People’s Republic of China—Hong Kong Special Administrative Region: Staff Concluding Statement of the 2022 Article IV Consultation Discussions

IMF News, January 20, 2022

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Published: January 20, 2022

From Strong Recovery to Sustainable Growth

Economy recovered strongly supported by swift and bold policy responses to multiple shocks since 2019, including social unrest, U.S.-China tensions, and the pandemic.
Fiscal stimulus: about 12¼ and 3½ percent of GDP in 2020 and 2021, respectively.
Tentative handoff from public to private demand in 2021Q2-Q3 with recovery in private consumption and investment offsetting fiscal withdrawal and softening external demand.
Private consumption remains below pre-pandemic level; employment in some contact-intensive sectors (e.g., retail services) declined further in 2021 despite overall unemployment rate falling from a peak of 7.2 percent in the three-month period ending in February 2021 to 4.3 percent in October.
Real GDP projections:
- 2021: 6.4 percent
- 2022: 3.0 percent
Negative output gap expected to narrow to about 1 percent of potential GDP.
CPI inflation projected to gradually rise to about 2 percent in 2022.
Medium-term outlook: potential GDP growth expected to slow to below 3 percent due to structural headwinds such as population aging; pandemic scarring via uneven labor market recovery partially offset by increasing digitalization.

Balance of Risks

Downside risks:
- Pandemic-related uncertainty and new variants could slow border reopening and private consumption recovery.
- Slower-than-expected global recovery, sustained supply chain disruptions, de-globalization and decoupling risks.
- Sharp rise in global risk premia, disorderly tightening in major advanced economies, large housing market corrections, escalating U.S.-China tensions, and shifts in market confidence in Hong Kong SAR’s international financial center status could affect capital flows.
Upside risks:
- Faster-than-expected border re-opening could strengthen private consumption.
- Faster global recovery could boost exports.
- Greater Bay Area (GBA) development could improve medium- and long-term growth prospects.

Supporting Balanced and Inclusive Growth

A. Adjusting Macroeconomic Policy to the Pace of the Recovery

Shift financial policy focus from liquidity to solvency issues for corporates and individuals as recovery progresses.
Authorities plan to engage banks on exit strategy from loan repayment deferral scheme expiring at end-April 2022; welcome initiative.
Leverage robust corporate insolvency framework to restructure viable firms and allow nonviable firms to exit; planned statutory corporate rescue procedure in line with international best practice is timely.
Countercyclical capital buffer (CCyB) cut during the pandemic appropriate; HKMA should be ready to adjust CCyB consistent with systemic risk assessments.
Fiscal consolidation guidance:
- 2022: cyclically adjusted primary balance tightening by about 1½ percent of potential GDP.
- Medium term from around 2023: gradual consolidation at about ½ percent of GDP per year.
Near-term fiscal support: more targeted measures for low-income households, unemployed workers, and affected SMEs; leverage digitalization for better targeting (example: additional electronic consumption vouchers for low-income households meeting assistance criteria; temporary relaxation of Comprehensive Social Security Assistance Scheme eligibility).
Medium-term fiscal tools: consider a dedicated unemployment benefit system to expand automatic stabilizers.

B. Addressing Structural Challenges via Fiscal Policy

Social welfare and healthcare: strengthen medical services and financial assistance for the elderly, notably among low-income households.
Education and training: upgrade human capital with focus on digital-related technologies to mitigate scarring and facilitate sectoral labor reallocation.
Public housing: step up expenditure to increase public housing and related infrastructure; critical to address supply-demand imbalance and improve affordability.

C. Tax Reform

Comprehensive tax reform over the medium term is imperative to address long-term fiscal needs, build buffers, and secure greater equity.
Considerations from international benchmarking: introduce a VAT, raise excise taxes, increase progressivity of personal income tax by raising tax rates on top brackets; consider taxes on capital gains and dividends.

Strengthening Productivity and Competitiveness

Further integration with regional and global economies to strengthen status as regional trade hub.
Hong Kong SAR considering participation in RCEP; current members account for more than 70 percent of Hong Kong SAR’s total trade.
In GBA development, strengthen coordination among regulators in Mainland China and Hong Kong and Macao SARs, accounting for legal, regulatory, and institutional differences.
Accelerate digitalization initiatives (Smart City Blueprint, “Fintech 2025”) to facilitate sectoral reallocation toward digitalized services and promote financial inclusion for low-income groups, the elderly, and SMEs.

Safeguarding Financial Stability

Financial system remains resilient supported by significant policy buffers, a strong external position, and strong institutional frameworks.
Hong Kong SAR financial system continued expanding robustly during the pandemic and retained role as major international financial center.

