The Hong Kong SAR economy has gathered momentum since the second half
of 2016 and over the course of 2017, in line with the global economic
recovery. The macroeconomic outlook has improved significantly and a
robust recovery is expected to continue. Nevertheless, the outlook
faces multiple challenges, both external and domestic. Hong Kong SAR is
well placed to navigate through these challenges given the strong
buffers and robust policy frameworks in place, including ample fiscal
reserves, strong financial regulatory and supervisory frameworks, and
the Linked Exchange Rate System, which serves as an anchor of
stability. Policies should aim to further build buffers and use them
effectively, if needed, to secure sustainable growth over the medium
term.
While the near-term growth outlook has improved, risks remain
tilted to the downside.
1. Context.
Hong Kong SAR has successfully navigated challenging global tides
over the last decade. Growth has been supported by low global
interest rates and Hong Kong SAR’s role as a trading and financial
gateway between Mainland China and the rest of the world. Momentum
accelerated since mid-2016 and over the course of 2017 amid the
global recovery, robust Mainland China growth, booming housing
prices, and rebounding credit growth. The labor market remained
tight, with the unemployment rate edging down. However, housing
prices more than tripled over the past decade, leading to
deteriorating housing affordability. Also, while income inequality
has narrowed slightly, it remains high.
2. Outlook. The strong growth momentum is expected to continue in the near
term. Growth picked up strongly in 2017, amid robust domestic
demand and recovering external demand. 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 projected to
continue 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. Over the medium term, with the continued gradual global
recovery and orderly monetary tightening in the U.S., Hong Kong SAR
is projected to grow at about 3 percent, its medium-term potential
growth.
3. Risks. The balance of risks has improved since last year.
Stronger-than-expected global growth and faster-than-anticipated
implementation of reforms in Mainland China could further improve
Hong Kong SAR’s growth outlook. Also, Mainland China’s Belt and
Road Initiative (BRI), which aims to foster global and regional
cooperation in infrastructure, trade and finance, and plans for the
development of the Guangdong-Hong Kong SAR-Macao SAR Bay Area
create opportunities for Hong Kong SAR over the medium term, given
its unique position as a gateway to Mainland China and as a global
financial center. Even so, overall risks are still tilted to the
downside, from both external and domestic sources. These include:
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Correction in property prices.
Despite a series of government measures, property prices rose by 15
percent (yoy in September), amid the demand-supply imbalance. IMF staff analysis suggests that the degree of
overvaluation has increased . Also, the sensitivity of households’
debt service burden to interest rate changes remains high as a
significant portion of new mortgages are on floating rates and
indexed to the Hibor. In addition, a disorderly housing market
adjustment could have a significant impact on private consumption
through negative wealth effects. Furthermore, even though banks’
balance sheets are currently strong, a disorderly housing price
correction could trigger an adverse feedback loop between house
prices, debt servicing ability and lower consumption, which would
result in weakening growth leading to second round effects on
banks’ balance sheets.
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Tighter-than-expected global financial conditions.
Financial conditions could tighten more than expected if volatility
jumps as a result of monetary policy surprises in the U.S. or Euro
Area. Unanticipated tightening in financial conditions would weigh
on domestic demand and create financial stress in Hong Kong SAR
given its highly globally-integrated financial sector.
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Disorderly adjustment in Mainland China.
This would hit the tourism, trading and logistics industries, which
account more than a quarter of GDP and employment in Hong Kong SAR.
While Hong Kong SAR has benefitted from deepening financial
linkages, new spillover channels for volatility and financial
stress have been created, including the high and rising exposure of
the banking system to Mainland China (currently assessed to be
manageable).
-
Retreat from cross-border integration
.
The risk of a shift toward inward-looking policies, including
protectionism, is rising in many advanced economies. Such policy shifts would reduce cross-border
flows of trade, investment, and labor, which could dampen
productivity and global growth. Hong Kong SAR would be negatively
affected due to its high degree of openness.
