Public Information Notice: IMF Concludes Article IV Consultation held in 1998 with the People's Republic of China in Respect of the Hong Kong Special Administrative Region

February 11, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

The IMF Executive Board on January 29, 1999 considered a report on the Article IV consultation1 discussions with People’s Republic of China in respect of the Hong Kong Special Administrative Region, which were held in late 1998.


The Asian financial crisis had a severe impact on Hong Kong SAR. The Hong Kong dollar came under speculative pressure on several occasions since October 1997, the asset price bubble—which had developed over the previous year—deflated, and market sentiment weakened in response to deteriorating economic conditions in the region. This led to upward pressure on domestic interest rates, which further weakened asset prices. By mid–1998, the local stock index and residential property prices had fallen by over 50 percent from their peak in 1997, reducing wealth by more than 100 percent of GDP.

The deteriorating regional situation sharply reduced external demand for Hong Kong SAR’s exports of goods and services. Domestic exports and reexports declined, although the effect on the trade balance was more than offset by a reduction in retained imports. Private consumption turned negative and private investment decelerated. These factors, together with the fall in asset prices, led to a slowdown in economic activity. As a result, real GDP contracted—by 7 percent on a year-on-year basis in the third quarter of 1998. The consumer price index started to decline from July, with inflation turning negative in October. Wage growth moderated and the unemployment rate rose to 5¾ percent, the highest level in 17 years.

The Hong Kong SAR government responded with a series of measures to mitigate the effects of the contraction in economic activity and to stabilize the property market. The 1998 budget, announced in February, contained some tax concessions and higher capital spending. In June, government land sales were suspended for the remainder of the fiscal year, and some additional tax cuts and spending increases were announced. These measures, together with the cyclical downturn, imply a considerable deterioration in the budgetary position in FY1998/99.

The economic slowdown and the increase in interest rates were reflected in a slowing of the monetary and credit aggregates. With real interest rates rising to their highest level in recent years, year-on-year broad money growth fell to 10½ percent at end–1998, from 15 percent in mid–1997. Onshore credit growth slowed as banks became more cautious in lending, while offshore lending fell as many foreign banks, especially Japanese banks, scaled back their Hong Kong SAR branches’ lending operations to meet liquidity needs in their home markets.

In August, the depreciation of the yen against the U.S. dollar led to renewed pressure against the Hong Kong dollar, which came under heavy speculative attack. At the same time, stock and futures prices plummeted. The Hong Kong SAR government, arguing that markets were being manipulated and concerned that domestic confidence could be seriously weakened, took the unprecedented step of intervening directly in the stock and futures markets.

Stock market operations have since ceased. A number of regulatory changes to enhance transparency and increase the cost of speculative activity in the stock and futures markets have been announced, some of which have already been implemented. An independent company has been established to manage and work out a liquidation strategy for the government’s share holdings. The Hong Kong SAR government has also introduced a package of technical measures designed to strengthen the transparency and operation of the linked exchange rate system, including a rediscount facility aimed at reducing interest rate volatility.

Financial market conditions have stabilized markedly since that time, aided by the appreciation of the yen, interest rate cuts in major industrial countries and in the mainland of China, and the continued steady performance of the mainland of China economy. Interbank interest rates have eased and, at the shorter end of the maturity spectrum, are presently at levels equal to those in the U.S.; in addition, money and credit growth has begun to pick up (although the latter remains very weak). The local stock index at end–January 1999 was around 40 percent higher than in the trough in mid–August. The number of property transactions rose sharply in November and remained stable in December, providing tentative signs of a recovery in the residential propertymarket. The financial position of the banking system remains strong, although the economic contraction has inevitably caused nonperforming loans to rise and profits to come under pressure.

Executive Board Assessment

Executive Directors observed that, notwithstanding its strong economic fundamentals, the Hong Kong SAR economy had been severely affected by the Asian financial crisis over the past year. Activity had been hard hit by falling demand in regional economies, the depreciation of trading partners’ currencies, and the adjustment of the bubble in domestic asset prices. Against this backdrop, there had been pressures on the linked exchange rate system, higher domestic interest rates, and a further weakening of domestic demand.

