Transcript of a Video Teleconference on the IMF’s Preliminary Conclusions of the 2012 Article IV Consultation with the Hong Kong SAR


with Steven Barnett, Mission Chief for Hong Kong SAR and Division Chief, Asia and Pacific Department,
Papa N’Diaye, Deputy Division Chief, Asia and Pacific Department,
December 12, 2012

MS. WONG: Good morning. I am Daisy Wong of the IMF’s External Relations Department. May I first welcome all of you to come to the IMF Press Conference today. It is about the IMF’s Annual Article IV Consultation with the Hong Kong SAR. Today we are releasing the Preliminary Conclusions of the 2012 Article IV Consultation.

May I first introduce our colleagues at the IMF headquarters in Washington DC. As you can see, on the right is Mr. Steven Barnett. He is Mission Chief for the Hong Kong SAR and he also serves as Division Chief for the IMF’s Asia and Pacific Department. Joining him is Mr. Papa

N’Diaye. He is Deputy Division Chief of the Asia and Pacific Department. Hi, good evening Steve and Papa.

MS. WONG: Also, back to Hong Kong here, we have Mr. Sean Craig. He is our resident representative for the IMF’s Hong Kong Office here. May I first ask Steve to say a few words to highlight this year’s consultation? Steve, go ahead.

MR. BARNETT: Okay. Thanks for that kind introduction and thanks to everyone for joining us here today. We often describe these annual discussions as “a health check-up”, so as Daisy suggested, we’re here today to discuss the Preliminary Conclusions from that annual health check-up. I thought I could say just a few words about the process. How do we arrive at these conclusions? First, we do our homework. Then, a team of us from Washington go and visit Hong Kong, what we call our “mission”, and we discuss with a variety of groups. The government, the HKMA, bankers, analysts, companies, NGOs and our goal is to form a balanced view of the developments in Hong Kong.

I would note that this is not a one-off event where we go to Hong Kong, but that we actually engage in on-going surveillance and that Sean and another economist have been stationed, full-time, in Hong Kong SAR so we engage on a day-to-day basis. As I mentioned, our goal is to provide an independent view on developments, the outlook and risks, with a particular emphasis on identifying risks and the policies to control those risks. So, kind of, with that as background, let me highlight some of our key findings from this year’s consultation. I will focus on four issues, the macro-economic context, the key risks, the Linked Exchange Rate System and I will conclude with an advertisement with some of our recent research.

First on the context. Hong Kong SAR is a small and highly open economy that also serves as an international financial center. As such, the economy is going to be exposed to shocks in the global economy. I think this year we are seeing a firsthand example of that. Indeed, due to the slowdown in trade, we are seeing -- we have revised down our growth projections for Hong Kong SAR this year to 1¼ per cent for this year and 3 per cent for next year. Nonetheless, domestic demand has proven fairly resilient thanks to a strong labor market and support of fiscal policies. The slowing this year which is linked to a reduction in trade actually highlights the first key risk. That is the risk of what we call “an external shock”.

What could trigger an external shock this year? When we look at the global economy, clearly a worsening of the Euro area crisis or the U.S. fiscal cliff are some key risks. The realization of any of these risks would, indeed, have an impact on Hong Kong SAR and our advice is if such a risk should materialize, that the authorities should deploy a rapid fiscal stimulus with an emphasis on offsetting the impact on growth, but also, importantly, helping protect low income and vulnerable households from the impact of the shock.

On the domestic side, the main risk is the property sector. As I am sure all of you that are well aware, prices have doubled since their trough in 2008 and then increased 20 per cent this year. A shortage of supply, strong local and non-local demand and low interest rates in the United States are all contributing to this run-up in prices. A run-up by its very nature that poses the risk of a correction, possibly an abrupt correction which would have an impact on banks and the economy.

To contain these risks, policies are needed on a variety of fronts. One key goal is to safeguard financial sector stability. In simple terms, this means ensuring that banks and households have enough buffers that they could weather a potential downturn in prices. Here, the HKMA has responded proactively to contain these risks. We have seen with what we call, “macro-prudential measures”. These are steps like lowering or tightening the debt-to-income ratios, the loan-to-value ratios. All meant to provide buffers for households and the financial system. These measures date back more than two years. Looking forward, these type of tools should continue to be used in line with evolving risks.

