People’s Republic of China—Macao Special Administrative Region: Staff Report for the 2014 Article IV Consultation Discussions
Author:
International Monetary Fund. Asia and Pacific Dept
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Publication Date:
24 Jul 2014
eISBN:
9781498365000
Language:
English
Keywords:
ISCR; CR; SAR; authority; banking system; Macao SAR; SAR household sector; sovereign wealth fund; foreign reserve; financial market; current account; fiscal policy; Global; real interest rate
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KEY MESSAGESSetting. Discussions took place for the first time since the handover of Macao SAR from Portugal to China in 1999. Prudent macroeconomic management has underpinned rapid development in the territory, which is now the world’s largest gaming center. As a small, open and tourism-dependent economy, Macao SAR is currently also benefiting from loose global monetary conditions and a Mainland-related boom.Outlook and risks. Growth should stay strong over the next few years at 8–10 percent buoyed by gaming exports and investment, with inflation remaining around 5–5½ percent. However, the economy is vulnerable to external shocks, in particular a slowdown in tourism, due to shocks in the Mainland or Hong Kong SAR or other setbacks to the global recovery. The buoyant property market could also correct if demand fundamentals shift or interest rates rise abruptly with the withdrawal of unconventional monetary policy abroad.Macroeconomic policies. The policy stance is appropriate, with scope for further tightening of macroprudential policies should property prices continue to rise sharply. If downside risks materialize, targeted fiscal stimulus should be used to buttress growth. In the event of a severe property downturn, some countervailing measures could be cautiously unwound. The currency board is the best arrangement for Macao SAR.Financial stability. Important progress has been made in strengthening financial stability in line with the 2011 FSAP recommendations. Prudential measures should focus on managing potential credit and liquidity risks from a gaming slowdown and the property sector, as well as spillovers from shocks in the Mainland and Hong Kong SAR.Longer term challenges. Looking further ahead, Macao SAR’s public finances face a moderation in gaming revenues juxtaposed against spending needs from population aging. A sovereign wealth fund to manage part of the territory’s fiscal reserves and medium-term budgeting could therefore be useful. As the gaming sector matures, economic diversification toward other services will be key for stable growth.

Abstract

KEY MESSAGESSetting. Discussions took place for the first time since the handover of Macao SAR from Portugal to China in 1999. Prudent macroeconomic management has underpinned rapid development in the territory, which is now the world’s largest gaming center. As a small, open and tourism-dependent economy, Macao SAR is currently also benefiting from loose global monetary conditions and a Mainland-related boom.Outlook and risks. Growth should stay strong over the next few years at 8–10 percent buoyed by gaming exports and investment, with inflation remaining around 5–5½ percent. However, the economy is vulnerable to external shocks, in particular a slowdown in tourism, due to shocks in the Mainland or Hong Kong SAR or other setbacks to the global recovery. The buoyant property market could also correct if demand fundamentals shift or interest rates rise abruptly with the withdrawal of unconventional monetary policy abroad.Macroeconomic policies. The policy stance is appropriate, with scope for further tightening of macroprudential policies should property prices continue to rise sharply. If downside risks materialize, targeted fiscal stimulus should be used to buttress growth. In the event of a severe property downturn, some countervailing measures could be cautiously unwound. The currency board is the best arrangement for Macao SAR.Financial stability. Important progress has been made in strengthening financial stability in line with the 2011 FSAP recommendations. Prudential measures should focus on managing potential credit and liquidity risks from a gaming slowdown and the property sector, as well as spillovers from shocks in the Mainland and Hong Kong SAR.Longer term challenges. Looking further ahead, Macao SAR’s public finances face a moderation in gaming revenues juxtaposed against spending needs from population aging. A sovereign wealth fund to manage part of the territory’s fiscal reserves and medium-term budgeting could therefore be useful. As the gaming sector matures, economic diversification toward other services will be key for stable growth.

Context

1. After more than 400 years of Portuguese rule, Macao SAR returned to China’s sovereignty at the end of 1999. Discussions took place with the consent of the Chinese authorities. They were the first since the handover, although the IMF has maintained a relationship with Macao SAR, focused mainly on technical assistance and training (including an FSAP in 2011). Like neighboring Hong Kong SAR, Macao is a Special Administrative Region of the People’s Republic of China. With its economic and social systems remaining unchanged for 50 years under its governing constitution (The Basic Law), the territory is a free port and separate customs jurisdiction.

