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Press Release
IMF endorses Hong Kong SAR's policy on economic recovery
Tuesday, November 30, 1999
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
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
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
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
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
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
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.
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.