The second goal is to ensure the healthy development of the real estate market which also includes addressing concerns about affordability. Here, measures like the Buyer’s Stamp Duty (BSD), the Special Stamp Duty (SSD), will be helpful in addressing the demand and supply and balances in the short run. However, in the longer term, the healthy development of the real estate market ultimately hinges on ensuring a sufficient supply of new housing, including public housing. Although we see this as the biggest domestic risk, we consider the probability of a price correction large enough to trigger major macro-economic and financial consequences to be fairly low in the near term.

Let me turn to the Linked Exchange Rate System. As is true for our consultations with all economies, we pay particular attention to exchange rate surveillance. I would add that we discussed this issue in depth last year and it is included in our Staff Report which is available on the Internet. Our main finding is that the Linked Exchange Rate System continues to be the best arrangement for Hong Kong SAR and warrants continued support. The arguments are compelling. First, it has been an effective, credible arrangement that has worked for nearly three decades. Second, our assessment is that the real exchange rate is broadly in line with fundamentals, and that is not by accident. That nominal wages and prices adjust to restore equilibrium or to prevent misalignments from persisting. Then finally, the conditions to support the Linked Exchange Rate System are in place. This includes the flexible market that I mentioned earlier, robust and proactive financial oversight and sound fiscal policy. On fiscal policy, I would add that fiscal reserves are now over 30 per cent of GDP.

Finally, as my last point, let me summarize some recent research that staff did in support of this year’s consultation. The Linked Exchange Rate System implies that Hong Kong imports its monetary policy from the United States. This, in turn, puts more of a burden on fiscal policy as a demand management tool. So, we looked at two questions. One, how is macro-performance in Hong Kong compared to that of other economies that have different exchange rate systems? What do we find? Well, we found that it is true or there is some evidence that Hong Kong’s GDP growth is somewhat more volatile than in other economies but that actually, on average, the growth performance has been on par.

The second is then, given that the economy is subject to more volatility, has fiscal policy, the main tool for demand management, been used effectively to counteract this? Our finding is that, yes, despite the fact that Hong Kong has small automatic stabilizers, fiscal policy has been used effectively as a countercyclical tool. I think this year’s budget provides a good example of that where we saw timely measures to support demand, just as the economy was slowing due to the worsening of external conditions. Our advice going forward is similar. That next year, given the outlook for the economy, that there continues to be scope for fiscal policy to support demand. With that as background, we would add that fiscal prudence has been an important backbone for the economy so it is important that these policies are implemented symmetrically. So if stimulus is put in place during a slowdown, then it is withdrawn when the economy recovers.

With that, thank you very much and now we are happy to answer any questions you might have.

MS. WONG: Thanks very much. I think we are ready to take questions. So, please identify your name and organization when you raise the question and please come over to the front and use the mic so that Steve and Papa could hear your questions clearly.

QUESTION: Good morning. I have two questions. The first one is about the property market. Can you give us the outlook of Hong Kong property market in 2013? And as you mentioned that BSD and SSD have dampened housing demand, will there be any further adjustment of property prices? If yes, by how many per cent? The second is about the political situation of Hong Kong. Recently pressure has been mounting on [Hong Kong Chief Executive] CY Leung saying that he is no longer a trustworthy person because of the unauthorised building works at his home on the Peak. Some protestors even called on him to quit. Do you think that such political instability will affect the economy of Hong Kong? Thank you.

MR. BARNETT: Thanks. Let me take the first question first on the property market outlook, in particular the effectiveness of the BSD and SSD. I think the key with these measures is to look at the impact, assess whether they need to be fine-tuned and that could be symmetrically, whether there is a need for further tightening of these measures or whether there is space to relax these measures. When we look back at the introduction of the SSD originally, it clearly had an impact on transactions, short term re-sales. I think the broader issue in the property market is not to target, a particular level of prices but to pursue policies that safeguard financial stability and, in the long term, promote the healthy development of the market which really is going to hinge on increasing land supply as the authorities have intended to do.

MR. N’DIAYE: One thing to notice maybe and to add to what Steve has said is that, the impact of those measures to increase the land supply will take time and, you know, it is likely to materialize only after three, four or even five years down the road.

MR. BARNETT: Then on the political question. To be honest I don’t think we are in the best position, as an economist, to answer this type of political question.

