As a small and open economy with close economic links with the rest of East Asia, Hong Kong, China was inevitably vulnerable to shocks from the regional financial turmoil. The economy suffered a severe set-back in 1998. Domestic demand slackened considerably during the year, as local sentiment was depressed by volatility in the financial markets and a slump in asset prices. External demand was hard hit by the fall-off in demand in the region. As the ripple effect of the setback spread over, the economy remained weak in the first quarter of 1999. Yet visible improvements have been observed in the economy on both the domestic and external fronts since the second quarter.

Real GDP contracted by 5.1% in 1998, reversing the robust growth of 5.3% in 1997. Analysed by main GDP component, all but government spending had declined. Over the course of 1998, the decline in GDP began to taper off in the fourth quarter, falling by 5.7% from the previous year, smaller than the 6.8% decease in the third quarter. The year-on-year decrease moderated further to 3.4% in the first quarter of 1999. On a seasonally adjusted quarter-to-quarter basis, the decline in real GDP likewise narrowed, from 1.4% in the third quarter of 1998 to 0.6% in the fourth quarter and further to only 0.3% in the first quarter of 1999.

On domestic demand, consumer spending decreased by 6.7% in 1998. While spending on most goods suffered a large setback, spending on food and services were relatively more stable. Consumer spending was still weak in the early part of 1999, amidst higher unemployment and moderating incomes. Yet the year-on-year rate of decline moderated from a 9.1% decrease in the fourth quarter of 1998, to 4.8% in the first quarter of 1999. The improvement should have continued since, as consumer confidence was gradually restored on the rebound in share prices and steady revival in the residential property market.

Overall investment spending declined by 6.6% in 1998. Expenditure on machinery and equipment was held back by high interest costs and an uncertain business outlook. Building and construction activity was still rather intensive in the first half of 1998, but has slowed down considerably since then. This was related in part to the completion of the Airport Core Programme, and in part to the property market slump which dampened private sector building activity. Overall investment spending fell further by 24.4% in the first quarter of 1999 compared with a year earlier. There were nevertheless more new private sector building projects commencing in 1999, as the residential property market has revived since late 1998.

On external trade, total exports fell by 4.3% in 1998. This was due to the marked decline in exports to East Asia, which together accounted for around half of Hong Kong, China’s total exports. Imports shrank even more, by 7.2% in 1998, as retained imports were much reduced as a result of the economic downturn. Although inbound tourism picked up visibly in the second half of 1998, exports of services still recorded a decrease of 6.5% for the whole of 1998. Imports of services fell by 0.6% in 1998, due to the setback in overall business activity. Yet export performance improved visibly in the first half of this year, contributed to the pick-up in exports to the United States and to a number of East Asian markets. The year-on-year decrease in total exports moderated to around 2% in the second quarter of 1999, from a 9.6% decline in the fourth quarter of 1998. With inbound tourism sustaining a recovery, exports of services rebounded to an increase of 1.4% in the first quarter of 1999 over a year earlier, and the growth momentum should have continued since. Meanwhile, imports of services in the first quarter of 1999 were virtually unchanged from a year earlier.

With the improvement in overall economic activity already evident in the first half of 1999, a more visible revival is envisaged in the second half of the year. For 1999 as a whole, real GDP is forecast to grow by 0.5%. Domestically, consumer spending should continue to recover from the low level of last year. Although private sector investment may remain slack until the overall business outlook turns distinctly better, public sector building and construction activity should gather momentum in the latter part of the year. Externally, exports of goods and services should continue to improve, as the East Asian economies recover and the situation in other overseas markets holds steady. The growth momentum of inbound tourism is also expected to continue.

Consumer price inflation eased distinctly over the course of 1998 and turned negative towards the end of the year. For 1998 as a whole, the composite consumer price index (CPI) rose by an average of only 2.8%, markedly down from the 5.8% increase in 1997. It fell by 2.9% in the first half of 1999 over a year earlier. This reflected the expeditious adjustment in domestic costs and prices, which had continued amidst the economic downturn brought about by the regional financial turmoil. The freeze in government fees and in a number of public utility charges also contributed. Moreover, imported inflation was subdued, helped by the generally soft world commodity prices and low to negative inflation in the major supplier economies. As the adjustment process is expected to continue into the rest of this year, the composite CPI is forecast to decline by an average of 2.5% in 1999.

The labour market slackened markedly over the past year or so, with the seasonally adjusted unemployment rate rising from 2.5% in the fourth quarter of 1997 to 6.2% in the first quarter of 1999, and the underemployment rate from 1.3% to 3.0%. Apart from corporate downsizing and retrenchment caused by the economic downturn, there was also a easing in the manpower resource balance following a faster growth in labour supply than in labour demand. Labour wages in money terms had moderated, from a year-on-year increase of 7% in late 1997 to virtually no change in March 1999.

Yet along with a gradual improvement in overall business conditions, there was some pick-up in employment growth in the more recent months. In line with this, the seasonally adjusted unemployment rate and the underemployment rate both edged down slightly, to 6.1% and 2.9% respectively in the second quarter of this year.

The combined visible and invisible trade account turned to a small surplus of HK$4.6 billion in 1998, equivalent to 0.4% of GDP in that year, after deficits in the preceding few years. The economic downturn in 1998, coupled with the winding down of the Airport Core Programme, reduced import demand markedly. The significantly reduced visible trade deficit was more than offset by the continued sizeable surplus in the invisible trade account.