2. Macao SAR is a small and highly open economy, with a population of around 600,000 spread over only 31km2. Its economic fortunes are driven by tourism, mainly related to the gaming industry. Visitors originate mostly from the Mainland and Hong Kong SAR, and rose to a record-high of 29 million in 2013. Gaming directly accounts for four-fifths of exports, three-quarters of fiscal revenue, one-quarter of employment, and more than half of GDP at current producer prices (Figure 1 and Appendix II).

Figure 1.
Figure 1.

Key Economic Features

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: CEIC; World Bank Atlas; IMF, WEO; and IMF staff calculations.

3. A decade-long gaming boom has lifted per capita incomes near global highs. For the first three years after the handover, the economy was mired in deflationary growth in the aftermath of a property slump, a sharp rise in bad loans, and dwindling tourism due to the Asian crisis and SARS. After February 2002, liberalization of the casino industry and relaxation of tourist travel policies by the Mainland revitalized the economy. By the middle of the decade, Macao SAR had overtaken Las Vegas as the largest gaming center in the world. However, inflationary pressures—both consumer and property prices—have picked up, and inequality has remained a concern during this period of rapid growth.

4. Prudent macroeconomic management has enabled Macao SAR to navigate global and regional shocks, to which it is exposed due to its openness and narrow base. The policy framework has served Macao SAR well in maintaining financial stability and a strong external position, while successfully weathering several external shocks, including the recent global crisis. It is anchored by the combination of a currency board pegged to the Hong Kong dollar (and hence indirectly the U.S. dollar), flexible markets, and a commitment to safeguarding fiscal discipline and financial stability.

  • Monetary conditions. Under the currency board arrangement, domestic liquidity grows in line with international reserves and monetary conditions are tied to those in Hong Kong SAR (and thus ultimately the United States). The domestic currency, the pataca, is more than 100 percent backed by foreign assets.

  • External position. Macao SAR is a net external creditor, with a sizable current account surplus, large foreign reserves, and no exchange restrictions on current and capital account transactions (Figure 2). The real effective exchange rate has appreciated in recent years, mirroring developments in the U.S. dollar.

  • Public finances. Owing to the boom in the gaming sector and cautious management of public finances, Macao SAR has enjoyed large fiscal surpluses in recent years. It has no public debt and holds fiscal reserves of nearly 60 percent of GDP, serving as a key buffer against external shocks.

  • Financial system. At nearly 250 percent of GDP, Macao SAR’s financial sector is large, bank dominated, and mainly foreign owned (Figure 3). Local banking operations have strong balance sheets, are flush with liquidity through domestic deposits, and benefit from the financial and risk management support of their parent banks. There are no organized capital markets and about 60 percent of financial assets are external.

Figure 2.
Figure 2.

External Position

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: Bloomberg; CEIC; Haver Analytics; IFS; IMF, Information Notice Systems; IMF, WEO; IMF, WEO: Lane and Milesi-Ferretti (2007) dataset; World Bank, WDI; and IMF staff calculations.
Figure 3.
Figure 3.

Banking Sector Developments

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Source: AMCM; CEIC; and IMF staff calculations.

5. Supportive policies in the United States and the Mainland also helped Macao SAR rebound from the global crisis. After averaging 14 percent during the preceding six years, growth fell to low single-digits in 2008 and 2009, as tourism plummeted following a tightening of visa policies by the Mainland and the onset of the global recession. Growth recovered quickly thereafter, lifted by two major forces. First, the loosening of monetary conditions in the United States, which led to a corresponding fall in domestic interest rates, facilitated rapid credit growth aimed at both domestic and external borrowers, and increased foreign inflows into Macao SAR’s property sector. Second, the strong recovery in the Mainland and its supportive measures toward the territory—including speeding up cross-boundary infrastructure projects and facilitating greater economic and financial integration—helped boost investment and service exports.

