Current Outlook
The economy of Hong Kong is undergo- ing a deep transformation. Hong Kong is rapidly integrating with the regional econ- omy of southern China, to a large extent as a result of China's economic liberal- ization. The city has become a crucial link between the region and international markets. In recent years, Hong Kong has enjoyed strong GDP growth, but also jumps in labor costs. By outsourcing pro- duction of manufactures to low-cost firme in China, export samnings have remained buoyant. At the same time, capital in- flows into Hong Kong and Chinese de- mand for Hong Kong dollar financial as- sets have been building up. Thus, Hong Kong has been able to maintain a strong... currency and low interest rates
spite domestic labor shortages, expen- sive land, and high non-traded sector in- flation.
In 1992, the Hong Kong economy grew 5% in real terms, with domestic de- mand rising even more rapidly at 9.8%. The fastest-growing component was in- vestment, which rose 11.3%. Investment was driven mostly by new equipment spending, which grew 23% above 1991. By contrast, construction was stagnant for a second year in a row. Both private and public consumption rose somewhat above 8%. Exports also grew very rapid- ly - by 19% but direct Hong Kong ex- ports barely changed; re-exports - which now account for 75% of exports of goods grew 28%; and exports of ser- vices rose 10%. As in every year since 1984, the balance of trade in goods and services was positive, and it was approx- imately equal to 1.9% of GDP.
The expectation for 1993 is for es- cantially Stoody
dy trends for Ovērāji yruwiii of GDP (around 5.5%). In particular, the rate of growth of machinery investment should slow down from the 1992 level, but it is likely to still remain strong (around 15%). As in 1992, private con- struction should stay stagnant, owing to the recent completion of several major projects. The minimum cash payment on individual mortgage loans has been raised to 30%. However, public-sector in- vestment will rise.
Exports are set to surge after the Chinese government reafirmed its ex- pansionary economic stance (although we believe the Chinese policy stance may tighten later in the year). Most East Asian countries also continue to prosper. In the rest of the world, the stagnation of Europe and Japan should be offset by faster growth in the US. Nevertheless
strong GDP growth in Hong Kong may leave its trade deficit at about 4% of GDP somewhat less than the 4.5% deficit of 1992. Although now extended for an- other year, the US could again threaten to withdraw China's status as most fa vored nation. In that case, demand for Hong Kong re-exports and services would automatically fall, significantly slowing GDP growth. Although imports would also drop, the trade deficit could temporarily increase.
A potential problem lies in the persis- tence of relatively rapid rates of inflation. In 1992, the GDP deflator rose 10.3%, and it is not expected to decline signifi- cantly in 1990-Inflaikiu partly reflects the structural factors such as the effects of integration with the economy of southern China and Hong Kong's limited (though not fixed) supply of land and labor. Inflation in the tradables sector has been subdued (prices of imports declined .7% in 1992), but price increases in the non- tradables have accelerated. These diver- gent trends reflect the growth in real in- comes, which in turn is a result of pro- ductivity gains and of a steady shift to higher value-added jobs.
Inflation also has a cost-push com- ponent. Nominal wage growth has been rapid, reflecting tight labor markets, rising rent costs, and ingrained inflationary ex- pectations (real wages have been atag- hant in 1991-92), inflationary expecta tions seem to have become embodied in nominal wage growth. Inflation also re- flects strong growth in aggregate de- mand. Active credit policies play a limited role, given Hong Kong's fixed exchage rate regime, but heavy capital inflows nave pushed interest rates down in re- cent years. These rates are very low compared to inflation, and therefore have stimulated aggregate spending. Additionally, the government sector has also enacted relatively expansionary budgets in recent years. Cost inflation and high demand growth thus seem to be the main reasons for the bigger trade daficits of 1991 and 1992.
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Despite high inflation, interest rates in Hong Kong tend to trace those of U.S. dollar instruments. The Hong Kong dollar is also trading at HK$ 7.73/US$ small premium above the official rate. (Together with the U.S. dollar, the H.K. dollar has depreciated relative to non- dollar currencies in recent years.) The explanation for this paradox lies ultimate- ly on financial factors. The economic Boom in southern China has encouraged
Hong Kong 3
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