IMF Executive Board Concludes 2018 Article IV Consultation with People's Republic of China—Hong Kong Special Administrative Region

IMF News, January 25, 2019

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Published: January 25, 2019

Outlook

Hong Kong SAR’s economy is expected to grow 3.5 percent in 2018.
Growth is expected to slow to 2.9 percent in 2019.
Over the medium-term, the economy is expected to grow at around 3 percent, close to its potential.
Private consumption (aided by tight labor market) and investment (benefitting from projects currently in the pipeline) are expected to continue supporting growth.
Headwinds include increased trade tensions, tighter global financial conditions, and slower growth in Mainland China.

Risks and Buffers

Balance of risks has shifted to the downside.
Key risks: further escalation of U.S.-China trade tensions; possible disorderly tightening of global financial conditions; slower-than-expected growth in Mainland China; a sharp housing market correction.
Risks are likely correlated and could materialize together, amplifying effects.
Opportunities: development of the Greater Bay Area given Hong Kong SAR’s position as gateway to Mainland China and as a global financial center.
Buffers:
- Fiscal reserves at the end of 2017: 41 percent of GDP, or 28 months of government spending.
- FX reserves: around 127 percent of GDP or twice the monetary base.
- Banks have built strong capital and liquidity buffers, significantly above international standards.
- One of the strongest net International Investment Positions in the world.

Financial Sector Policies

Financial regulation and supervision have been strengthened, including implementation of Basel III requirements on capital, liquidity, and loss absorbing capacity.
Countercyclical capital buffer has been increased further.
Net stable funding ratio introduced.
Rules on loss-absorbing capacity requirements for authorized institutions to be operationalized by year-end.
Supervision of bank loans to property developers tightened through higher capital charges.
Mainland China-related exposures are closely monitored.
Authorities should consider measures to extend the regulatory perimeter to reduce regulatory arbitrage from lending by property developers.
Securities and Futures Commission intends to impose quantitative limits on margin lending by brokers.
Development of a risk-based capital regime for insurance companies is in Phase‑2, focusing on detailed rules for quantitative requirements.

Housing Policy

Current combination of macroprudential measures and stamp duties remains appropriate.
Housing prices remain overvalued and affordability has deteriorated.
Significant increase in housing supply is the most needed course of action.
DSD/NRSD is assessed to be a capital flow management measure and macroprudential measure under the IMF’s Institutional View of Capital Flows and should be phased out once systemic risks dissipate.

Exchange Rate Regime and External Position

The Linked Exchange Rate System (LERS) remains the appropriate exchange rate arrangement for Hong Kong SAR.
LERS has served as an anchor of stability, aided by Hong Kong SAR's flexible economy, ample fiscal buffers, and strong financial regulation and supervision.
Hong Kong SAR’s external position and the HK dollar remain broadly in line with medium-term fundamentals and desirable policy settings.

Fiscal Policy and Long-term Fiscal Challenges

The FY2018/19 budget is expected to deliver a fiscal stimulus that is not needed given the economy's strong cyclical position.
Increased expenditure on social welfare, health, and education is welcome; some allowances could be better targeted, and spending on public housing should be raised.
Other expenditure increases should be carefully analyzed because they may be difficult to reverse and could complicate long-term fiscal management when aging pressures arise.
Authorities should consider reversing recent tax cuts and strive for greater countercyclicality in the face of both positive and negative shocks.
Long-term fiscal challenges:
- Aging will lead to higher pension and healthcare spending.
- Housing market normalization may lead to structural fiscal deficits.
- Tax Policy Unit should study tax-broadening measures; identified options include introducing/raising indirect taxes like sales tax or VAT and raising excise taxes.
- Periodic expenditure reviews should continue to ensure quality of fiscal spending.
- Strong fiscal buffers afford time to plan for future needs.

Inequality

Authorities’ efforts to reduce inequality and poverty through subsidies, allowances, social welfare payments, and public housing should continue.
Introduction of the Annuity Scheme and the reverse mortgage can help ensure adequate retirement income.
Additional steps recommended:
- Increasing progressivity of personal income taxation.
- Ensuring adequate levels of spending on housing, health, education and social welfare.
- Better targeting existing benefits.

Competitiveness and Long-term Growth

Efforts to raise labor force participation of women and older workers should continue.
Plan to abolish the arrangement for "offsetting" severance payment and long service payment with Mandatory Provident Fund benefits is welcome and should proceed.
Plans to develop the bond market and further promote innovation and technology are positive steps.
Further expansion of Hong Kong SAR’s role as a leading financial center and gateway to Mainland China should help long-term growth.