6. The outlook is bright, but Macao SAR needs to prepare for future shifts in the global and domestic landscape. With the United States beginning to withdraw from unconventional monetary policy as its economy gains strength and the Mainland engaging in major structural reforms to rebalance its growth, Macao SAR will face a different global environment. This will bring opportunities for further development of services that Macao SAR should position itself to seize. At the same time, macroeconomic and prudential policies may need to be recalibrated as these shifts may heighten volatility. Over a longer horizon, growth could slow as the gaming sector matures and the population ages. As a result, Macao SAR will need to preserve its traditional strengths by bolstering financial soundness, ensuring external stability, maintaining fiscal prudence, and diversifying the economy. These issues formed the basis of the discussions, as described below.

Outlook and Risks

7. The economy has continued to perform strongly over the last year. Growth rose to 11.9 percent in 2013 from 9.1 percent the previous year, driven by a pick-up in gaming exports (Table 1). Robust activity and low unemployment kept inflation relatively elevated at 5½ percent. Notwithstanding some countervailing measures by the government, property prices increased by nearly 40 percent again last year, supported by rising incomes and low interest rates. The banking system remains in solid health, with robust growth in both deposits and loans.

Table 1.

Macao SAR: Selected Economic and Financial Indicators

article image
Sources: CEIC; Haver Analytics; IMF, International Financial Statistics; national authorities; and IMF staff estimates.

Contribution to annual growth in percent.

BPM6 methodology. Current account, net for 2013 is staff projection.

Part of foreign reserves transferred to fiscal reserve fund since 2012.

Balance as of January of following year, after approval by Legislative Assembly.

8. Under the baseline global outlook, Macao SAR’s prospects are highly favorable (Table 2). Growth is likely to remain robust, at 8-10 percent through 2017, on the back of gaming exports as the global economy strengthens and continued investment related to several casino expansion projects, including construction of hotels and large entertainment complexes. Amid brisk activity and historically low unemployment, inflation should stay around 5-5½ percent. At the same time, demand for property will continue to be supported by strong economic growth and low, albeit slowly rising, interest rates. The current account is expected to decline as a share of GDP, as the services surplus narrows due to capacity constraints in the tourism sector while the merchandise trade deficit rises somewhat due to capital and raw material imports associated with high investment. Meanwhile, the capital and financial account should remain in deficit as the public sector accumulates assets overseas due to rising fiscal reserves and banks continue to lend abroad, taking advantage of rising external demand and interest rates as the global recovery gains momentum. In 2018 and 2019, private investment will contract as work on expansion projects is completed. As a result, growth is likely to moderate to mid-single digits. The current account surplus should tick up, reflecting a slowdown in goods imports and a pick-up in service exports as new capacity comes on line.

Table 2.

Macao SAR: Medium-Term Macroeconomic Framework

article image
Sources: CEIC; Haver Analytics; IMF, International Financial Statistics; national authorities; and IMF staff estimates and projections.

Contribution to annual growth in percent.

BPM6 methodology. Data for 2013 are staff projections.

Majority of reserve asset build-up during projection period is likely to be reflected in fiscal reserves, are managed separately since 2012.

9. However, given the economy’s narrow base, a potential sharp drop in tourism and gaming revenues is a core risk. Such a decline could stem from a renewed downturn or protracted stagnation in the United States and euro area that stalls the global recovery, a severe slowdown in the Mainland or Hong Kong SAR or a fall in visitors due to visa policy changes in the Mainland or any weaknesses in Macao SAR’s AML/CFT framework (see risk matrix in Appendix I). In addition to hurting growth and fiscal revenue, such shocks could lead to liquidity strains and deterioration in banks’ asset quality.

10. The main domestic risk is a sharp correction in the property market, triggered by a shift in demand fundamentals or abrupt tightening in liquidity conditions. Housing affordability has deteriorated sharply through the global crisis and staff models suggest potential price overvaluation (Box 1). A number of triggers could result in a shift in expectations or fundamentals supporting the property market. These include a shock to the gaming and tourism industries that stunts economic growth or a sharp rise in interest rates, due to faster-than-anticipated withdrawal of unconventional monetary policy abroad or increased financial market volatility in its wake (mirroring developments in the United States due to the currency board). A severe downturn in the property market could have a significant negative impact on credit quality, fiscal revenue, and overall economic performance. Construction accounts for around 80 percent of fixed capital information, around 4.7 percent of GDP in value-added terms, and nearly 10 percent of employment. The financial sector is also exposed, with mortgages and the construction sector together accounting for almost half of private domestic credit.

A01ufig01

Property Market Indicators

(In percent)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: CEIC; and IMF staff calculations.1 Excluding financial investment.