QUESTION: When arriving at the projection of 3 per cent economic growth for Hong Kong, what are your assumptions for the economic growth in the United States and China?

MR. BARNETT: That is a great question and highlights that given the importance of trade for Hong Kong, that our growth projections in Hong Kong are clearly dependent on our projections in the global economy. So for 2013, we project global growth, let me get these numbers right, at 3.6 per cent. We project China’s growth to be 8¼ per cent GDP and Papa, I may need your help on the U.S. growth.

MR. N’DIAYE: I think it is about [ 2¼ ] per cent [in the latest World Economic Outlook report published in October 2012]… It is being revised.

MR. BARNETT: I understand that the projections will be revised in late January. We based it on the projections existing at the time of our consultation. So 3.6 for the globe, 8¼ for China.

MR. N’DIAYE: So the projections are made in the context of a rebound. Well let’s say a pickup, a slight pickup in global growth. From 3.3 per cent this year to 3.6 per cent next year for global growth, of which China is a major contributor because we are expecting growth in China to increase from 7¾ per cent this year to, as Steve said, 8¼ per cent next year. Therefore, the drag that we see from external demand on Hong Kong’s growth is going to be less next year than this year. This year we are expecting net external demand to subtract about 1¾ percentage points of Hong Kong growth. That negative drag is going to somewhat wash away next year. That would have helped the rebound that we see -- that we are expecting in Hong Kong’s growth from 1¼ per cent to 3 per cent next year.

QUESTION: What is the worst scenario for the Hong Kong property market? I think the question we just discussed earlier was the policy risk. I am not sure whether we meant the failure in policy risk could be the biggest risk to the Hong Kong property market, so could you elaborate this point a little bit more than that? Thanks.

MR. BARNETT: Sure, thanks. I emphasize that we see that the property sector is the main source of domestic risk in Hong Kong. Maybe we can spell out what do we mean by that. What we see is that with the rapid increase in prices it naturally poses a risk that there could be a correction in prices. If there were to be a correction, this would have impact on households, on banks, and this could create a feedback loop where household wealth declines. Therefore, their spending declines, therefore GDP activity declines. Therefore corporate borrowing, the quality of corporate assets and household assets may decline. This is what we kind of call “a negative feedback loop”. So we see this as the biggest risk to the economy which is why we emphasize so much the policies that (a) can help improve the resilience of the economy and then also, (b) prevent these type of risks from materializing. I would underscore that we see this as a fairly low probability event of such risk materializing in the near term. When I say such risks, I mean the risk that a correction in prices would trigger major economic and financial consequences.

QUESTION: Just one simple question. Do you see any negative impact of the continued inflow of capital into Hong Kong?

MR. BARNETT: I guess a short question deserves a short answer. I think the short answer would be -- the very short answer would be, “No”, but I think it shows the Hong Kong system is very open to capital flows and trade flows. The challenge is what happens to those capital flows and to ensure that those capital flows don’t finance huge expansion or unwarranted expansion of credit. The system itself can handle the capital flows and then it is important then to safeguard against the risks from the secondary impact of those capital flows with the key risk being an increase in credit expansion and asset prices.

MR. N’DIAYE: I guess one of the risks is that capital inflows come into Hong Kong and start fuelling rapid increases in asset prices, be it in the equity market or in property. I mean, we have seen so far inflows and you can see it from the fact that the exchange rate has been hitting the strong side of the band in the past few months. I must say that the inflows so far have been limited compared with what we have seen post-Lehman. The economy has been adjusting quite well to those inflows, so far.

QUESTION: What about the overall inflation pressure under this current situation?

MR. BARNETT: I mean, as we noted, we see the inflation pressures are moderating and we expect them to continue next year, to moderate. We look at the factors driving inflation and, in particular, pulling inflation down. One of them has been declining food prices in the Mainland (China). There is a tight relationship between food prices in the Mainland and the food prices in Hong Kong SAR. Another factor has been the cooling economy with growth slowing. That has eased pressure on consumer prices. Maybe the third factor, which is pushing in the other direction, is that the increase in property prices is, in turn, translating into an increase in rent. Rent tends to feed into the CPI with about a 24-month moving average pace. So that would be one factor pushing the other way.