4. Buffers.
Strong policy frameworks and ample buffers have been built and
strengthened over the last decade, which will help to weather
challenges.
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External. Vulnerabilities in the international investment position are low
with large net foreign assets and foreign exchange reserves;
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Fiscal. Conservative fiscal management over the past decades and strong
real estate-related revenues have helped build buffers, with fiscal
reserves amounting to about 25 months of total government
expenditure and gross government debt of less than 0.1 percent of
GDP; and
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Banks.
Banks have built up strong capital buffers and ample liquidity,
well above international standards, and asset quality remains very
strong, thanks to enhanced regulatory and supervisory frameworks.
Policy efforts have enhanced resilience of the banking system to
property price shocks with progressive tightening of
macroprudential measures since 2009.
Policy Recommendations
Continuing to ensure long-term fiscal sustainability while
increasing short-term flexibility
5. The current fiscal stance is assessed to be appropriate and
additional fiscal stimulus is not needed due to the economy’s
cyclical position.
Fiscal policy continued to be conservative in FY16/17 with 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, which is appropriate despite the near-zero output
gap, because its composition mostly reflects carry over of delayed
implementation of infrastructure and land supply projects from the
previous year and strengthening of social safety nets. As a robust
recovery is expected to continue in the near term with a
close-to-zero output gap, there is little need for additional
fiscal stimulus in FY18/19 and beyond, and several temporary tax
relief measures could be phased out.
6. There would be benefits from greater short-term fiscal
countercylicality in the face of negative shocks.
As the main demand management tool under the currency board
arrangement, fiscal policy should support aggregate demand to a
greater extent when cyclical conditions worsen and tighten
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. In particular, if downside risks
materialize, the government should actively use fiscal policy to
support domestic demand. Short-term countercyclical measures should
be aligned with long-term goals to ensure they do not exacerbate
unfavorable long-term fiscal trends.
7. The authorities should consider possible adjustments to the
fiscal framework in the face of medium- to long-term challenges
to ensure fiscal sustainability.
Aging will lead to higher pension and healthcare spending
(estimated to rise by 2 percentage points of GDP by 2030), as well
as social spending. Also, education and capital spending should be
preserved as investment in both physical and “soft” infrastructure
is essential to maintain and boost competitiveness. In addition,
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, with associated social and
economic costs. Thus, the authorities should consider policy
options to preserve the sound fiscal position, including:
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Expenditure reprioritization.
Efforts to rein in non-essential expenditure growth through
expenditure reviews and reprioritizing overall spending should
continue but are likely insufficient to offset the additional
long-term spending needs.
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Revenue mobilization while maintaining competitiveness.
The emergence of structural deficits over the long term requires
early analysis and consideration of options to raise revenues while
maintaining competitiveness. Options identified through
international benchmarking, relative to other global financial
centers, include: (i) introducing/raising indirect taxes (such as
VAT and excises) to avoid overreliance on direct taxation; and,
(ii) increasing top marginal income tax rates modestly. In this
context, the establishment of the new tax policy unit to review
possible broadening of the tax base is welcome. This unit should
study the relative distributional, efficiency and growth impacts of
these and other revenue measures for the medium to long term.
Deflating the housing boom safely
by continuing to use the current three-pronged approach
8. Amid the booming and overvalued property market, sustained
increases in housing supply are critical to resolving the
structural supply-demand imbalance.
Housing supply has been rising with the implementation of the
government’s Long-Term Housing Strategy, which was adopted in 2014.
To complement this, the government is finalizing Hong Kong 2030+,
which is a longer-term development strategy to provide land and
housing on a more sustainable basis. However, given various
obstacles to further increasing supply in the near term, including
the lack of ready sites and relevant development restrictions, it
appears that it will be difficult to meet the ten-year housing
supply target set under the Strategy in practice. Thus, there is
benefit to expediting the process for identifying land and building
sites, together with conducting the relevant environmental,
transport, and community facility assessments.
