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

March 2, 2001

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.

On February 16, 2001, the Executive Board concluded the Article IV consultation with People's Republic of China in Respect of the Hong Kong Special Administrative Region.1


The recovery from the Asian crisis, which began in mid-1999, gained momentum in 2000. Initially, the turnaround was driven by net exports, reflecting the rapid growth of Mainland re-exports (by far the largest component of Hong Kong SAR's trade). Since late 1999, net exports gave way to domestic demand—spurred largely by restocking of inventories—as the dominant driver of growth. Private investment also picked up from the low base of 1999. However, the recovery in consumption has been somewhat slower. The unemployment rate has declined slowly from March-May 1999 peak of 6¼ percent to 4½ percent in late 2000. The prolonged deflation—which has helped unwind the appreciation of the real exchange rate during the Asian crisis, thereby improving external competitiveness—has eased considerably.

Market confidence has strengthened. Riding on strong foreign portfolio inflows, stock prices surged in the early part of the year, before weakening in line with the U.S. market to settle around pre-crisis levels. The capital inflows also pushed money market rates below those in the United States for the better part of 2000. Overall, monetary conditions are liquid, as reflected in a rising bank deposit-to-loan ratio. Lending rates, especially on mortgages, have also declined substantially but remain high in real terms due to deflation.

Hong Kong SAR banks endured the recession relatively well, despite the high exposure to the property sector. At an average 18 percent, bank capitalization remained well above the Basle standard, the ratio of nonperforming to total loans has started to decline from its peak of 10½ percent in the third quarter of 1999, and profitability was up. The HKMA also embarked on a gradual liberalization of remaining interest rate rules operated by the Hong Kong Association of Banks—the first phase of which was completed in July 2000. The final phase is scheduled for July this year. Despite the strong recovery, loan growth remains low, with the pick up in investment being financed mainly internally and through the equity market.

Hong Kong SAR's budgetary position has traditionally been in surplus, and fiscal policy generally has not been countercylical except during the Asian crisis. In response to the crisis, the government eased fiscal policy temporarily, mainly by bringing forward large public sector projects. With the improvement in the economic situation, public investment has been reduced. However, for FY 2000 the government envisages a slightly higher fiscal deficit than budgeted, reflecting a shortfall in privatization revenue.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They were impressed with the rapid economic recovery in 1999-2000 after a short but painful period of adjustment following the Asian crisis. Directors noted that real GDP rebounded, unemployment declined, and market confidence remained strong, despite regional uncertainty and high oil prices. They credited this turnaround to the flexibility of Hong Kong SAR's markets, and to the authorities' pragmatic handling of fiscal policy during the recession.

Directors observed that the continued fall in prices did not reflect generalized demand weakness, but mainly the lagged response of rental contracts to the correction in property prices. They pointed out that deflation had improved Hong Kong SAR's competitiveness by reversing the real exchange rate appreciation that had occurred during the early stages of the Asian crisis. Looking ahead, Directors noted that, according to staff estimates, economic growth in 2001 is likely to slow to its trend rate of around 4 percent, reflecting the fading impetus from stock building and a weaker external environment, while deflation will give way to low inflation. However, downside risks remain, especially if the external environment worsens, and will require continued vigilance by the authorities.

Directors observed that Hong Kong SAR's rules-based approach to economic policy has been effective and reiterated their strong support for the linked exchange rate system, which has been underpinned by commodity and factor price flexibility in the domestic market and continues to provide a stable and transparent policy framework. They observed that the measures introduced by the Hong Kong Monetary Authority in 1998 to strengthen the currency board appear to be working well and welcomed the authorities' intentions to continue refining the system as circumstances warrant.

Directors commended the authorities' long record of skillful fiscal management. They praised the pragmatic injection of fiscal stimulus during the Asian crisis in 1998-99 when, within a medium-term framework of returning to budget balance, traditional surpluses gave way to a deficit. Directors viewed the fiscal stance in 2001-02, as charted in last year's medium-range forecast, to be appropriate.

Over the longer term, Directors noted that the aging of the population and the need to upgrade human capital continually to maintain a competitive service-based economy would put pressure on health and education spending, while revenue growth could slow if stamp duties and other property-related revenues lag behind GDP growth. In this context, Directors welcomed the timely establishment of the Task Force on Review of Public Finances to study the causes of the recent deterioration in the operational fiscal balance, and of an Advisory Committee to examine the pros and cons of a broad-based goods and services tax and alternative revenue-enhancing measures. In this context, a few Directors noted that the particular advantages of Hong Kong SAR's tax system should not be undermined.

Directors recommended that the authorities also consider measures to control the growth in health spending, such as greater cost-sharing arrangements in the area of public health, including more private insurance and higher user fees, with appropriate safeguards for the needy.

Directors expressed concern that income disparity had worsened during the Asian crisis, as real incomes of low-skilled workers declined significantly. They supported the authorities' approach of tackling this issue through greater public efforts in raising skill levels, while also stressing the need to have an adequate safety net in place, especially in view of the aging population.

