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The Government's Half-Yearly Economic Report 1998 was published today (Friday).
The Government Economist, Mr K Y Tang, described the economic situation in the first half of the year and provided updated GDP and price forecasts for 1998. The main points and details are as follows.
MAIN POINTS
* The Hong Kong economy continued to slow down in the second quarter of 1998, as it was adjusting to the profound impact of the regional financial turmoil.
* Externally, exports of goods slackened further, hit by reduced import demand in the region as recession loomed in the affected economies. Yet inbound tourism began to show signs of revival most recently.
* Locally, consumer demand was depressed by slackened income, higher unemployment and further fall in asset prices. But investment spending on machinery and equipment rebounded, mainly underpinned by increased intake of transport equipment.
* Private sector building activity should have remained rather intensive. Public sector building and civil engineering activity was bolstered by the on-going hectic work under the Public Housing Programme and by the rush to full completion of the Airport Railway. Interior decoration business however remained weak, putting a downward drag on overall construction output.
* A crude initial assessment suggests that the Gross Domestic Product (GDP) could have fallen by around 5% in real terms in the second quarter of 1998 over a year earlier. This was down from the 2.8% decline in the first quarter, mainly reflecting the further slackening in both local consumer demand and export performance in the second quarter. The peak GDP growth in the second quarter of 1997 also rendered a high base of comparison for that quarter.
* In face of the continued economic downturn and an uncertain business outlook, some employers had moved to downsize their workforce even more. Increased entry of fresh graduates and school leavers into the workforce lifted unemployment further. The seasonally adjusted unemployment rate and the underemployment rate rose to 4.4% and 2.6% respectively in the second quarter of 1998 (4.8% and 2.6% respectively in the three months ending July).
* Consumer price inflation in terms of the Composite Consumer Price Index fell to 4.0% in June, and further to an 11-year low of 3.2% in July, giving an average increase of 4.5% in the first seven months of 1998. Domestically generated inflation stayed mild, while imported inflation was virtually absent.
* GDP for 1998 as a whole is now forecast to contract by around 4% in real terms. This is mainly in recognition of the lacklustre performance so far, as well as the subdued economic sentiment, slack employment conditions, high interest cost and tight credit constraint locally which will continue to hamper consumer and investment demand for the rest of the year. The figure of -4% may be compared with the average of -3% suggested by eight reputable forecasters of Hong Kong's economy.
* Externally, the weak economic situation in most part of the region, and particularly in Japan, will continue to curtail Hong Kong's export performance. The disruption in cargo handling services at the new airport, though virtually ended, have aggravated the decline in exports in the third quarter. The expected improvement in inbound tourism may nevertheless provide a partial offset.
* With the inherent flexibility of costs and prices in Hong Kong, the economy has been adjusting speedily to uphold competitiveness. Wages are softening. Property prices and rentals have already fallen substantially from their peaks in 1997. As inflation is now down to its lowest level since 1986, the cost of living and cost of doing business in Hong Kong have both moderated. Consumer price inflation in terms of the Composite CPI is now forecast at an average of around 3.5% in 1998. The local workforce is adapting promptly to the more difficult employment conditions, and the corporate sector is slimming for better cost economy and greater operational efficiency. Thus once the regional environment and the local sentiment improve, these will provide Hong Kong with a strong basis for expeditious return to positive growth.
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DETAILS
Overall performance
A crude initial assessment based on incomplete information at this stage suggests that the Gross Domestic Product (GDP) could have fallen by around 5% in real terms in the second quarter of 1998 over a year earlier, further down from the 2.8% decline in the first quarter. This was mainly due to a further slackening in both local consumer demand and export performance in the second quarter. A particularly high base of comparison from the peak GDP growth in the second quarter of 1997 also contributed.
External trade
Hong Kong's exports slowed down further in the second quarter of 1998, upon the shrinkage in import demand in the region. While exports to those East Asian economies hit by the regional financial turmoil fell markedly further, exports to Japan also slackened significantly as its economy remained sluggish and the yen stayed weak. Growth in exports to the mainland of China (the Mainland) decelerated as its import demand moderated.
On the other hand, exports to the United States registered a further notable increase in the second quarter. Exports to the European Union also accelerated in growth, with the pick-up being particularly noticeable for the United Kingdom. Thus so far, the impact of currency depreciation in the region on Hong Kong's exports to the conventional overseas markets did not appear to have been very significant. Yet given the marked decline in exports to markets in East Asia, total exports still fell by about 1% in real terms in the second quarter of 1998 over a year earlier, further down from the 1% increase in the first quarter. For the first half of 1998 as a whole, total exports were virtually unchanged in real terms from a year earlier.