Directors observed that the steep adjustment to the shocks had proceeded remarkably rapidly, demonstrating the flexibility of the economy. Asset prices had fallen sharply and labor costs and inflation were declining. Aided by the more recent appreciation of regional currencies, this had helped improve external competitiveness. Against this background, Directors expected that signs of a recovery could begin to emerge in the second half of the year, although they cautioned that the Hong Kong SAR Government (Hong Kong SARG) should remain vigilant, as the short-term outlook remained subject to uncertainty in view of the still lingering consequences of the Asian crisis and the unsettled nature of global financial markets.

While the ongoing adjustment had had substantial costs in terms of output and employment, Directors observed that this had been inevitable in view of the size of the external shocks Hong Kong SAR had faced, as well as the openness of its economy. Noting that the linked exchange rate system had contributed significantly to the remarkable growth and financial stability of the economy in the past fifteen years, Directors strongly supported the Hong Kong SARG’s commitment to maintaining the exchange rate link, and welcomed the Hong Kong SARG’s determined efforts to defend the linked exchange rate system, including by allowing interest rates to rise, over the past year. Directors also welcomed the Hong Kong SARG’s recent efforts to strengthen the operation and transparency of the linked exchange rate system.

Directors underscored that the operations of the Hong Kong SARG in the stock and futures markets to combat simultaneous pressures in the foreign exchange and stock markets had raised concerns regarding the role of the government in the securities market and potential conflicts of interest, as well as a number of technical problems, which should be addressed quickly. In this context, the recent setting up of an independent corporation to manage and eventually dispose of the Hong Kong SARG’s holdings was a welcome step. Some Directors considered that the Hong Kong SARG’s action had been necessary to defend the system in the recent exceptional circumstances, but stressed that the Hong Kong SARG should refrain from further intervention in equity markets to ensure the integrity of a rules-based policy framework. More generally, Directors observed that this experience attested yet again to the need for increased transparency and data disclosure on the part of private investors, in addition to enhanced public sector transparency.

Directors welcomed the Hong Kong SARG’s strong emphasis on transparency in the regulatory framework governing the securities market; the proposed review of existing legislation and strengthened coordination among the various regulatory bodies; and the tightening of enforcement of existing rules on illegal trading. Directors also supported the Hong Kong SARG’s proposals to strengthen the regulatory and supervisory framework for nonbank financial institutions, and to monitor the financial position of the corporate sector more closely.

Directors commended the Hong Kong SARG’s consistent record of fiscal prudence, observing that the accumulation of substantial fiscal reserves had played an important role in sustaining confidence in financial markets, and had significantly increased the Hong Kong SARG’s room for maneuver in the current economic downturn. Directors suggested that under the present economic conditions, and given the outlook for growth and unemployment in 1999, it would be undesirable to tighten fiscal policy during the next fiscal year. However, a deficit should be set within a medium-term framework, incorporating a return to budget balance, so that it was clearly seen as being temporary in nature. Moreover, any additional revenues from asset sales, which had a limited impact on aggregate demand, should be used to rebuild fiscal reserves.

Directors observed that the financial position of Hong Kong SAR’s banks and the quality of the regulatory and supervisory system, which were high by international standards, had been further strengthened by recent regulatory and supervisory improvements. While pressures on the banks would continue in 1999 as the full effects of the economic slowdown were felt, the situation was expected to remain manageable. In this context, the impact of the bankruptcy of the Guangdong International Trust and Investment Company (GITIC), and associated financial pressures on other mainland-related enterprises, would need to be carefully monitored. Noting the high degree of exposure of the banking system to property lending, Directors also called for close monitoring of both banks and the Hong Kong Mortgage Corporation to ensure that the overall financial system remained sound.