The visible trade deficit continued to narrow in the first half of 1999, to 4.0% of the total imports in that period, from 9.3% in the same period last year. This was due to reduced intake of goods for local use. As imports of both goods and services are expected to pick up in the second half of this year, the combined visible and invisible trade account is projected to return to a small deficit of HK$3.5 billion for the whole of 1999, equivalent to only 0.3% of GDP.

Throughout 1998 and the first half of 1999, the exchange rate of the Hong Kong dollar against the US dollar remained stable at around the linked rate of 7.80. Subsequent to the introduction of technical measures to strengthen the currency board arrangements in Hong Kong, China in September 1998, the Hong Kong dollar exchange rate traded within a narrow range of HK$7.740-HK$7.759 to US$1. The stable Hong Kong dollar is underpinned by the robustness of the linked exchange rate regime, sound economic fundamentals, a well-supervised and generally healthy banking sector, fiscal prudence and strong reserves.

The market exchange rate of the Hong Kong dollar against the US dollar closed the second quarter of 1999 at HK$7.756 to US$1. The Effective Exchange Rate Index of the Hong Kong dollar fell by 4.4% during 1998, before rising by 2.3% during the first six months of 1999.

In fiscal year 1998-99, the Government incurred a deficit of HK$23.3 billion, largely as a result of a package of relief measures announced in June 1998. The full-year effect of the tax concessions introduced in the 1998 budget and the further one-off tax concessions introduced in the 1999 budget, together with the effect of the economic downturn, mean that revenue is likely to decline further in fiscal year 1999-2000.

On the other hand, in order not to jeopardize the prospects for economic recovery, the Government has not cut back on its spending plans. New and improved services continue to be introduced, particularly in the areas of education, health and social welfare. Infrastructural spending is also being sustained at a high level.

The fiscal deficit is thus expected to rise to HK$36.5 billion in fiscal year 1999-2000.

The primary objective of Hong Kong, China’s monetary policy continues to be maintaining stability in the external value of the Hong Kong dollar against the US dollar, at a fixed rate of HK$7.80 to US$1.

The total stock of inward foreign direct investment (FDI) in Hong Kong, China amounted to HK$732 billion (US$95 billion) at end-1997, representing an increase of 17% over end-1996. The United Kingdom remained the largest source of inward FDI, accounting for 25% of the total. It was followed by mainland China (with a 19% share), the United States (18%), and Japan (13%). Of the total, 93% was in the non-manufacturing sectors, particularly banking and finance, and the wholesale, retail and import/export trades.

There is no official data on Hong Kong, China’s outward FDI. Based on statistics released by some of the host economies, Hong Kong, China is known to have invested heavily in East Asia, particularly in the mainland of China. As at end-March 1999, the cumulative value of Hong Kong, China’s realized direct investment in mainland China amounted to US$142 billion, accounting for 52% of the total FDI there.

The economy of Hong Kong, China has been adjusting promptly to the adversities from within the region and beyond. Wages and earnings have softened. Property prices and rentals have fallen substantially from their peaks in 1997. Both the cost of living and the cost of doing business have come down significantly. But most important of all is the fact that the economic fundamentals of Hong Kong, China remained strong, as exemplified by its prudent budgetary management, sound monetary system, and a generally healthy banking sector. Companies have been adapting effectively to the changing business environment. All these are providing a solid base for continued recovery of the economy.

Over the medium-term, local consumer spending is expected to show faster growth than in 1999, as the labour market gradually improves and the negative impact of the regional financial turmoil on willingness to spend gradually dissipates. Overall investment spending is expected to recover steadily. Building and construction activity should progressively revive, on the back of the pick-up in private sector building output, and the boost to public sector civil engineering output from implementation of the priority railway projects. Strengthened economic activity and improved profits position resulting from the reduced cost of doing business should induce greater intake of machinery and equipment by the private sector. Export performance should also be more positive over the medium term, given the steady revival expected for the East Asian markets, sustained growth in the United States, and gradual pick-up in the European economies. Real GDP is projected to grow by a trend average of 3.5% per annum over the medium term.

Seeing an economic downturn, the Government introduced the largest tax concession ever in February 1998. More relief measures, aimed at boosting domestic demand, stabilising the property market, easing the credit and liquidity squeeze, and boosting tourism, were announced in June 1998. Furthermore, a Task Force on Employment was set up in May 1998 to monitor the progress of measures to tackle unemployment and create jobs.

With a view to fostering Hong Kong, China’s economic development in the longer term, the government has set in train a series of measures to promote the application of science and technology, to support industrial and commercial development, to enhance physical infrastructure and human resources, and to achieve a more efficient and cost-effective government. In the 1999/2000 Budget, further measures were announced to strengthen financial services, to promote information technology, and to bolster tourism.

Also, the government has been operating a Services Promotion Programme which looks systematically and comprehensively at the services sector of the economy, and identifies ways to further entrench the role of Hong Kong, China as the premier services centre in Asia. It is also operating a Helping Business Programme which reviews ways to help the business sector by cutting red tape, reducing the cost of compliance, identifying activities for transfer to the private sector, and introducing new and improved services in support of the business community.

Hong Kong, China: Overall Economic Performance

Source: Data are as submitted by member economies, unless otherwise specified.

Notes: (1) 3-month HIBOR average

Table 2. Forecasting Summary (% change from previous year)

Note: Trade official real GDP forecast for the period 2000-02 in the forecast trend growth rate during 1999-2002. The corresponding price forecast is in terms of the GDP deflator. The IMF forecast is from World Economic Outlook may 1999. The ADB forecast is from the Asian Development Outlook 1999. The OECD forecast is from the OECD Economic Outlook June 1999