9. Macroprudential measures have been effective in building
buffers in the financial system against possible housing market
adjustments.
These policies have helped limit financial system exposure to the
housing boom and strengthened banks’ mortgage loan origination
standards. As housing prices continue to rise and a disorderly
adjustment could pose significant macro-financial risks, these
measures should remain in place to protect the financial system.
However, amid tight prudential regulations on banks, property
developers, which receive financing from banks, have been rapidly
increasing lending to households, though their share relative to
banks’ mortgage lending remains low. Adjusting macroprudential
measures should be considered based on evolving financial stability
risks.
10. Stamp duties have helped contain house prices by curbing excess
demand, especially by cash buyers.
IMF staff analysis shows that stamp duties have been effective in
stemming price increases. By doing so, these measures have also
helped contain household leverage and systemic risk. However, high
stamp duty rates may render the housing market less liquid.
Moreover, the Buyer’s Stamp Duty and the Double Ad-Valorem Stamp
Duty are assessed to be capital flow management measures and
macro-prudential measures under the IMF’s Institutional View on the
Liberalization and Management of Capital Flows. Specifically, while
they are intended to contain housing price overvaluation and
systemic financial risk, they discriminate between residents and
non-residents. Both stamp duties are assessed to be appropriate
because: (i) they were put in place amid a surge of capital flows
into the property market; (ii) they were not used to substitute for
necessary macroeconomic adjustment; and (iii) additional tightening
of macro-prudential policies by the HKMA, which does not apply to
cash buyers, could exacerbate leakages to non-bank financial
institutions and property developers that are outside the
regulatory perimeter. While assessed to be appropriate, going
forward, once systemic risks from the housing market dissipate,
both stamp duties should be phased out and replaced with
alternative non-discriminatory measures. In addition, the
authorities could phase out mortgage interest deductibility as it
boosts demand for housing and encourages higher leverage.
Preserving an anchor of stability
11. The Linked Exchange Rate System (LERS) remains the best
arrangement for Hong Kong SAR.
The U.S. dollar is still the most commonly used international
currency in trade and financial transactions and Hong Kong SAR’s
economic cycles and financial conditions are, to a large extent,
influenced by the U.S. and the global economic/financial
environment. The currency board arrangement has been supported by
the flexible economy, ample fiscal and reserve buffers, and strong
financial regulation and supervision. LERS anchors the stability of
Hong Kong SAR’s highly-open economy with its large and 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 concerns of diminishing
competitiveness. Hong Kong SAR’s flexible product and labor markets
should allow rapid adjustment and help ensure that departures from
the equilibrium REER do not persist. The external position in 2016
is assessed to be broadly consistent with medium-term fundamentals
and desirable policy settings.
Maintaining financial stability
12. The financial system is well placed to cope with challenges
thanks to the robust regulatory and supervisory framework.
Potential systemic vulnerabilities and regulatory arbitrage are
closely monitored and addressed through coordination among the
government and the regulators in the Financial Stability Committee,
close dialogue with the Mainland China regulators, and active
participation in global fora. Banks have ample loss-absorption
buffers and limited vulnerability to short-term funding. Mainland
China-related exposures are being closely monitored and IMF staff
assesses the risks as manageable. Considering the large
credit-to-GDP gap (estimated at 35 percent by the Bank for
International Settlements), the introduction and progressive
increase of the countercyclical capital buffer (CCyB) is
appropriate. Substantial progress has also been made in
implementing the 2014 FSAP recommendations, including a
comprehensive framework for recovery and resolution, which
commenced operation in July 2017.
13. The authorities’ continued strengthening of the regulatory and
supervisory framework is welcome and crucial for maintaining
financial stability.
