1. Hong Kong Economic Situations Stephen Yan-Leung Cheung Prof. (Chair) of Finance City University of Hong Kong

2. Content 1.Hong Kong Economy 2.How can we position ourselves? 3.Opportunities in China Market 4.Uncertainties

3. Government Deficit (I) Year2004-05 ($billion) 2005-06 ($billion) 2006-07 ($billion) 2007-08 ($billion) 2008-09 ($billion) Operating revenue165.6170.7177.7184.9194.8 Operating expenditure212.2210.6207.1203.5200.0 Operating surplus/ (deficit)(46.6)(39.9)(29.4)(18.6)(5.2) Capital revenue37.956.844.556.049.3 Capital spending (including payments from the Capital Investment Fund) 53.452.345.939.637.1 Capital financing surplus/ (deficit)(15.5)4.5(1.4)16.412.2 Government bond issuance - Proceeds - Interest expense 20.0 0.5 - 1.0 - 1.0 - 1.0 - 1.0 Capital financing surplus/ (deficit) after bond issuance 4.03.5(2.4)15.411.2

4. Government Deficit (II) Year2004-05 ($billion) 2005-06 ($billion) 2006-07 ($billion) 2007-08 ($billion) 2008-09 ($billion) Consolidated surplus/ (deficit) before bond issuance - as a percentage of GDP (62.1) 4.9% (35.4) 2.7% (30.8) 2.2% (2.2) 0.2% 7.0 0.5% Consolidated surplus/ (deficit) after bond issuance - as a percentage of GDP (42.6) 3.4% (36.4) 2.7% (31.8) 2.3% (3.2) 0.2% 6.0 0.4% Fiscal reserves after bond issuance - as number of months of Government expenditure 223.8 10 187.4 9 155.6 7 152.4 8 158.4 8 Public expenditure - as a percentage of GDP 286.0 22.5% 277.7 20.8% 270.2 19.3% 264.3 18.0% 259.3 16.9% Source: The Budget 2004-05

5. Observations (I) Operating revenue cannot cover operating expenditure Operating deficit will last until 2008/09 Consolidated deficit will last until 2007/08

6. Observations (II) The consolidated surplus/ (deficit) is boosted by the 20 billion bond issue Interestingly, Mr. Tang’s speech did not mention about the payment Issuing bond is a source of financing not income

7. Operating Expenditure Forecast (in $billion) Source: The Budget 2004-05 Target Forecast

8. Operating Revenue Forecast (in $billion) Source: The Budget 2004-05 Target Forecast

9. Surplus/Deficit Forecast (in $billion) Source: The Budget 2004-05

10. Observations (III) Operating expenditure drops from 218 billion in 03/04 to 200 billion in 08/09 → 8% decrease Operating revenue increases from 155 billion in 03/04 to 200 billion in 08/09 → 29% increase Question is how to boost up government revenue

11. Facts Hong Kong has a narrow tax-base No room to increase direct tax rate –Salary tax –Profit tax Depend too much on direct tax –40:60 (indirect tax: direct tax) Only 40% working population pay salary tax For those who pay the standard tax rate (less than 1%) are responsible for more than 20% of the salary tax revenue Government becomes serious on GST

12. Economic Situation Hong Kong GDP in Q3 increased to 7.2% Close to the GDP in 2000 Q1, which was 13.6% (IT bubble) The total exports in Q4 2004 increased around 13% Tourism, individual travel scheme CEPA

13. Property Market Recovery Recovery in 2003 Q4 and 2004 Q1 Number of transactions increased by 22% in the first half of 2004 over the second half of 2003 Average property price dropped slightly recently but prices went up by 26% relatively to mid-2003 Affordability ratio improves substantially

14. Number and Value of Property Transactions

15. Prices for Residential Property

16. Affordability Index

17. Tourism Number of tourists arriving at Hong Kong increased –substantially from China, and –from other destinations Number of tourists arriving at Hong Kong in June 2004 exceeded the pre-SARS level In July 2004, number of tourists reached 1.99 million

18. Visitor Arrivals

19. Visitor Arrivals by Sources

20. Consumption Private consumption expenditure had an average growth of 7% in real term in Q1-3 2004 The volume of total retail sales increased by 6.8% in Dec 2004 Reflection of strong rebound of local consumers and tourists

21. Private Consumption Expenditure

22. Hong Kong’s Price Movement

23. Market Forecast Hong Kong’s Economic Growth Forecast (%) Government7.5 BOC HK7.6 HSBC7.8 DBS7.5 Merrill Lynch8.0 Citibank6.5 INC7.5 Sources: Census and Statistics Department, Reuters, and BOCHK Research

24. Hong Kong Economic Situation (I) Two Problems 1.Deflation –A period of 5 years & 8 months –CPI increased by 0.2% in Dec 04 but fell by 0.5% in Jan 05 –Declined in prices were recorded in Jan 2005 for housing (-3.1% in the Composite CPI), durable goods (-2.0% in the Composite CPI), miscellaneous services which cover package tours (-1.6% in the Composite CPI), and transport (-0.1% in the Composite CPI)

25. Hong Kong Economic Situation (II) 2.Unemployment Unemployment rate at 6.4% in Nov 04 - Jan 05 Structural problem Possible to drop to 5 - 6% The age group of 15 -19 has high unemployment rate How to improve the education level of population? How?

26. Changes Economic Role of China Sources of Growth

27. Implications for Development Policy Innovations are needed How Hong Kong will cultivate creatively within our economy

28. Ingredients Human Capital Investment

29. Ingredients Human Capital ( 才 ) Investment ( 財 )

30. Human Capital 1.Education 3+3+4 Creative abilities Student participation Questioning Debate 2.Import talented people

31. Research and Development Role of Government Role of private sector Role of universities Participation of intellectual property rights Incentives –Tax incentives –Competition China → Win-win situation

32. Uncertainties Oil price –US$50/barrel –US economic figures good/bad? –US interest rate increase

33. China Economy Macro-economic adjustment started to work? –Fixed asset investment slowed –2004 Q1-3 GDP increased 9.5% –Inflation is 1.9% in Jan of 2005 Prices of food items increased by 4.0% Prices of non-food items increased by 0.8% China economy further down may affect the external trade of Hong Kong

34. Ways Forward More integration with Pan-PDR Comparative advantages –Cost will never be an advantage –Quality of service –International network Human resources –Impact –Internal protection Do not be too ambition –be focused

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