Imports fell by about 2% in real terms in the second quarter of 1998 over a year earlier. This was caused in large part by the setback in domestic demand, as manifested in a larger decline in retained imports than in total imports, by about 4% in real terms in the second quarter of 1998 over a year earlier. For the first half of 1998 as a whole, total imports and retained imports fell by about 2% and 7% respectively in real terms over a year earlier.
The visible trade deficit narrowed to $67 billion in the first half of 1998, equivalent to 9.3% of the value of imports. The corresponding figures in the same period in 1997 were $96 billion and 12.6%. While the continued gain in terms of trade had contributed, this reduction was mainly related to the distinct slackening in import demand upon the slow-down in local economic activity. Thus the adjustment process in the local economy also led to an improvement in Hong Kong's trade balance.
On invisible trade, exports of services should have declined further in the second quarter of 1998, along with the weakness in inbound tourism and the slow-down in visible trade in that quarter, while imports of services should have recorded a small increase. Yet the invisible trade surplus should have remained sizeable, rendering a considerable offset to the deficit in the visible trade account.
Domestic demand
Local consumer spending was depressed in the second quarter of 1998. The slackened income and increased unemployment brought about by the downturn in the economy, together with the further decline in asset prices in recent months, had hit local consumer sentiment. In addition, the high interest rates discouraged spending on high-value items, whilst also reducing the disposable income of those households carrying mortgages. For the local retail business, the continued weakness in tourist spending dampened it even further. On a year-on-year comparison, the volume of retail sales was down by 16% in the second quarter of 1998, and by 15% for the first half of 1998 as a whole. Particularly large declines in sales were observed for commodities in department stores, for clothing and footwear, and for the high-value and more interest-rate-sensitive items such as motor vehicles, and jewellery and watches. Sales of basic necessities such as foodstuffs and commodities in supermarkets were less affected.
Yet overall investment spending fared better in the more recent months. On machinery and equipment acquisition, retained imports of capital goods rebounded to a growth of about 10% in real terms in the second quarter of 1998 over a year earlier, in contrast to a 12% decline in the first quarter. On building and construction, private sector building output in the second quarter of 1998 should have risen further along with intensive activity on existing projects, even though developers had turned more cautious in commencing new projects. Building output in the public sector was bolstered by the on-going hectic work under the Public Housing Programme. Concurrently, there was a rush on public sector civil engineering output for the Airport Railway, as the entire Airport Core Programme moved to full completion. Interior decoration business however remained weak, putting a downward drag on overall construction output.
The property market
The residential property market went down further during the first half of 1998, amidst a higher interest cost environment and tight mortgage lending policies of the banks. Following a dip in January, the market had a brief stabilisation in February and March. It then turned weaker in April, and took another dip in May and June, amidst renewed nervousness in the regional financial markets and continued tight liquidity locally. In face of weak acquisition interest, developers offered substantial price cuts and more flexible mortgage arrangements in the primary sales of pre-completion flats. This in turn exerted further downward pressures on the secondary market. Forfeiture of deposits and resale at a loss were widely reported. Amidst the subdued sentiment, two packages of measures to stabilise the residential property market were announced by the Government in late May and in late June.
Flat prices in June 1998 were on average 21% lower than three months earlier, 31% lower than six months earlier, and 40% lower than the peak level in October 1997. The rental market was likewise under much downward pressure, with an abundant supply of flats for lease. In the second quarter of 1998, flat rentals for new leases declined by an average of 3% over the first quarter, and by 14% from the peak level in the third quarter of 1997.
On commercial property, both end-user and investment demand for office space remained weak amidst a higher interest cost environment and an uncertain business outlook. A substantial supply of office space already available as well as coming on stream also dampened the market. Along with the setback in retail business, the market for shopping space likewise had a distinct fall. The market for industrial property remained quiet. Apart from the on-going relocation of production processes across the border, the setback in export performance and the general downturn in the property market in recent months also curbed acquisition interests.
In the first half of 1998, completions of both residential property and office premises rose markedly over a year earlier. Completions of storage premises also recorded a sharp increase as work on the Airport Freight Forwarding Centre at the new airport finished. On the other hand, completions of other commercial premises, industrial-cum-office premises and flatted factory space shrank. In parallel with the property slump and amidst tight liquidity locally, planned developments of all categories of property registered significant declines in the first five months of 1998 over a year earlier.