Looking ahead, Directors noted that unemployment would remain a pressing issue in the period ahead, and endorsed the measures undertaken by the Hong Kong SARG to accelerate infrastructure and labor-intensive investment projects, and the expansion of retraining and job placement schemes. In this context, Directors observed that the Comprehensive Social Security Assistance Scheme provided a safety net for people suffering from economic difficulties, while seeking to avoid reducing labor market flexibility. They supported maintaining these principles in the ongoing review of the scheme.

Directors expressed the view that Hong Kong SAR’s data provision to the Fund is adequate for surveillance, and commended the Hong Kong SARG for their efforts to disseminate a wide range of high quality economic and financial data on a timely basis. They looked forward to the publication of data on the external current and capital accounts in 1999, consistent with Hong Kong SAR’s commitment under the SDDS, and urged publication of more timely and detailed data on fiscal developments.

People’s Republic of China, Hong Kong Special Administrative Region:
Selected Economic and Financial Indicators

1995 1996 1997 1998

Real GDP (percent change) 3.9 4.6 5.3 -5.0 1
Real domestic demand 7.1 2.5 8.6 -6.2 1
Foreign balance (contribution) -3.3 2.0 -3.6 1.6 1
Saving-investment balance (percent of GDP) -4.3 -1.4 -3.5 -0.4 1
Gross domestic saving 30.5 30.7 31.9 33 1
Gross domestic investment 34.8 32.1 35.4 33.4 1
Inflation (percent change)
Consumer prices 8.7 6.0 5.7 2.6
GDP deflator 2.5 5.8 7.2 3.6 1
Employment (percent change) 1.1 3.5 4.6 1.8
Unemployment rate (percent) 3.2 2.8 2.2 4.7
Real Wages -1.0 0.4 1.0 ...
Government budget (percent of GDP)2
Revenue3 16.7 17.5 20.4 15.6 1
Expenditure 17.0 15.3 14.4 18.3 1
Consolidated budget balance3 -0.3 2.2 6.0 -2.7 1
Reserves at March 314 13.7 14.6 34.0 31.6 1
Money and credit (percent change, end-period)
Narrow money (M1) 2.8 14.2 -4.3 -5.0
Broad money (M3) 14.2 10.5 8.2 10.6
Loans for use in Hong Kong SAR 11.1 17.1 24.4 -3.9
Interest rates (percent, end-period)
Best lending rate 8.8 8.5 9.5 9.0
Three-month HIBOR 5.9 5.5 9.1 5.1
Merchandise trade (percent change)
Export volume 12.0 4.8 6.1 -3.2 1
Domestic exports 1.9 -8.4 2.2 -4.9 1
Reexports 14.3 7.5 6.8 -2.9 1
Import volume 13.7 4.3 7.2 -4.2 1
Export value 14.9 4.0 4.2 -7.4
Import value 19.2 3.0 5.2 -11.5
External balance (in billions of US$)
Merchandise trade balance -19.6 -18.4 -21.1 -11.0
In percent of GDP -14.1 -11.9 -12.1 -6.4
Goods and nonfactor services balance5 -6.1 -2.2 -6.0 0.0 1
In percent of GDP -4.3 -1.4 -3.5 0.0 1
Foreign exchange reserves (in billions of U.S. dollars, end of period) 55.4 63.8 92.8 89.6
(In months of retained imports) 9.1 10.7 14.7 17.7 1

Sources: Data provided by the Hong Kong SAR authorities; and IMF staff estimates and projections.

1Staff estimates.
2Fiscal year begins April 1.
3Excludes change in the net worth of the Land Fund.
4Fiscal reserves at end-FY 1997 include the HK$203 billion balance in the Land Fund (15.1 percent of GDP).
5National account basis.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described. As a Special Administrative Region of the People's Republic of China, Hong Kong SAR is not a member of the IMF. The Article IV consultation with People's Republic of China in respect of the Hong Kong Special Administrative Region has been held with the Hong Kong SAR authorities every year since October 1997.


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