People’s Republic of China—Hong Kong Special Administrative Region: Staff Concluding Statement of the 2017 Article IV Consultation Discussions

IMF News, November 29, 2017

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People’s Republic of China—Hong Kong Special Administrative Region: Staff Concluding Statement of the 2017 Article IV Consultation Discussions

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Bibliographic details

• Published: November 29, 2017

Overview and recent performance

• Date: November 29, 2017.
• The Hong Kong SAR economy gathered momentum since the second half of 2016 and over the course of 2017, in line with the global economic recovery.
• Momentum accelerated since mid-2016 amid: low global interest rates, Hong Kong SAR’s role as a trading and financial gateway to Mainland China, robust Mainland China growth, booming housing prices, and rebounding credit growth.
• Labor market remained tight with the unemployment rate edging down.
• Housing prices more than tripled over the past decade, leading to deteriorating housing affordability.
• Income inequality has narrowed slightly but remains high.

Outlook and key projections

• Near term:
  • Annual growth is projected to rise to 3½ percent in 2017 and remain strong at 2⅔ percent in 2018, up from 2 percent in 2016.
  • Consumption is expected to be supported by a tight labor market.
  • Investment is expected to remain strong, with major infrastructure and housing projects in the pipeline.
  • Inflation remains contained at below 2 percent.
• Medium term:
  • With continued gradual global recovery and orderly U.S. monetary tightening, Hong Kong SAR is projected to grow at about 3 percent, its medium-term potential growth.

Risks (balance and key downside scenarios)

• Overall: Balance of risks improved since last year but remains tilted to the downside from external and domestic sources.
• Specific risks:
  • Correction in property prices:
  • Property prices rose by 15 percent (yoy in September).
  • IMF staff analysis suggests the degree of overvaluation has increased.
  • High sensitivity of household debt service burden to interest rate changes because significant portion of new mortgages are on floating rates and indexed to the Hibor.
  • A disorderly housing market adjustment could significantly reduce private consumption via negative wealth effects and trigger adverse feedback loops affecting banks’ balance sheets.
  • Tighter-than-expected global financial conditions from monetary policy surprises in the U.S. or Euro Area could increase volatility and weigh on domestic demand.
  • Disorderly adjustment in Mainland China could hit tourism, trading and logistics industries, which account for more than a quarter of GDP and employment in Hong Kong SAR.
  • Retreat from cross-border integration (protectionism, inward-looking policies) could reduce trade, investment, and labor flows and damp productivity and global growth; Hong Kong SAR would be negatively affected due to high openness.

Buffers and resilience

• External: Low vulnerabilities in the international investment position with large net foreign assets and foreign exchange reserves.
• Fiscal: Conservative fiscal management has built buffers:
  • Fiscal reserves amounting to about 25 months of total government expenditure.
  • Gross government debt of less than 0.1 percent of GDP.
• Banks: Strong capital buffers and ample liquidity, well above international standards; asset quality remains very strong.
• Macroprudential: Progressive tightening since 2009 has enhanced resilience to property price shocks.

Fiscal policy recommendations

• Current assessment:
  • Current fiscal stance assessed as appropriate; additional fiscal stimulus is not needed given cyclical position.
  • FY16/17 recorded a larger-than-expected fiscal surplus of 4½ percent of GDP.
  • IMF staff projects the fiscal surplus in FY17/18 to narrow to 2¼ percent of GDP.
  • Little need for additional fiscal stimulus in FY18/19 and beyond; several temporary tax relief measures could be phased out.
• Short-term countercyclicality:
  • Fiscal policy should be the main demand management tool under the currency board arrangement, supporting aggregate demand when cyclical conditions worsen and tightening otherwise.
  • The current fiscal rule of adherence to at least budget balance should be implemented flexibly and symmetrically over the cycle, rather than every year.
  • If downside risks materialize, the government should actively use fiscal policy to support domestic demand; short-term measures should align with long-term goals.
• Medium- to long-term fiscal framework adjustments:
  • Aging will lead to higher pension and healthcare spending (estimated to rise by 2 percentage points of GDP by 2030).
  • Revenues could decline by at least 3 percentage points of GDP as the real estate market stabilizes.
  • A structural deficit will emerge by 2030 unless additional revenues are mobilized or social safety nets are scaled back significantly.
  • Suggested policy options:
  • Expenditure reprioritization via expenditure reviews, though likely insufficient alone.
  • Revenue mobilization while maintaining competitiveness, including options identified by international benchmarking:
  • Introducing/raising indirect taxes (such as VAT and excises) to avoid overreliance on direct taxation.
  • Increasing top marginal income tax rates modestly.
  • The new tax policy unit to review broadening of the tax base is welcomed; it should study distributional, efficiency and growth impacts of revenue measures.