The labour market
Along with the setback in economic activity, there was a marked easing in labour market conditions in recent months. The seasonally adjusted unemployment rate showed a further sharp rise, from 3.5% in the first quarter of 1998 to 4.4% in the second quarter (and further to 4.8% in the three months ending July 1998). The median duration of unemployment tended to lengthen. The underemployment rate also leaped, from 1.9% to 2.6% (whilst remaining stable at 2.6% in the three months ending July). The proportion of the employed population working long hours also declined in the second quarter of 1998 when compared with a year earlier.
Labour supply continued to grow significantly in the second quarter of 1998, underpinned mainly by the sustained rapid growth in the population of working age on the back of continued large inflow of returning emigrants and immigrants from the Mainland. A slightly higher labour force participation rate as compared to a year earlier also contributed. On the other hand, reflecting the slack demand for labour, vacancies fell substantially across the board.
The rise in unemployment rate in the second quarter of 1998 over the first quarter was most visible in those sectors which were harder hit by the repercussions of the regional financial turmoil, including in particular retail, real estate, and restaurants and hotels. There was also a further leap in unemployment rate in the construction sector. In the financing, insurance and business services, as well as the community, social and personal services sectors, the unemployment rates were relatively lower. As to the underemployment rate, the increase was concentrated in construction, transport, manufacturing, and restaurants and hotels.
Both earnings and wages softened. In the first quarter of 1998, overall earnings rose by 5% in money terms, but were little changed in real terms, over a year earlier. These represented a considerable deceleration from the respective increases of 9% and 4% in the fourth quarter of 1997. In March 1998, overall wages also went up by 5% in money terms but recorded zero growth in real terms from a year earlier. These were again slower than the corresponding increases of 7% and 2% in September 1997.
Inflation
Consumer price inflation eased considerably further, as the process of internal cost and price adjustment to the impact of the regional financial turmoil proceeded. By July 1998, inflation in terms of the Composite Consumer Price Index fell to an 11-year low of 3.2%. For the first seven months of 1998 as a whole, the Composite CPI rose by an average of 4.5%, much slower than the average increase of 5.8% in 1997.
Domestically generated inflationary pressures had receded considerably further, as the increase in wages slowed and as property prices and rentals fell substantially. Amidst a very keen competition for business, the prevalence of price discounts made possible from cost savings, cut-back on profit margins, corporate streamlining and productivity enhancement, also kept inflation in check. At the same time, imported inflation was virtually absent.
The financial sector
During the first half of 1998, the spot exchange rate of the Hong Kong dollar against the US dollar remained stable, moving largely between 7.735 and 7.750. Despite the weakening of the Japanese yen during the first two weeks of June, the Hong Kong dollar continued to hold firm on the strong side of the link rate of 7.8. The spot exchange rate closed at 7.744 by the end of June. The forward exchange rate of the Hong Kong dollar was more volatile amidst the regional currency turbulence in January and June. Yet in each episode, the forward exchange rate was able to stabilise quickly afterwards.
In mid-June, the sharp depreciation of the Japanese yen brought about another wave of shock to the Asian financial markets. While the three-month HIBOR rose above 10%, the overnight HIBOR was pushed up to above the LAF offer rate. Again, the more acute upward pressure on local interest rates subsided quickly as the regional currency markets became less volatile. The overnight and three-month HIBOR closed at 6.125% and 9.5% respectively at the end of June 1998, compared with 4.5% and 9.125% at end-1997.
Overall demand for loans remained weak amidst the setback in economic activity and a higher interest cost environment. Concurrently, banks remained cautious in lending. During the second quarter of 1998, loans to financial concerns, stockbrokers, wholesale and retail trades, import and export trades, and the manufacturing sector all declined. But residential mortgage loans and loans for building, construction and property development and investment increased. Loans to the transport sector also grew further. As Hong Kong dollar loans rose marginally by 0.2% while Hong Kong dollar deposits remained flat during the second quarter, the Hong Kong dollar loan-to-deposit ratio edged up to 111.5% at end- June, from 111.3% at end-March.
