People’s Republic of China—Hong Kong Special Administrative Region: Staff Concluding Statement of the 2019 Article IV Consultation Discussions

IMF News, December 4, 2019

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• Published: December 4, 2019

Slowing growth and macroeconomic outlook

• After robust growth of 3 percent in 2018, economic activity weakened significantly in 2019 and the economy fell into a technical recession in Q3.
• Drivers of the slowdown:
  • Rising trade tensions between the U.S. and China and heightened uncertainty affecting exports and investment.
  • Private consumption and visitor arrivals declined significantly due to social unrest starting in summer 2019.
  • Housing sector moderation with property prices declining by about 4 percent between May and September.
• Labor market and inflation:
  • Unemployment rate remained low at 2.9 percent in Q3.
  • With an estimated negative output gap of about 2¾ percent of GDP in 2020, inflation is projected to fall to around 2½ percent as food prices stabilize.
• Growth projections:
  • GDP is expected to contract by 1.2 percent in 2019.
  • Growth is projected to rise to 1 percent in 2020, led by a recovery of private consumption but remain well below potential growth of about 2½ percent.
• Risks to the outlook:
  • Downside risks: further escalation of U.S.–China trade tensions; restrictions in technology and financial sectors; significant slowdown or disorderly adjustment in Mainland China; deterioration of sociopolitical situation; delays in addressing insufficient housing supply and high income inequality; potential adverse feedback loop between house prices, the real economy, and the financial sector.
  • Upside risks: easing of trade tensions; development of the Greater Bay Area.

Buffers and financial resilience

• External and fiscal buffers:
  • FX reserves at around 120 percent of GDP or twice the monetary base.
  • Net international investment position of about 390 percent of GDP.
  • Fiscal reserves of about 40 percent of GDP.
• Financial sector resilience:
  • Banks’ capitalization and liquidity levels are well above international standards following enhanced regulatory and supervisory frameworks.
  • Key Basel III standards implemented; countercyclical capital buffer lowered from 2.5 to 2.0 percent in October 2019 to support lending.
  • HKMA updated liquidity facilities and introduced a new resolution facility.
  • Securities and Futures Commission capped total margin lending to clients by brokers for stock purchases at five times of the brokers’ capital since October 2019.
  • Insurance Authority progressing with a risk-based capital regime; third quantitative impact study launched in August 2019.

Policy recommendations — A. Fiscal support for macroeconomic stability

• General guidance:
  • With comfortable fiscal reserves, expansionary fiscal policy is needed to support the near-term slowdown while maintaining long-term sustainability given rapid population aging.
  • Align short-term measures with long-term goals and shift spending forward (e.g., on identified infrastructure projects).
• Near-term actions:
  • Increase government spending significantly to cope with the downturn and address structural housing supply and income inequality issues.
  • Mission supports announced measures: support for SMEs, further tax relief, extra social security payments, and subsidies for households.
  • Projected fiscal stance: fiscal surplus to remain at about 1 percent of GDP over the medium term.
  • Recommend an additional comprehensive medium-term fiscal package, including another fiscal stimulus in the current fiscal year targeted to vulnerable households and SMEs.
• Specific fiscal package quantified effects:
  • Spending increases of around 1½ percent of GDP per year (8 ppt of GDP in total over 2019–24), relative to the projected baseline, would help close the negative output gap over the medium term with a drawdown of fiscal reserves of about 5½ ppt of GDP.
  • Possible components:
  • Targeted transfers: additional fiscal spending of about 2½ ppt of GDP over two years, frontloaded to the current fiscal year, targeted to vulnerable households and SMEs (extra allowances, rent relief, subsidies for low-income students).
  • Housing/infrastructure: cumulative increase in spending of 3½ ppt of GDP over the next five years would increase real GDP by about 2¼ ppt during this period.
  • Education/training: increasing spending cumulatively by 2 ppt of GDP over the next five years would increase real GDP by about 2½ ppt in the long run.
• If growth falters more than expected:
  • Provide more near-term fiscal support: additional targeted spending to vulnerable households and SMEs; scale up retraining programs and housing/infrastructure projects.
• Medium-term fiscal sustainability measures:
  • Raising revenues: consider introducing a VAT, raise excise taxes, increase the top personal income tax (PIT) rate and the tax rate under personal assessment; reverse the lowering of effective PIT rates since 2018 once conditions improve; consider introducing a carbon tax for some sectors.
  • Optimizing spending: conduct regular fundamental expenditure reviews; prepare a long-term healthcare spending strategy.
  • Improve budget planning and execution: reduce reliance on property-related revenues; avoid systematic under-execution of operating expenditures.
  • Increase labor force participation: expand provision of childcare services, especially for children below two years and at subsidized rates for poor/single parent families, to encourage female labor force participation.