11. Authorities’ views:

  • Outlook and risks. The authorities agreed with the baseline outlook. While acknowledging that Macao SAR is susceptible to external shocks, they felt that risks were receding, particularly with the global recovery in train and the Mainland’s strong reform plan for rebalancing its economy. On balance, the authorities view the normalization of US monetary policy as beneficial for Macao SAR, since it should normalize domestic interest rates, cool property prices, and contain imported inflation as the exchange rate strengthens with the U.S. dollar. They noted that global financial markets expect the exit to be gradual and well-executed with interest rates only rising slowly over time, and therefore do not anticipate significant volatility. Even in the extreme event of a bumpy exit, they felt Macao SAR’s vulnerability is reduced by the paucity of short-term capital inflows, owing to the persistent surplus position of the public and private sectors and lack of domestic money or capital market instruments. Nevertheless, they recognized that there could be a more tangible impact on domestic credit conditions and the property market.

  • Property market. The authorities felt that the rise in property prices was reflective of fast income growth, very tight supply of land, and loose global monetary conditions. While it was hard to determine the fair value of housing in this environment, they were concerned about worsening affordability and focusing attention on containing any financial stability risks that may arise. They were encouraged that measures implemented in the last few years—including lowering caps on loan-to value (LTV) and debt service-to-income ratios and hiking stamp duties—have helped cool the market by slowing transactions, lowering the share of property-related loans, and reducing foreign speculative activity. On the latter, they noted that the share of nonresidents in the total value of property purchases had fallen from over 20 percent in 2011 to less than 5 percent in 2013. Notwithstanding the territory’s space constraints, supply is also being mobilized to help meet rising demand, with 19,000 public housing units completed in the last few years and plans for reclaiming around 3.5 km2 of land.

A01ufig02

Housing Affordability

(Price-to-income ratio1)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: AMCM; CEIC; Haver Analytics and IMF staff calculations.1 Price of a 70 sq.m. home as a multiple of annual household disposable income

Calibrating Macroeconomic Policies

12. Under the baseline, current macroeconomic policies are set to continue. Maintaining the authorities’ cautious approach to fiscal management, the 2014 budget is based on conservative revenue projections and another sizable surplus is expected (Table 3). The fiscal stance and recent surpluses provide a cushion to withstand any future downturns. This is especially important given the absence of monetary policy discretion under the currency board arrangement.

Table 3.

Macao SAR: Central Government Accounts

article image
Sources: National authorities; and IMF staff calculations.

13. Macroprudential policies remain focused on strengthening the resilience of the banking sector to risks from a slowdown in gaming and rapidly rising property prices. The gaming sector is predominantly financed overseas, but banks are indirectly exposed through lending for gaming operators’ working capital and related industries (such as hotels and construction), as well as the sector’s importance to the wider economy. Bank exposure to the property market is significant, and debt service on mortgage loans is around 25 percent of household incomes based on newly-approved mortgage data. The banking system has buffers to cushion shocks through solid profits and strong capital positions, as well as potential support that foreign banks could provide to their branches or subsidiaries operating in Macao SAR. To further mitigate these risks and identify potential weak points, industry-wide stress testing that captures both domestic and external shocks and dynamic provisioning should be established. At the same time, close scrutiny of the drivers of sharp property price increases in recent years, including investor composition, will help guide prudential measures. The authorities have taken a number of timely steps to curb speculative activity and boost supply in the last few years. Should price acceleration persist, international experience (notably from Asia) suggests that tighter housing-related tax policies—including higher stamp duties and property taxes—and additional macroprudential measures—such as limits on credit exposure to the property sector, stricter caps on debt service coverage, or lower LTV ratios for purchases of second or more homes—could be used to curtail excessive price growth and contain systemic risk (Box 2).

A01ufig03

Asia: Housing Prices and Macroprudential Policies (MPPs)1

(Average across all episodes; year-over-year percentage change in housing prices)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Source: IMF Asia and Pacific Regional Economic Outlook (April 2014).1 Relevant tightening policies introduced over the period 2000:Q1-2013:Q1. Excludes overlapping episodes within four quarters.