The local stock market consolidated in April, and dipped more sharply during May and June, as the regional financial markets were hit by the social unrest in Indonesia, the protracted economic and financial problems in Japan, and the weak Japanese yen. Locally, the further slackening in economic activity and rising unemployment also dampened market sentiment. The Hang Seng Index dropped to a low of 7 463 on 15 June, and then recouped some of the loss along with a rebound of the yen in the latter part of the month. The Index closed the second quarter of 1998 at 8 543, representing a decline of 26% from three months earlier, and 20% from six months earlier. (In the early part of August, the Hang Seng Index dipped further, amidst the marked correction in the US stock market, another spate of regional currency turbulence induced by the chronic weakness of the yen, and speculative attack on the local financial markets which threatened exchange rate stability of the Hong Kong dollar. The Index touched a new low of 6 660 on 13 August. Activation of the Government's counter measures against the speculation resurrected the Index to a closing level of 7 923 on 27 August.)
Updated forecasts for 1998
So far, the regional economic and financial situation remains downbeat and fluid. Many economies in East Asia have slipped into recession, as the collective impact of the regional financial turmoil fully emerges. The worsened economic conditions in Japan and the continued weakness of the yen add to the severity of the situation. Moreover, the ripple effect of the regional financial turmoil seems to have spread to some of the advanced economies and even to certain emerging markets. Inevitably, Hong Kong as an integral part of the regional economy will continue to face the shocks and volatilities emanating from elsewhere in the region and beyond.
Against the outturn in the first half of this year and the external environment as described, the GDP and price forecasts for 1998 have been reviewed by component. The updated forecasts by component are shown in Table 1.
On visible trade, the dip in import demand in Japan and in all the other East Asian economies will continue to curtail Hong Kong's overall export performance. While exports to the United States and the European Union should still fare better, they could provide only a partial offset. The recent orders-on-hand position and feedback from manufacturers and traders point to a likely further slow-down in export performance in the coming months. The impact on trade from the disruption in air cargo handling services at the new airport, though of only short-term nature and probably less than the earlier estimate given a better profile of recovery of the operations in August, also has to be taken into account. Total exports are thus forecast to decline by about 2% in real terms in 1998. Within this total, re-exports are forecast to decrease by around 2% and domestic exports by around 3.5% in real terms.
Imports of goods are likewise expected to decline further in the coming months. This is in recognition of the envisaged further slow-down in re-export trade, as well as the continued setback in domestic demand which will precipitate a further fall in imports kept for local use. Total imports of goods are thus forecast to decline by about 3.5% in real terms in 1998, and within these, retained imports by around 7% in real terms.
On invisible trade, visitor arrivals fell less markedly in June and then picked up more significantly in July. Following the Government's specific facilitation measures, the pick-up in visitor arrivals was particularly large for visitors from the Mainland and Taiwan. With also a low base of comparison in the second half of last year, inbound tourism can be expected to improve in the coming months. As to offshore trading, business should continue to rise on the back of sustained growth in exports by foreign-funded enterprises in the Mainland. But exports of transportation, financial and other business services to East Asia will fare less well amidst reduced regional demand. Given the slack performance so far, for 1998 as a whole, exports of services may still show a decline of around 4% in real terms.
Imports of services are expected to show only a small increase of about 1% in real terms in 1998. There has been a strong growth in expenditure of Hong Kong residents travelling abroad so far in the year. But with increased unemployment and slackened income, some slow- down in outbound travel seems likely in the coming months. Imports of other trade-related services and of various professional and other business services are also likely to remain weak, amidst the fall-off in both local and regional demand.
Locally, consumer sentiment is likely to remain subdued so long as unemployment remains high, income remains under downward pressure, and the asset markets remain slack. High interest cost is also a deterrent, particularly in regard to purchases of high-value and more interest-rate-sensitive items. Moreover, the exceptionally strong consumer spending growth in the second and third quarters of last year give a high base of comparison for the same quarters of this year. Feedback from the major local retail outlets suggests that retail business will remain low in the coming months. In view of these factors, private consumption expenditure is envisaged for a further marked decline in the third quarter, followed by a lesser decline in the fourth quarter as the base of comparison in the corresponding quarter of last year drifts considerably lower. For 1998 as a whole, private consumption expenditure is forecast at a decline of around 4.5% in real terms.
Government consumption expenditure on a national accounts basis is forecast at a modest growth of around 2% in real terms in 1998. The actual growth rate so far this year has been even lower, as there were significant pension pay-outs and as defence cost was still incurred in the same period last year. Some pick-up in government spending is nevertheless envisaged in the coming months.
