Transcript of a Video Teleconference on the International Monetary Fund’s Preliminary Conclusions of the 2011 Article IV Consultation with the Hong Kong SAR

with Nigel Chalk, Mission Chief for China and Hong Kong SAR Hong Kong
November 16, 2011

MS. WONG: First of all, I want to welcome all of you to the IMF press conference today. We are releasing the Preliminary Conclusions of the IMF 2011 Article IV Consultation with the Hong Kong SAR. May I introduce the host today? He is Mr. Nigel Chalk, Mission Chief for Hong Kong and China, and he’s Senior Advisor in the IMF’s Asia and Pacific Department. Next to him is Ms. Gita Bhatt. She is Senior Officer of Media Relations. Back to the floor here, next to me are our Resident Representatives for Hong Kong, Mr. Sean Craig and Mr. Andre Meier. May I now ask Nigel to begin with making a short opening remark? Nigel.

MR. CHALK: Thank you Daisy. So, first of all, logistics, what we released today is the concluding statement we provided to the Hong Kong Government at the end of our mission in late October. Following on from this statement, what we will do is produce a staff report which will go to our Executive Board of the IMF and be considered by Executive Board at the end of this month. And then we anticipate, as is usually the practice, the Hong Kong government will consider publishing that staff report shortly after the board discussion. Let me just say a couple of words to add to what is in the concluding statement on the broad themes of the consultation this year and amplify a little bit on our views.

So, in terms of the themes in the statement itself I would point to the three broad themes for Hong Kong. One is on the property market. The second one on the pace of credit growth in Hong Kong. And the third issue is related to the Renminbi internationalization process. I think, when you look at all of these themes, there is an overarching theme that covers all of them. And this is the development that we’ve been seeing for many years now in Hong Kong and it’s an increasing inter-connectedness and an increasing integration with the Mainland economy. And over the past couple of years, the nature of that connectedness and the nature of that integration has been evolving and we picked that up in this year’s consultation as a general theme. Obviously, Hong Kong is very connected to the Mainland in terms of trade, very connected in terms of things like CEPA. The Hong Kong banks are increasingly expanding their branch network on the Mainland.

But what we see this year, and what we’ve highlighted in those three themes of credit, property and the Renminbi, is the connection to the Mainland. Clearly, the Renminbi internationalization process is very good for Hong Kong but one of the impacts of that is that financial markets in Hong Kong are becoming increasingly connected to the financial markets in the Mainland because of the presence of Renminbi trading offshore in Hong Kong. On credit, we can see the expansion of credit in Hong Kong and a large part of that credit is being devoted to Mainland enterprises. So, we’re seeing increasing connectedness between the lending operations of banks in Hong Kong to the Mainland corporations .

And on property, there’s certainly a Mainland presence in the property market in Hong Kong. And that also is another layer of interconnection between the two economies.

Finally, in addition to these themes, we have had quite extensive discussions with both the government and the private sector in Hong Kong on the external environment, and that’s another theme we’ve covered in the concluding statement. There certainly was a lot of concern over the evolving situation in Europe and the potential impact that may have on Hong Kong. And that impacts Hong Kong in a number of different ways, through the impact on growth and trade affecting Hong Kong directly, the effect on financial market volatility and risk aversion in global financial markets have an impact on Hong Kong’s international financial center.

And also, on the banking side, the impact of potential strains in funding, for instance in foreign currency funding markets can have on Hong Kong. So, those are just the main issues that were covered in this year’s consultation. Now, I would like to open it up to your questions.

MS. WONG: Thank you Nigel. Before we start the Q&As, I want to remind everyone that the content of the Preliminary Conclusions and that of this conference call is embargoed until 11:00 am Hong Kong time. Okay, I think we are ready to take questions. So, please raise your hand and identify your name and organization. Thank you.

QUESTIONER: I just have a question about the growth of Hong Kong that IMF predicted next year, it will be 4 per cent, right? So, may I know what is the reason that Hong Kong’s economic growth will slow down? And also as the Chief Executive, Mr. Donald Tsang, of Hong Kong has predicted that the growth of Hong Kong may be slowed down to 2 per cent and there may be a so-called technical recession which means... the growth of two quarters will be negative. So how will you comment on the comments of Mr Chief Executive? Thanks.