MR. N’DIAYE: In general, I would just add to what Steve has said that, these inflows tend, in general, to inflate fast asset prices and they inflate good prices in Hong Kong. We have done some research in the past that has shown that. So if you want to see any inflationary pressure, it would materialize first in the asset market and then later on in the goods market.

QUESTION: This is Jack from TVB. We can see that China’s economy has reached a bottom. Will it influence the stock market of Hong Kong and what are the risks for the investors of Hong Kong stock market? Thank you.

MR. BARNETT: Well, on the question about China, we shouldn’t digress to the Mainland from Hong Kong SAR but we would agree that we see growth in the Mainland picking up next year. I don’t think we would want to speculate on the impact that that would have on equity prices but more broadly, clearly a recovery in the Mainland… is good for the region and good for the global economy. The Mainland, if you will, has positive spillovers in terms of supporting the Hong Kong SAR economy and in terms of supporting the regional economy so it should be a plus in that respect.

QUESTION: What are the risks for the investors in Hong Kong stock market next year?

MR. BARNETT: Again, let me not just focus on the stock market but I think the risks for the Hong Kong SAR economy would be the risk that we flagged. I think they come in really two flavors. One is the external risks which are related to the external environment and things like the potential worsening or possible worsening of the Euro area crisis or the U.S. fiscal cliff, or although we think it is unlikely, a hard landing in China. These are the kind of external risks. The second kind of risk would be the domestic risks and here, as I think we have discussed, we see the key source of domestic risks to be the property market.

MR. N’DIAYE: And low probability.

MR. BARNETT: Yes, but a low probability.

QUESTION: I know that you expect that the GDP growth will recover to around 3 per cent and also that inflation is around 3 per cent [next year]. Have you done any adjustments before? Is it the final value? Thank you.

MR. BARNETT: The final value that is still a current projection. I guess we constantly would look at our projections in light of evolving global circumstances in Hong Kong’s economy but, of course, we don’t publish our projections weekly or daily or monthly. These are still the projections in this Preliminary Concluding Statement, are still our current projections.

MS. WONG: Papa, you want to add something? No.

MR. N’DIAYE: No, I think it is fine. He said it all.

QUESTION: Just a follow-up on the economic growth in China. Do you think your projections of 8¼ per cent for 2013 a bit optimistic or realistic? The second question is, what is your view on the current low interest rate environment? I mean the consensus is the continuation until 2015 even 2016. What do you think?

MR. BARNETT: We are the team that produces the China projections. I think it is fair to say we think they are realistic. To any projections, of course, there is upside risks and downside risks but our current projection is still 8¼ and I would say the risks are fairly balanced on the upside and downside. I take it your second question is really about how does the monetary policy in the U.S. spill over and impact Hong Kong. I like to give Papa the hard questions.

MR. N’DIAYE: I think we will avoid commenting on how long interest rates will stay low in the United States. There you have the commitment by the Fed so we won’t comment on that. I think what is important from Hong Kong’s perspective is that these monetary conditions are automatically imported and therefore directly felt in the domestic economy. The authorities, by the authorities I mean both the government and HKMA, are taking necessary steps to safeguard the financial system while at the same time, taking measures to address some of the consequences of these low interest rates which are apparent in, for example, the rapid increase in property prices. So, I think from the government’s perspective, the important questions are how these global conditions impact Hong Kong and what policies the government has been putting in place and needs to put in place to mitigate the risks that emanate from those conditions.

MR. BARNETT: Let me just to conclude on that thought. Really one of the emphases of our surveillance is on risk management. The question is how to deal with it, the low interest rate environment. We talk about safeguarding the financial system but, you know, more specifically making sure that… credit growth is not going too fast because low interest rates could fuel the demand for borrowing and so when we say, “safeguarding financial stability”, one simple angle of that is just ensuring that credit growth isn’t too fast. So this is the kind of example we have of safeguarding financial stability and managing risks.

MR. N’DIAYE: That leverage is not too high.

MR. BARNETT: Yes.

MS. WONG: Thank you very much. I also want to let you know that Steve and Papa are also responsible for analysing the Chinese economy for the IMF, but the IMF’s consultation on China happens in the summer, so we will have another chance to discuss them later. Thank you very much and good night to Steve and Papa. Of course, Sean is here. If you have more questions, you are welcome to come over and we can discuss further. Thank you very much everybody.

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