Directors observed that the banking system had demonstrated its resilience during the turbulence of the Asian crisis. They attributed this resilience to prudent banking practices, strong legal institutions, and an effective supervisory framework. Directors welcomed the scheduled removal of the remaining deposit interest rate ceilings in July 2001, and commended the efforts to establish a commercial credit reference agency.

Directors welcomed the recent steps to reform the securities market that would enhance Hong Kong SAR's reputation as an international financial center, including, in particular, the establishment of a U.S. dollar clearing system in Hong Kong SAR; the proposed introduction of deposit insurance; the introduction of the composite Securities and Futures Bill; and the move to risk-based supervision of banks and regular assessment of cross-market risks. Directors also welcomed the authorities' interest in participating in a Financial Sector Assessment Program.

Some Directors observed that, while the banking sector and equity markets in Hong Kong SAR continue to intermediate the economy's financing needs efficiently, there remains further scope to strengthen the international financial center through the deepening of the private debt market. Directors also welcomed the progress achieved in disposing the domestic equities acquired during the stock market intervention in August 1998 in an orderly and transparent manner.

Directors noted that China's upcoming accession to the WTO is likely to have significant effects over time on the economy of Hong Kong SAR. They observed that, while Hong Kong SAR is likely to lose some traditional activities, such as trans-shipment trade and low value-added financial services, new opportunities will open up as demand for advanced financial and managerial services from the Mainland is expected to rise. Although available studies suggest that, on balance, the impact of accession would be beneficial for Hong Kong SAR, they stressed that, in order to take full advantage of the increased opportunities, Hong Kong SAR will need to continue to pursue steadfastly its efforts to upgrade the economy's infrastructure and human capital.

Directors noted that, although Hong Kong SAR is one of the most open economies in the world, domestic competition issues need to be monitored closely, especially in some of the unregulated sectors, as the lowering of business costs would remain critical to the economy's future. In this connection, they urged the authorities to keep under review the most appropriate ways of ensuring transparent and fair competition, including the option of establishing a formal competition law. They also stressed the importance of improving the quality of corporate accounts and disclosure, especially for small and medium-sized enterprises.

Directors welcomed Hong Kong SAR's compliance with the Fund's Special Data Dissemination Standard. They commended the authorities' efforts to publish data on their international investment position and bring forward the publication of external debt data to mid-2002. They urged the authorities to continue to make progress in publishing a monetary survey and fiscal accounts in a standardized international format.

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

  1997 1998 1999 2000

Real GDP (percent change) 5.0 -5.3 3.1 10.0
Real domestic demand (contribution) 8.4 -10.3 -5.0 9.0
Foreign balance (contribution) -3.4 5.0 8.1 1.0
Saving-investment balance (percent of GDP) -3.1 1.4 5.6 5.6
Gross domestic saving 31.3 30.4 30.7 31.9
Gross domestic investment 34.4 29.0 25.1 26.4
Inflation (percent change)        
Consumer price 5.8 2.8 -4.0 -3.7
GDP deflator 5.8 0.6 -5.3 -6.3
Employment (percent change) 3.2 -1.3 -0.5 3.4
Unemployment rate (percent) 2.2 4.7 6.3 5.0
Real wages 1.0 0.1 3.8 ...
Government budget (percent of GDP) 1/        
Revenue 21.2 17.1 18.9 18.9
Expenditure 14.7 19.0 18.1 19.1
Consolidated budget balance 6.6 -1.8 0.8 -0.2
Reserves at March 31 34.6 34.4 36.0 34.8
Money and credit (percent change, end-period)        
Narrow money (M1) -4.3 -5.0 13.9 ...
Broad money (M3) 8.2 10.5 7.7 ...
Loans for use in Hong Kong SAR 24.4 -3.8 -7.2 ...
Interest rates (percent, end-period)        
Best lending rate 9.5 9.0 8.5 ...
Three-month HIBOR 9.1 5.1 5.7 ...
Merchandise trade (percent change)        
Export volume 6.1 -4.3 3.7 16.7
Domestic exports 2.2 -7.9 -7.2 6.1
Reexports 6.8 -3.7 5.4 18.2
Import volume 7.2 -7.1 0.2 14.8
Export value 4.2 -7.4 0.1 16.7
Import value 4.9 -11.5 -2.5 17.9
External balance (in billions of US$)        
Merchandise trade balance -17.3 -7.8 -3.2 -6.3
In percent of GDP -10.1 -4.8 -2.0 -3.8
Current account balance -6.2 3.9 10.5 9.6
In percent of GDP -3.6 2.4 6.6 5.9
Foreign exchange reserves (in billions of U.S. dollars, end of period) 92.8 89.6 96.3 107.5
(In months of retained imports) 14.6 17.1 19.8 ...

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

1/ Fiscal year.

1 Under 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. This PIN summarizes the views of the Executive Board as expressed during the February 16, 2001 Executive Board discussion based on the staff report.


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