MR. CHALK: Generally, we see the domestic economy doing quite well in Hong Kong – unemployment has fallen to a very low level, domestic consumption is also doing very well. The main risk we see in Hong Kong right now probably is in the external environment. And that weakness in the external economy, we have already started to see in the Hong Kong numbers, the trade numbers, which we think will continue through next year. Right now, we don’t see that slowdown as being that dramatic but we do see growth in Hong Kong of around 4 percent next year and I would add that given the uncertainty in the international environment, the range of risk around that growth forecast is probably tilted to the downside with more of a chance that growth will come in lower than that number. As to the potential for a recession in Hong Kong, given the baseline forecast that we see under our current projection of global economic growth, we don’t feel that a recession is a likely scenario in Hong Kong right now. But should the situation of the global economy deteriorate further, certainly -- what we estimate is that the impact on Hong Kong is much higher than 1 to 1. A 1 per cent decline in growth in the global economy tends to have a much bigger effect on Hong Kong -- in terms of – leading to a decline of somewhere around 1.5 per cent in Hong Kong. That is mostly because Hong Kong is a very open economy, very reliant on trade, and also very reliant on financial services and usually, if we’re going to see volatility in global markets, it’s going to affect the financial services components of growth. So Hong Kong is exposed on both perspectives -- being an international financial center and being very trade-oriented and trade reliant including for trade services. So that’s why in this report we see growth as lower next year. We’re not projecting a recession at this point but we are conscious of that potential.

QUESTIONER: I would like to know -- as you mentioned that if there is like the crisis worked out in Europe then Hong Kong may enter recession. Do you think like -- if Greece or Italy have default or like any kind of -- what is the scale of the crisis? And also, what is the percentage of chance do you think this kind of crisis will break out in Europe? Thank you.

MR. CHALK: So, in our World Economic Outlook in September, one of the things we did was we articulated a downside scenario in Europe and then explained how that might evolve. In that scenario, the World Economic Outlook forecast, we forecasted a downward pressure on global growth. And -- so what we did was we took that scenario, something approximately close to that scenario, and we looked at what we would forecast would happen to Hong Kong. We found that, as you said, a decline in global growth would certainly push Hong Kong into recession. It would mean growth next year would be slightly negative instead of coming in at around 4 per cent. So the effect probably is quite large. In terms of probability, we don’t see this as a high probability event, but we think the consequences of such an event happening are very serious for Hong Kong. It definitely needs to be factored into policymaking right now. And in particular, the government should be ready, should that scenario start to evolve, to act very quickly particularly in putting in place a fiscal stimulus in order to provide some support for the domestic economy. It’s unlikely that they would be able to fully offset the downdraft that would be felt from a big shock in the global economy but at least they will be able to mitigate it, you know, in the same ways as they did in 2008.

QUESTIONER: You mentioned about the linked exchange rate system that it will be the best choice for Hong Kong. But as you said earlier, Hong Kong is highly related to Mainland China’s economy. So, as the situation in US and in Hong Kong is very different, why this is still best choice for Hong Kong?

MR. CHALK: Yes. The exchange rate system has been in place for a long time in Hong Kong, there is a lot of credibility behind that regime. In order for that regime to work well, it needs for the Hong Kong economy to be very flexible, it needs for domestic price and the wages to adjust instead of the exchange rate, in order to adapt to the changing external and domestic circumstances. And we have seen repeatedly in Hong Kong their exchange rate system does that, we see a lot of flexibility in the domestic economy and we see the economy adjust to both the inflation and deflation as it gets hit by positive and negative shocks. We think the exchange rate system works really well, it’s very credible, it’s very effective; and if you look at the pros and cons and all the different alternatives for Hong Kong, you’ll come to the very firm conclusion that the benefits of that system to Hong Kong outweigh the potential costs.

QUESTIONER: I think in the item four here, you suggest the government stop deliver the money for the whole city and -- but the second part, you mentioned if the Chinese economy is really facing this slowdown problem, probably there is a chance for the government to do more to support the people to get through the difficult time. I’m not sure whether do you think at this time, you know, the 6,000 [Hong Kong dollar cash handout] is not really a good idea and the government really should not do it ever more?