A. Opportunities and Challenges from Rising Ties with Mainland China

Deepening financial linkages: launch of cross-boundary Wealth Management Connect Scheme in the GBA and Southbound Bond Connect Scheme; HKMA collaboration with People’s Bank of China on Multiple CBDC Bridge project and cross-border retail e-CNY testing.
e-CNY potential: reduce costs and increase speed of cross-border transactions; compliance risks across jurisdictions need careful study before large-scale adoption.
Monitor Mainland China-related credit risks:
- NPL ratio from Mainland-related lending: 0.8 percent as of June 2021.
- Hong Kong SAR banks’ overall NPL ratio: 0.9 percent.
Monitor credit exposure to Mainland China’s real estate sector given recent financial stress in several Mainland property developers.
Ensure internal credit risk models for Mainland Chinese borrowers, particularly low-rated real estate exposures, are sufficiently forward-looking.
Continue close monitoring of banks’ exposures to non-bank Mainland Chinese entities and conduct periodic stress tests of banks’ large exposures in addition to regular stress testing.

B. Strengthening Resilience to Global Risk Sentiment

Maintain free flow of capital to safeguard Hong Kong SAR and regional/global financial stability; preserve rule of law and high-quality regulatory framework.
Closely monitor financial markets and banking sector; be ready to contain systemic risk with clear communication.
Liquidity monitoring recommendations:
- Integrate all bank liquidity stress tests into a single framework to enhance monitoring of vulnerable segments such as foreign bank branches relying on unsecured interbank funding.
- Integrate monitoring and stress testing of investment funds’ liquidity into supervisory framework.
Linked Exchange Rate System (LERS) remains appropriate anchor; credibility ensured by transparent rules, ample fiscal and FX buffers, strong regulation, flexible economy, and prudent fiscal framework.

C. Containing Housing Market Risks

Three-pronged approach to increase housing affordability and contain risks remains valid; more efforts needed to raise housing supply.
Housing production increased on average since 2015 but still fell short of target by about 30 percent on average.
Staff welcomes identification of land to provide 330,000 public housing units within the next ten years and urges authorities to bring actual production back to target without further delays.
Urgent comprehensive approach: increase land supply (land resumption, reclamation, rezoning), expedite and streamline land identification and production processes.
Northern Metropolis development strategy could help boost housing supply over the longer-term period.
Maintain existing residential property market-related macroprudential policies for now; any changes should be data-dependent with attention to regulatory leakages.
Council of Financial Regulators should lead strengthening surveillance and data collection on lending by non-bank lenders; regularly reassess need to expand regulatory perimeter.
Stamp duties: effective in containing speculative activity and external demand; staff recommends phasing out the New Residential Stamp Duty (a residency-based capital flow management measure and a macroprudential measure levied at a higher rate on non-residents than on first-time resident home buyers) once systemic risks from non-resident inflow dissipate.

D. Further Enhancing Regulatory and Supervisory Frameworks

Ongoing efforts to strengthen regulatory and supervisory frameworks are welcome.
Early implementation of FSAP recommendations, improved data collection through Granular Data Reporting.
Enhance macroprudential oversight via a more comprehensive and systematic approach to identify and address systemic risk.
Fintech and operational resilience:
- Strengthen operational resilience and cyber security alongside fintech development.
- Improve cross-regulator coordination for a holistic activity-based approach across sectors (cyber and IT-related risks, RegTech adoption, artificial intelligence).
- Continue reviewing regulatory perimeter for non-bank fintech firms.
- Closely monitor trading of virtual assets to identify and mitigate risks, including fraud and money laundering/financing of terrorism.

Seizing Opportunities for a Greener Economy

Significant progress over last decade on climate change; updated action plan to achieve carbon neutrality before 2050 with intermediate target of reducing carbon emissions by 50 percent from the 2005 level before 2035 is welcome.
Consider introducing additional carbon pricing mechanisms to incentivize energy saving and green transportation while supporting low-income households.
Strengthen systemic risk analysis for climate-related risks:
- Embed climate-related risks in financial institutions’ risk management and authorities’ systemic risk analysis.
- Authorities to adopt mandatory climate-related financial disclosures aligned with the Task Force on Climate-related Financial Disclosures by 2025.
- Promote climate-focused scenario analysis by financial institutions.
Develop green and sustainable finance ecosystem:
- Adopt forthcoming internationally accepted standards, subsidize eligible green and sustainable bond issuers and borrowers, and scale up government green bond issuance to develop Hong Kong SAR into a green and sustainable finance center.
- Capitalize on opportunities from Mainland China and strengthen regional and international collaboration to maintain status as a major international financial center.

Source: People’s Republic of China—Hong Kong Special Administrative Region: Staff Concluding Statement of the 2022 Article IV Consultation Discussions.