Housing market—three-pronged approach and recommendations

• Supply:
  • Sustained increases in housing supply are critical to resolving structural supply-demand imbalance.
  • Housing supply has been rising under the Long-Term Housing Strategy (adopted 2014); Hong Kong 2030+ is being finalized for longer-term land and housing development.
  • Practical obstacles (lack of ready sites, development restrictions) may make meeting the ten-year housing supply target difficult; benefit to expediting land/site identification and related assessments.
• Macroprudential measures:
  • Have been effective in building buffers and limiting financial system exposure to the housing boom.
  • Measures have strengthened banks’ mortgage loan origination standards; they should remain in place while risks persist.
  • Property developers have been increasing lending to households; authorities should consider adjusting macroprudential measures as financial stability risks evolve.
• Stamp duties and other demand measures:
  • Stamp duties have helped contain house prices and household leverage; IMF staff analysis finds them effective.
  • Buyer’s Stamp Duty and Double Ad-Valorem Stamp Duty are assessed as capital flow management and macro-prudential measures under the IMF’s Institutional View because they discriminate between residents and non-residents.
  • These duties are assessed appropriate given: (i) surge of capital flows into property; (ii) not substituting for necessary macroeconomic adjustment; (iii) additional HKMA tightening could exacerbate leakages to non-bank financial institutions and property developers outside the regulatory perimeter.
  • Going forward, once systemic housing market risks dissipate, both stamp duties should be phased out and replaced with alternative non-discriminatory measures.
  • Authorities could phase out mortgage interest deductibility as it boosts housing demand and encourages higher leverage.

Preserving the monetary anchor and external position

• The Linked Exchange Rate System (LERS) remains the best arrangement for Hong Kong SAR.
• LERS is supported by flexible economy, ample fiscal and reserve buffers, and strong financial regulation and supervision; it anchors stability for a highly open, globally integrated financial sector.
• Over the medium term, as U.S. monetary policy normalizes, the HK dollar could resume real appreciation in line with the U.S. dollar, raising competitiveness concerns.
• Flexible product and labor markets should allow rapid adjustment to prevent persistent departures from equilibrium REER.
• The external position in 2016 is assessed to be broadly consistent with medium-term fundamentals and desirable policy settings.

Financial stability—assessment and recommendations

• Overall assessment:
  • The financial system is well placed to cope with challenges due to robust regulatory and supervisory framework.
  • Potential systemic vulnerabilities and regulatory arbitrage are monitored via the Financial Stability Committee, Mainland China dialogue, and global fora participation.
• Specific points:
  • Banks have ample loss-absorption buffers and limited short-term funding vulnerability.
  • Mainland China-related exposures are closely monitored and assessed as manageable.
  • Large credit-to-GDP gap estimated at 35 percent (Bank for International Settlements); introduction and progressive increase of the countercyclical capital buffer (CCyB) is appropriate.
  • Substantial progress made on 2014 FSAP recommendations; comprehensive recovery and resolution framework commenced operation in July 2017.
• Regulatory priorities:
  • Strengthen oversight of non-bank institutions (securities markets, broker dealers, asset managers) to prevent risks from new channels connecting Hong Kong SAR and Mainland China.
  • Mitigate risks from property developers’ lending to households; HKMA tightened capital requirements for banks lending to developers with high mortgage lending-to-equity ratios.
  • Maintain high standards for securities listing.
  • Continue development of the new risk-based capital regime for insurance (Phase 2 focuses on detailed quantitative rules).
  • Continue close monitoring of Mainland China exposures.
  • Enhance oversight of cybersecurity risks.
• Fintech:
  • Authorities’ initiatives (Fintech Facilitation Office, Fintech Innovation Hub, central bank digital currency project, cross-border collaboration) are welcome.
  • Need to balance greater efficiency and innovation with stability and integrity risks (cyberattacks, money-laundering, terrorism financing).
  • Use of “regulatory sandboxes” is appropriate; regulators should continue to review and enhance fintech regulatory framework.

Inclusive growth, social policy and labor market

• Authorities’ actions:
  • Spending on social welfare, housing and health has increased to around 33 percent of public spending.
  • Almost half of all households live in subsidized housing.
  • Statutory minimum wage introduced in 2011 and increased three times; it has helped boost labor supply without damaging wage flexibility.
  • Plans to enhance the Low-Income Working Family Allowance Scheme (boost monthly payments and relax income and working hour requirements) are welcome.
  • Authorities are enhancing the multi-pillar retirement protection system and developing financial products to convert assets into post-retirement income.
• Recommendations:
  • Continue promoting sharing of growth benefits.
  • Implement changes to the Mandatory Provident Fund system, including abolition of the arrangement for “offsetting” severance payment and long service payment.
  • Working hours policy should balance equity and labor force participation without compromising competitiveness.
  • Review social safety net with consideration for consolidating and strengthening means-testing of programs for the elderly.
  • To address projected decline in labor force, consider providing childcare for young children to boost female labor force participation and increase fertility.

Closing remark

• The mission thanked the Hong Kong SAR authorities for their hospitality and the open and productive nature of discussions.

Staff Concluding Statement of the 2017 Article IV Consultation Discussions, November 29, 2017.

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References

• People's Republic of China and the IMF
• People's Republic of China - Hong Kong Special Administrative Region and the IMF
• People's Republic of China - Macao Special Administrative Region and the IMF
• IMF Policy Advice -- A Factsheet
• Mission Concluding Statements
• PRESS CENTER
• https://www.imf.org/en/home