Overall investment spending in the economy, as represented by gross domestic fixed capital formation, is forecast to decline by around 4.5% in real terms in 1998, with distinct falls in public sector construction, private sector spending on machinery and equipment, and transfer costs of land and buildings.
Private sector expenditure on building and construction is expected to increase by around 2% in real terms in 1998. This is mainly in recognition of the intensive building activity in the first half of the year. But a distinct slow-down is likely to occur in the coming months, as existing projects move to completion while many new projects are being deferred. The more recent figures on building consents show substantial decreases. Moreover, non-site construction activity is likely to remain slack, as interior decoration work is curtailed by the sharply reduced turnover in the property market. Real estate developers' margin, as representing services rendered by developers and hence closely linked to the level of building activity in the private sector, is forecast to increase by around 6.5% in real terms in 1998, again mainly on the back of a robust outturn in the first half of the year. Following the severe downturn in property trading, transfer costs of land and buildings are forecast to decline markedly, by 50% in real terms in 1998.
As to the public sector, completion of the Airport Core Programme has resulted in a temporary lull in civil engineering output. Work on the MTR Tseung Kwan O Extension and the KCR West Rail to be commenced later in the year cannot yield much volumes at the initial stage. On the other hand, the continued hectic activity under the Public Housing Programme will provide certain offset. Still, public sector expenditure on building and construction is expected to be substantially lower in 1998, by around 11% in real terms. Taking the private and public sectors together, total expenditure on building and construction is forecast to fall by around 3% in real terms in 1998.
After a rebound in the second quarter, machinery and equipment acquisition is likely to weaken again in the coming months, as investment intentions will continue to be undermined by an uncertain business outlook, high interest cost and tight credit constraint. For 1998 as a whole, total expenditure on machinery and equipment is forecast to decline by about 4% in real terms. Within this total, expenditure by the private sector is forecast to fall by around 4% in real terms, while expenditure by the public sector may show only a marginal rise.
Overall, GDP is forecast to contract by around 4% in real terms in 1998. Given the subdued sentiment prevailing locally and the reduced demand in the region, economic performance in the near term is likely to remain on a downtrend, albeit probably less so for the fourth quarter than for the third quarter upon a considerably lower base of comparison towards the end of last year.
While a spot forecast of the rate of change in GDP is provided, it actually embraces a range of uncertainty or possible error. Computation of the mean absolute error of the discrepancies between the forecast and the subsequent actual outturn over each of the past ten years shows that, as is to be expected, the forecast error is widest for the first-round forecast done in the early part of the year, and then progressively narrows with successive regular updates of the forecast during the course of the year as more quantitative data about the actual economic situation in the current year become known. For the mid-year update, the mean absolute error is calculated as 0.5 of a percentage point from the present spot forecast of -4%. The calculations are shown in Table 2. But in addition, it must be noted that currently much of the volatilities in fact come from abrupt changes in external factors, and to that extent the mean absolute error derived from past track record may not be able to reflect the range of variabilities fully. For comparison purpose, Table 3 has been prepared to indicate similar forecasts made by reputable organisations. The average figure of their forecasts is -3%.
Except for a brief relapse in March, consumer price inflation in terms of the Composite CPI has been on a steady easing trend throughout the first seven months of 1998. This is part and parcel of the adjustment process of the economy to weather the impact of the regional financial turmoil. Both domestically generated and externally induced inflation can be expected to remain generally subdued for the rest of the year. The effect of the severe flooding in the Mainland on food supply and food prices in Hong Kong has so far been minimal, though still needs to be watched. The Composite CPI is forecast to increase by an average of 3.5% in 1998.
With the inherent flexibility of costs and prices in Hong Kong, the economy has been adjusting speedily to uphold its competitiveness. Wages are softening. Property prices and rentals have already fallen substantially from their peaks in 1997. As inflation is now down to its lowest level since 1986, the cost of living and cost of doing business in Hong Kong have both moderated. The workforce is adapting promptly to the more difficult employment conditions, and the corporate sector is slimming for greater cost economy and operational efficiency. Thus once the regional environment and the local sentiment improve, these should provide Hong Kong with a strong basis for expeditious return to positive growth.
(The Half-yearly Economic Report 1998 is now on sale at the Government Publications Centre on Ground Floor, Lower Block, Queensway Government Offices, at $58 a copy.)
End/Friday, August 28, 1998
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