## 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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## Bibliographic details
- Published: November 29, 2017

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### 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](http://www.imf.org/external/country/CHN/index.htm)
- [People's Republic of China - Hong Kong Special Administrative Region and the IMF](http://www.imf.org/external/country/HKG/index.htm)
- [People's Republic of China - Macao Special Administrative Region and the IMF](http://www.imf.org/external/country/MAC/index.htm)
- [IMF Policy Advice -- A Factsheet](https://www.imf.org/en/about/factsheets/imf-surveillance)
- [Mission Concluding Statements](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2017/11/29/ms112917-china-hong-kong-special-administrative-region_