MR. CHALK: Well, I think if you look at the situation this year in the domestic economy, you’ve had growth quite strong, the economy exceeding potential growth. You have inflationary pressures in the domestic economy. And we didn’t really see any particular need for an aggregate fiscal stimulus to support domestic demand or domestic growth because the economy is running along quite nicely. So in that sense, we felt that the expansion of fiscal expenditures this year tended to be more pro-cyclical than they ought to have been. Instead of offering some restraint on the economy it was actually adding to growth. Having said that, we do see that there’s issues related to housing in Hong Kong, with prices moving ahead of income. There’s also issues related to the impact of inflation, food price inflation particularly, on lower income groups in Hong Kong. So we definitely see a role of government policy to act, to support the lower income groups through social systems, support to the elderly, support for people in public housing. What we don’t really see the need for is these universal transfers attributed to the entire population including the transfers -- you mentioned the HK$6,000 transfer -- but also transfers of money into people’s electricity accounts, universal transfers in the forms of reduction of rates. We just don’t see the need for those in the current state of the economy. Having said that, as I said before, if the economic situation deteriorates then we think the first line of defence should be fiscal policy. In that world, the government would be playing an appropriate countercyclical role of the economy gets hit by an external negative shock, the government should step in counter-cyclically, to provide support for the domestic economy which would help cushion some of the negative effects of the external shock.

QUESTIONER: Excuse me, may I follow up? I mean do you think it’s not proper for the government to do that this year?

MR. CHALK: From a macroeconomic perspective, we don’t see the need for universal transfers this year, either in the form of the $6,000 or in the form of electricity subsidy nor in the form of rates subsidies. We do see a need for targeted support for lower income groups.

QUESTIONER: Commenting on the Renminbi, because in your report you say an expectation of Renminbi appreciation over the medium term have aided the rapid development of offshore market. But so far, the Renminbi has risen about 4 per cent this year against the US dollar. So how far will it go? Because last year, it’s about roughly --

MR. CHALK: I can’t make that prediction on currencies, I’m afraid.

QUESTIONER: And the second question is about the -- I’m not sure whether it’s the worst case scenario or not, but you say the staff estimated in the event of sudden downside shock that radiates out from the Europe and reduces global growth around 3 percentage points, Hong Kong would fall into recession growth by dropping 4 to 4.5 percentage points below your forecast, right? So does it mean the worst case scenario will be about a 0.5 [percent of] GDP decline next year?

MR. CHALK: Yes, for next year, it’s something like that.

QUESTIONER: And then how about years ahead?

MR. CHALK: The scenario that is outlined in the WEO report was a relatively sharp decline in growth and then a very slow recovery from that growth downturn. Now that is a scenario to play out -- I think Hong Kong would have slightly negative growth next year and, going forward, relatively low growth in mind of the slow global recovery.

QUESTIONER: There are some saying that China may adopt a looser monetary policy and Premier Wen [Jiabao] has mentioned some similar things -- what is the possibility of this to happen and what will be good to Hong Kong? Thank you.

MR. CHALK: I think one consequence of the tighter monetary policy in the Mainland that we’ve seen over the past year and a half in Hong Kong has been an expansion of credit from the Hong Kong banks to the Mainland corporations as those corporations were unable to get that credit domestically in the Mainland market. So what that does is it raises two questions when we’ve seen this sort of experience in the international community, when you see this pattern of expansion of credit, you’ve always got to wonder about two things. First is credit quality, are the underlying standards being maintained? Is the bank managing risk well? And I think we came away relatively comfortable that -- the underlying risk of these loans weren’t that high and the regulators were being very cautious in trying to maintain underwriting standards. Second issue is related to funding. You could ask the question “where is the funding for this loan growth”. This is something more of a concern given the current global environment. You see loan to deposit ratios going up quite fast in foreign currency, particularly in non-Renminbi foreign currency, as well as local currency. And this is set against the uncertainty that the global environment and could be the case that we’re going to be in a negative scenario in the global environment where currencies and lending market will take a significant downturn which will then raise questions of would the banks still have that funding and will they be able to support their foreign currency lending. So we raised those concerns and their various implications. And there are definitely risks that the regulators are fully aware of and they are acting proactively to mitigate some of those risks including by requiring banks to have clear business plans on how to fund loans for lending. And also –in ensuring the maturity of the loans that they’re giving out is closely matched to the maturity of the funding so that they’re able to support the lending.