Policy recommendations — B. Containing housing market risks

• Strategy validation:
  • Continue the three-pronged approach: macroprudential measures, stamp duties, and increasing housing supply.
  • Housing prices remain overvalued and affordability stretched; sustained supply increase is critical.
• Supply actions:
  • Accelerate increase in land allocation for residential housing; expedite identifying land/building sites and streamline environmental, transportation, and other assessments.
• Macroprudential stance:
  • Stand ready to adjust measures based on financial stability risks; tighten further if housing prices and mortgage lending increase rapidly.
  • Apply the same macroprudential policies to all mortgage providers to prevent regulatory leakages to non-banks.
• Stamp duties:
  • New Residential Stamp Duty (NRSD) continues to be appropriate while systemic risk from the housing market remains elevated.
  • Under the IMF’s Institutional View on capital flows, NRSD should be phased out and replaced with alternative non-discriminatory macroprudential measures when systemic risks from non-resident inflows dissipate.
• Mortgage Insurance Program (MIP) changes and monitoring:
  • Eligibility adjustments: maximum property values eligible for higher LTV ratios with the MIP were raised from HKD 4 to 8 million (LTV ratio of 90 percent) for first-time home buyers and from HKD 6 to 10 million (LTV ratio of 80 percent) for all home buyers.
  • MIP financing: about 9 percent of new mortgages were financed with this insurance for the first nine months of 2019.
  • Authorities should carefully monitor overall impact on housing market and household leverage and stand ready to adjust macroprudential policies and the MIP.

Policy recommendations — C. Safeguarding financial stability

• Ongoing priorities:
  • Consider sectoral macroprudential measures (e.g., sectoral risk weights or caps on total sectoral exposures) to limit concentration risk given elevated private non-financial sector debt and pockets of corporate vulnerability.
  • Maintain close coordination with home country authorities of Hong Kong SAR-based subsidiaries/branches of global banks, particularly on resolution planning and loss-absorbing capacity requirements.
• AML/CFT findings and actions:
  • Recent FATF assessment found Hong Kong SAR has a solid AML/CFT system with a strong legal and institutional framework.
  • Authorities should enhance prosecution of money laundering involving crimes committed abroad and strengthen supervision of certain non-financial businesses.
  • Implement priority actions from the Mutual Evaluation Report on AML/CFT, including transparency of corporate and trusts.
• Fintech and operational resilience:
  • HKMA stepped up supervision of technology risk management and operational resilience.
  • HKMA granted eight virtual banking licenses expected to become operational from late 2019; virtual banks must meet same supervisory rules as conventional banks.
  • Implement Cybersecurity Fortification Initiative and enhance cross-agency collaboration to close regulatory loopholes timely.
• Opportunities:
  • Green finance: three green finance initiatives launched in May 2019, including promoting Green and Sustainable Banking.
  • Greater Bay Area: Outline Development Plan announced in February 2019; measures to improve cross-border cooperation and pilot initiatives to allow e-wallets for cross-border payment and streamline opening Mainland bank accounts by Hong Kong SAR residents on a pilot basis.

Policy recommendations — D. Preserving an anchor of stability (Linked Exchange Rate System)

• LERS assessment:
  • The Linked Exchange Rate System (LERS) remains the appropriate arrangement for Hong Kong SAR to anchor monetary and financial stability.
  • Credibility of the currency board arrangement supported by transparent rules, ample fiscal and FX reserves, strong regulation and supervision, flexible economy, and prudent fiscal framework.
• Operational status:
  • LERS continues to function well despite increased global financial market volatility: interbank rates stable, net capital outflows limited, and market expectations of HKD/USD exchange rate well anchored.
  • Authorities should continue policies to support smooth functioning of the LERS, including strong public communications on the arrangement and HKMA’s FX operations and enhanced communication on overall FX and money market developments.

Mission concluding statement, December 4, 2019 — IMF Communications Department

References

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