
3. The prolonged decline in domestic prices, which helped bring about needed economic adjustment, may now be coming to an end. The deflation primarily reflected the downward adjustment in property prices and rentals, which were out of line with economic fundamentals prior to the crisis. However, given the expected rise in nominal wages and property prices and rentals, we anticipate that deflation will give way to inflation of about 1 percent next year.
4. The above projections are subject to a margin of uncertainty in both directions. Some of the downside risks are external: higher oil prices may have an even larger than anticipated effect on Hong Kong's export markets, while large declines in world equity markets could adversely affect the domestic stock market. However, there are domestic risks as well: further declines in property prices, while helpful from a long-run competitiveness point of view, may dampen consumer and investor sentiment. On the upside, one should not discount the possibility of stronger export growth after the recent gains in competitiveness.
5. Against this background, we have the following observations on economic policy in the near term:
* An impressive aspect of fiscal management has been Hong Kong SAR's ability to combine a pragmatic injection of fiscal stimulus during the exceptional circumstance of the Asian crisis with adherence to the principle of fiscal prudence set out in the Basic Law. Given the projected reversion of GDP growth to trend, we do not believe that additional fiscal stimulus is needed. The small deficit projected this year merely reflects an exogenous revenue shortfall from MTRC privatization and from lower investment income, and the current fiscal stance should result in surpluses starting in FY 2001-02.
* The flexibility of the domestic cost structure has allowed the linked exchange rate regime to work smoothly despite the turmoil of the Asian crisis. The link continues to provide a stable policy framework, and safeguards introduced in August 1998 to strengthen the currency board appear to be working well, although the new measures have yet to be stress tested. While there is no urgency for additional measures, the HKMA should keep an open mind on further technical refinements, including formalizing two-way convertibility for clearing balances.
6. In the coming years, a number of structural issues will need to be tackled.
(i) LONG-TERM FISCAL POLICY: Although the Basic Law provides an institutional predisposition for fiscal discipline, this does not mean that the system is free of fiscal stresses. In particular, our preliminary analysis shows that population dynamics and the imperative to upgrade skills will result in a trend rise in health and education spending over the long-term. Also, revenue growth could slow as stamp duties and property-related receipts lag behind GDP growth. Given these trends, adherence to the Basic Law beyond 2010 may call for additional measures, some of which are already under consideration. Accordingly, we would recommend that the Task Force on Review of Public Finances examine these longer-term issues. One policy option that merits serious consideration is the case for a low-rated, broad-based consumption tax. Another option is to allow for greater cost sharing to limit rising government expenditure on health care, including higher user fees-with safeguards for the needy-and more private insurance.
(ii) FINANCIAL SECTOR DEVELOPMENT: Prudent bank practice, strong legal institutions, and effective supervision allowed the banking system to weather the turbulence of the Asian crisis, with banks continuing to report positive profits and making full provision against higher non-performing loans. However, well after the crisis, bank lending has not recovered. Among other things, this may reflect the limited transparency of small and medium enterprises, which has hindered risk-based lending and prompted banks to shift into safer-but less profitable-mortgage loans. In this connection, recent efforts to raise corporate transparency (better accounting standards) and to catalyze the establishment of a commercial credit reference agency are commendable.
We also support the upgrading of securities regulation and financial infrastructure, including:
* The recent merger of the exchanges and clearing houses, which will reduce costs and consolidate risk management;
* The proposed introduction of deposit insurance, which will need to be appropriately structured to minimize moral hazard risks;
* The move to more risk based supervision of banks and regular assessment of cross market risk-banking, securities, derivatives, and insurance-by the Council of Financial Regulators. In this connection, Hong Kong SAR would benefit from participation in a Financial Sector Assessment Program, which is a peer review of regulatory practices and financial sector vulnerabilities.
(iii) DOMESTIC COMPETITION: Hong Kong SAR has one of the most open economies in the world, with flexible product and factor markets, but lowering business costs will remain crucial to the economy's future. Against this background, we have continued to hear concerns about the limited degree of domestic competition, particularly in the non-tradables sector. Many, including the Consumer Council, have pointed out to us that the absence of a general competition law has hindered the authorities' own efforts to investigate anti-competitive behavior and to promptly trigger a remedial process. As such, we believe that further consideration should be given to developing a supportive legal framework.
(iv) UNEMPLOYMENT, INCOME DISTRIBUTION, AND EDUCATION: Although it has declined from peak levels, the unemployment rate remains high by historical standards. Adding to this is the social burden of growing income disparity. The policies implemented over the past two years-including the various initiatives to provide retraining-have helped and, together with continuing economic growth, should reduce unemployment. However, over the longer-term, there is wide agreement that Hong Kong SAR will need to place greater emphasis on education if income distribution is to improve and the economy is to successfully transition to a higher value added service economy. A buildup of human capital will require higher public outlays, as well as education reform.
(v) STATISTICS: By next month, Hong Kong SAR will have achieved full compliance with the Fund's SDDS data standards. We welcome this progress in providing the public with important economic data on a timely basis, and would also like to commend the efforts of the Census and Statistics Department to publish data on the international investment position and to bring forward the schedule for publishing external debt data to mid 2002. At this stage, we see two areas where there is room for improvement. One is the presentation of fiscal data on a standardized international format, i.e. the IMF's Government Finance Statistics (GFS). The other is to begin compiling a monetary survey.
7. The greatest challenge facing Hong Kong SAR is adjusting to the Mainland's prospective entry into the WTO. The key task will be to ensure that the economy can build on its current advantages, including flexible markets, a more competitive cost structure in recent years, and strong legal and regulatory institutions. At the same time, policymakers will have to put in place structural reforms-especially an emphasis on education and financial infrastructure-that exploit the new opportunities. We remain optimistic that these challenges will be met.
End/Tuesday, November 14, 2000
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