QUESTIONER: May I just have a question concerning about inflation of Hong Kong. You’ve mentioned that the property price may also affect the inflation of Hong Kong next year. At the same time, the economic growth of Hong Kong may slow down also next year. So, do you think there is a risk of so-called stagflation in Hong Kong?

MR. CHALK: Normally, what we see in property, it’s actually very difficult right now to try and get a sense of where the markets are going. When we were there a year ago, all of the forces of the Hong Kong property market were basically pushing the property market upwards. There was very little pushing back on the other side. This year, it’s quite different. I think the combination of the policy being taken by the government to reduce loan to value ratios and providing land supply, seems to be having an effect. And the second issue is, perhaps more importantly, is that concerns and worries about the global environment really seem to have changed and that has affected expectations about how the property market will evolve. There’s no longer this very solid expectation of price growth in the property market. On the other hand, the domestic property market is still very tight in terms of supply over the next couple of years with the new apartments in Hong Kong are very low levels of new construction. Interest rates have risen on mortgages but they’re still quite low from a historical perspective. And the domestic economy is doing quite well. Unemployment is low, household income growth is going quite well. And those factors will tend to push the market up. And so we don’t really know what the relative balance is between those factors. I think it will take several months of data before we get a real sense of where the market is going. And in terms of the inflation and -- what we see next year, as you say, is inflation staying relatively high in the 4-5 percent range, largely because of continued inflation from a delayed pass through of property price inflation to CPI. And really what that is, is actually a lagged effect of the property price inflation that has already happened in Hong Kong. It takes somewhere around 24 months for property prices to go up so that can be reflected in higher rents, and then for that to be measured in CPI. So, the inflation is essentially a part of what has already happened. So, you’re going to have some overhang from property related inflation into next year, and it’s going to keep inflation high. By the end of next year, that dynamic should be starting to decline.

QUESTIONER: May I just have a quick follow up? The economy of Hong Kong will slow down, right? So do you think there may be a risk for stagflation that is the inflation trend is higher than the economic growth?

MR. CHALK: Well, I think we still see inflation at around 4 to 5 per cent next year, that’s for most of the year. And growth of around 4 [per cent], I don’t think that you can characterize that as stagflation. What we will see is after the economy slows, the inflation rate components that are not linked to property, those will definitely come down. So the predominant driver of inflation really should be -- property prices feeding through rentals, driving inflation. So it’s not the same as stagflation at all because its driven by high property prices but that the other components should not be going up because the economy will slow taking some of the impetus out of non-property inflation . And also, the other thing that will happen is food price inflation, imported from the Mainland also should start to decline.

QUESTIONER: I think Obama mentioned that he believed that Renminbi was very much undervalued and what’s your view point on that? And how would that invalidate Hong Kong or the exchange rate thing?

MR. CHALK: We simply state that a stronger RMB is in China’s interest. Achieving the government’s own policy plans we think is quite hard to achieve without the Renminbi being stronger. It’s going to be quite difficult for the Mainland to generate a healthy, vibrant service economy without a strong Renminbi. We think it’s going to be very hard for them to head financial sector reform without a stronger Renminbi. It’s going to be quite difficult to get household incomes up, develop a service economy, or move ahead with financial sector reform and liberalization without an appreciating currency. So we think all these things are needed to help rebalance the economy in China, to put more money in the hands of households, to boost domestic consumption in China. So we think stronger Renminbi is definitely in the interests of China.

QUESTIONER: Also, I think IMF has some report on the Chinese banks saying FDI, abnormally, is really facing this slow down and there will be some kind of loan problem for the major banks in China. And do you mind to follow up a little bit on that and how serious do you think is the situation? What will really happen? What kind of percentage do you think it will be?

MR. CHALK: I think I’d prefer to stick to the Hong Kong questions -- they did have questions last night on the FSAP.

MS. WONG: I think we can take another time to discuss China. Okay, are there more questions from the floor? I think we can take one more question. If not, then I want to conclude the video conference here and thanks very much Nigel for your time.



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