Key Statistics and Selected Indicators (2015–23, as provided)

Real GDP (percent change): 2015: 2.4; 2016: 2.2; 2017: 3.8; 2018: 3.5; 2019 (Proj.): 2.9; 2020 (Proj.): 3.0; 2021 (Proj.): 3.1
Contribution — Domestic demand: 2015: 1.4; 2016: 2.5; 2017: 5.2; 2018: 5.4; 2019: 3.3; 2020: 3.6
Private consumption (contribution): 2016: 1.3; 2017: 3.7; 2018: 4.0; 2019: 2.3
Gross fixed capital formation (contribution): 2015: -0.7; 2016: 0.0; 2017: 0.7; 2018: 0.9; 2019: 0.8
Net exports (contribution): 2015: -0.3; 2016: -1.4; 2017: -1.9; 2018: -0.4; 2019: -0.5
Output gap (in percent of potential): 2015: -0.2; 2016: -0.8; 2017: 0.2
Gross national saving (percent of GDP): 2015: 24.9; 2016: 25.5; 2017: 26.6; 2018: 25.6; 2019: 25.7
Gross domestic investment (percent of GDP): 2015: 21.5; 2016: 22.3; 2017: 22.2; 2018: 22.1; 2019: 22.1
Employment (percent change): 2015: 1.0
Unemployment rate (percent, period average): 2015: 2.6
Real wages (percent change): 2016: 1.2; 2017: 1.6
Inflation — Consumer prices (percent change): 2016: 1.5; 2017: 2.1
GDP deflator (percent change): 2016: 1.7; 2017: 2.0; 2018: 1.9
Consolidated budget balance (percent of GDP): 2015: 0.6; 2016: 4.5; 2017: 5.6; 2018: 1.8
Revenue (percent of GDP): 2015: 18.8; 2016: 23.0; 2017: 23.3; 2018: 21.0; 2019: 20.9; 2020: 21.2
Expenditure (percent of GDP): 2015: 18.2; 2016: 18.6; 2017: 17.7; 2018: 18.9; 2019: 19.0; 2020: 19.1; 2021: 19.5
Fiscal reserves as of March 31 (percent of GDP): 2015: 35.1; 2016: 38.3; 2017: 41.4; 2018: 42.2; 2019: 42.1; 2020: 41.9; 2021: 41.6; 2022: 41.3; 2023: 41.0
Loans for use in Hong Kong SAR (ex. trade financing): 2015: 6.3; 2016: 8.0; 2017: 16.1; 2018: 14.6; 2019: 8.4; 2020: 7.4; 2021: 9.1; 2022: 8.1; 2023: 9.3
House prices (end of period, percent change): 2015: 7.9; 2016: 14.7; 2017: 14.8; 2018: 5.9; 2019: 6.6
Credit Gap 1/: 2015: 11.0; 2016: 10.9; 2017: 19.6; 2018: 19.3; 2019: 10.2; 2020: 7.2
Hang Seng stock index (percent change): 2015: -7.2; 2016: 36.0
Merchandise trade — Export value (percent change): 2015: -1.8; 2016: 5.3
Merchandise trade — Import value (percent change): 2015: -4.1; 2016: -1.0; 2017: 8.7; 2018: 8.6; 2019: 3.9; 2020: 4.1
Foreign exchange reserves (in billions of U.S. dollars, end-of-period): 2015: 358.8; 2016: 386.2; 2017: 431.6; 2018: 447.7; 2019 (Proj.): 470.0; 2020 (Proj.): 492.8; 2021 (Proj.): 510.7; 2022 (Proj.): 528.1; 2023 (Proj.): 540.9
Foreign exchange reserves (in percent of GDP): 2015: 116.0; 2016: 120.3; 2017: 126.4; 2018: 123.6; 2019: 122.2; 2020: 119.9; 2021: 117.2; 2022: 113.9; 2023: 109.4
Net international investment position (percent of GDP): 2015: 324.2; 2016: 359.2; 2017: 409.4; 2018: 387.0; 2019: 372.1; 2020: 357.6; 2021: 344.4; 2022: 331.3; 2023: 318.7
Linked rate (fixed) — Market rate (HK$/US$1, period average): 2015: 7.752; 2016: 7.762; 2017: 7.793
Real effective rate (period average, 2010=100): 2015: 118.3; 2016: 118.2

Press Release No. 19/11 — IMF Executive Board Concludes 2018 Article IV Consultation with People's Republic of China—Hong Kong Special Administrative Region (January 24, 2019).