14. If shocks materialize, fiscal and prudential policies will need to be deployed as the main defense. In the first instance, automatic stabilizers should be allowed full play, although these are fairly small. If growth slows more significantly, Macao SAR could undertake rapid fiscal stimulus to shore up domestic demand through targeted tax relief and direct transfers to vulnerable households, support for SMEs, and accelerated infrastructure spending. Should the growth slowdown be accompanied by significant financial strains, liquidity and capital support could be temporarily made available to banks, as was announced during the onset of the global crisis. If domestic monetary conditions tighten suddenly due to the withdrawal of unconventional monetary policy, there may be scope for a macroprudential response, including using capital buffers to avoid a procyclical contraction in lending and monitoring market developments to decide whether and when measures should be recalibrated. In particular, if the property market experiences a sharp downturn, some prudential measures that were tightened during the upswing could be selectively and judiciously unwound, in line with dissipation in systemic risks.

15. Authorities’ views. The authorities agreed that the fiscal surplus envisaged for 2014 was appropriate, bolstering resources available to withstand any future shocks and underpinning confidence in the currency board. Given that property prices continue to rise, they remain vigilant to further acceleration, and could consider additional measures aimed at constraining housing credit supply and speculative demand to contain systemic risks. If shocks materialize, they concurred that fiscal and prudential policies would be the main tools to buttress growth and contain risks to financial stability. While they viewed the sudden tightening of monetary conditions as a low-probability event, they would continue to monitor closely market developments, notably with regard to the property sector. With banks having strong buffers—the average capital adequacy ratio stands at around 15 percent—and average household debt service-to-income ratios of around 30 percent, they felt that the economy should be able to withstand some price correction under such a scenario. If prices fell more precipitously, they were open to the idea of unwinding some housing-related measures enacted in recent years, They emphasized that they would only consider such unwinding provided it did not pose systemic risk, for instance by attracting less creditworthy buyers as the cycle turns, and thus harming household balance sheets and potentially weakening financial stability in the future

Bolstering Financial Soundness

16. Macao SAR’s financial system is bank oriented and foreign owned, with virtually all banks being either subsidiaries or branches of overseas banks. Banks fund themselves primarily through domestic deposits, placing the majority of their excess liquidity with their parent banks and offshore affiliates. If needed, branches can borrow liquidity from their parent banks. Macao SAR’s banking system is dominated by Mainland and Hong Kong SAR-owned banks—together, they account for almost 85 percent of total bank assets. The financial system appears competitive, featuring 26 commercial banks, two offshore banks, a postal savings bank and other credit institutions, insurance companies, finance companies, securities dealers, and pension funds.

17. Since the onset of the global crisis, rapid credit growth and a booming property market have emerged as key issues for financial stability in Macao SAR. Money supply and credit to the private sector have been growing at an annual average of around 15 and 30 percent, respectively. Moreover, growing interconnectedness with global financial markets has broadened transmission channels from external shocks. The global crisis has strongly demonstrated the need for an overarching framework and early warning systems to monitor systemic financial stability. In this context, staff’s Financial Stability Map suggests that the improving global economy and strong domestic growth have increased risk appetite, while low global interest rates and expanding money supply have eased monetary and financial conditions. As a result, Macao SAR is facing elevated risks from potential inward spillovers and market and liquidity shocks, and low to medium ones with regard to the macroeconomy and credit quality.

A01ufig04

Macao SAR: Financial Stability Map1

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Source:IMF staff estimates.1 Away from center signifies higher risks, easier monetary and financial conditions, or higher risk appetite.

18. Financial system resilience has been bolstered by the progress made on key recommendations from the IMF’s 2011 Financial Assessment Program (FSAP) (Box 3 and Table 4). The FSAP concluded that banks generally enjoy robust capitalization and adequate profitability. In line with its recommendations, progress has been made in further strengthening the supervisory framework, including by enhancing off-site analysis and improving communication with parent financial institutions. In addition, the financial safety net has been bolstered by the introduction of a deposit insurance scheme. Increasing the de jure operational independence of the Monetary Authority of Macao (AMCM) and developing a rapid remedial action framework to facilitate an orderly approach to addressing banking problems are being considered in the ongoing review of the Financial System Act, and Macao SAR plans to adopt fully the International Financial Reporting Standards (IFRS) to enhance the transparency of banks’ financial reporting. It is important to implement these remaining recommendations expeditiously.

Table 4.