Further strengthening the oversight regime for non-bank
institutions (including securities markets, broker dealers and
asset managers) would prevent risks, including those arising from
new channels connecting Hong Kong SAR and Mainland China. To
mitigate risks stemming from property developers’ lending to
households, the HKMA further tightened capital requirements for
banks that lend to property developers with high mortgage
lending-to-equity ratios. Recent efforts to enhance coordination
among different regulators, including coordination platforms for
fintech businesses, is a welcome development. High standards for
securities listing should be maintained for financial stability.
The development of the new risk-based capital regime for insurance
companies is in “Phase 2”, focusing on detailed rules for
quantitative requirements. Continued close and regular monitoring
of risks arising from Mainland China exposures will allow Hong Kong
SAR to reap the benefits of closer integration while mitigating
potential risks. Enhanced oversight of cybersecurity risks by the
authorities is welcome.
14. Hong Kong SAR is working to, and should continue to, tap new
opportunities as a global financial center.
Leveraging its position as a well-established international
financial center with comparative advantages such as skilled labor,
high legal standards and common languages with its main trading
partners, the authorities are further developing the asset
management industry as well as encouraging corporate treasury
centers to domicile in Hong Kong SAR. It is well positioned to
contribute to, and benefit from, increasing regional connectivity
and cooperation in investment, trade, and finance (including under
the BRI and the Guangdong-Hong Kong SAR-Macao SAR Bay Area), as it
can provide a platform for developing multiple channels for
funding. To do so, the HKMA’s establishment of the Infrastructure
Financing Facilitation Office is welcome.
15. The authorities need to balance carefully the tradeoff between
greater efficiency and maintaining stability in the face of
rapid developments in fintech.
The authorities’ support for fintech business developments through
various channels, including establishing the Fintech Facilitation
Office, the Fintech Innovation Hub, a central bank digital currency
project, closer cross-border collaboration with Singapore and
Shenzhen on fintech development (including the recently-announced
initiative with Singapore on Distributed Ledger Technology-based
trade finance platform), is welcome and will help enhance its role
as a key global financial center. Technological progress can
promote the development and adoption of new financial services as
well as affect the existing market structure. But, financial
regulation must adapt to remain effective and ensure that risks to
stability and integrity––including from cyberattacks,
money-laundering and terrorism financing––can be effectively
managed while not unduly stifling innovation. The authorities are
using “regulatory sandboxes”, which allow firms to test new
technologies and business models in a controlled environment and
enable regulators to address potential risks from new technologies
without curbing innovation. Going forward, the authorities should
continue to review and enhance the regulatory framework for fintech
to ensure that it remains effective.
Ensuring sustained and inclusive growth
16. The authorities have taken steps to address high inequality and
prepare for the needs of an aging population.
They have introduced several policies, and spending on social
welfare, housing and health has increased to around 33 percent of
public spending. Provision of public housing, amid deteriorating
housing affordability, has long been a policy priority as almost
half of all households live in subsidized housing. The statutory
minimum wage, introduced in 2011 and increased three times, has
helped boost labor supply without damaging wage flexibility. The
plans to enhance the Low-Income Working Family Allowance Scheme,
including by boosting monthly payments and relaxing the income and
working hour requirements, are welcome. The authorities are moving
forward to enhance the existing multi-pillar retirement protection
system, including strengthening social security for the elderly
with more financial needs and developing financial products to
convert assets into stable post-retirement income.
17. The authorities should continue to promote sharing the benefits
of economic growth.
Changes to the Mandatory Provident Fund system, including the
abolition of the arrangement for “offsetting” severance payment and
long service payment, should be implemented. Working hours policy
should strike a balance between equity and inducing labor force
participation while not compromising competitiveness, especially
the flexible labor market. In the context of reviewing the existing
social safety net, consideration should be given to consolidating
and strengthening means-testing of the programs geared to serve the
elderly. In view of the projected decline in the labor force over
the medium term, consideration should be given to providing
childcare for young children, which will boost female labor force
participation, as well as increase fertility.
In closing, the mission would like to thank the Hong Kong SAR
authorities for their kind hospitality and for the open and productive
nature of the discussions