Macao SAR: Selected Financial Soundness Indicators

article image
Sources: AMCM; and IMF staff calculations.

Core indicators

Encouraged indicators

Locally incorporated banks only.

All credit institutions.

For all banks (trading book data only, excluding banking book data).

19. Given heightened exposure to a few jurisdictions, close monitoring and co-operation with their home supervisors will help guard against adverse cross-border financial spillovers Counterparty risk is high, given that banks place the bulk of their surplus liquidity with banks abroad. At the same time, concentration risk has also risen due to increased bank exposure to a few jurisdictions, although mostly with high sovereign ratings and strong fundamentals. In particular, there are risks from lending to Hong Kong SAR, Portugal and the Mainland (together accounting for around two-thirds of external interbank assets). Credit and funding shocks emanating in these jurisdictions could have a significant impact on the domestic banking system (Box 4). To identify emerging risks, the AMCM should stress test and closely monitor banks’ foreign exposures, including through closer cooperation with home supervisors and an assessment of financial stability developments in those jurisdictions, while ensuring that banks maintain prudent underwriting standards and hold adequate buffers against potential risks. Publicizing more details about the nature of these exposures—including granular information on lenders, borrowers, and risk implications—would also provide useful information to supervisors, the market and the public.

20. Steps to strengthen further the AML/CFT framework are welcome. In 2007, Macao SAR underwent a mutual evaluation of its anti-money laundering and combating the financing of terrorism (AML/CFT) framework by the Asia Pacific Group on Money Laundering (APG). The areas found to have room for improvement included customer due diligence measures on financial institutions and designated nonfinancial businesses and professions (DNFBPs), confiscation and freezing of criminal assets, targeted financial sanctions required by UN Security Council resolutions, regulation and supervision of DNFBPs, measures on cross-border transportation of cash and bearer negotiable instruments, and international cooperation. In light of the information in Macao SAR’s progress reports to the APG and of the risks faced by the gaming sector, remaining measures needed to safeguard integrity in the gaming sector should be steadfastly implemented, in particular to bolster customer due diligence requirements in line with the Financial Action Task Force (FATF) standard, and to strengthen oversight of all market players, including junket promoters and their associates.

21. Authorities’ views. The authorities noted that significant progress has been made in bolstering financial stability in recent years, in line with FSAP recommendations. In addition, banks conduct regular reviews on the effectiveness of their risk management practices, internal controls and business strategies, and submit them to the AMCM on an annual basis. Any deficiencies identified by the AMCM require prompt remedial measures. Banks are also required to conduct their own stress tests and AMCM is working toward implementing sector-wide stress testing. In terms of cross-border financial spillovers, they pointed out that linkages with Hong Kong SAR and Portugal are long-standing and reflect limited domestic lending opportunities. More recently, lending to the Mainland has risen briskly to around 20 percent of banks’ overseas portfolio, spurred by increased integration and interest differentials. They noted that two Mainland banks account for the majority of these exposures, which are mainly related to trade financing, backed by collateral and letters of guarantee from their headquarters, and not to potentially more risky segments of the Mainland financial system (including “shadow” banks). If necessary, banks also have the discretion to off-load bad assets to their headquarters under local banking regulations. These features reduce credit risks. Nevertheless, as exposures will rise further with Mainland integration and given liquidity/counterparty risks, the authorities agreed that maintaining close cooperation with Mainland supervisors and publicizing more detailed information on exposures would be worthwhile. In terms of bolstering the AML/CFT framework, they noted that several steps have been taken in light of the APG recommendations. In particular, guidelines for financial institutions have been revised, junket promoters have been incorporated into customer due diligence measures, and the Financial Intelligence Unit has strengthened its ability to cooperate with its foreign counterparts.

Ensuring External Stability

22. Macao SAR’s external position is broadly consistent with medium-term fundamentals and desirable policies (Box 5 and Table 5). Exchange rate valuation models yield a broad range of estimates, which is not surprising given the uncertainty in such assessments for offshore centers like Macao SAR, whose gross exports and external assets are considerably larger than in other economies. The current account surplus mainly reflects the on-going gaming boom rather than any fundamental misalignment of the exchange rate or other undesirable policies. As a result, there is no convincing evidence of misvaluation. That said, in the event that the government were to scale up spending on health and education over the medium term (see below), this could lead to a somewhat lower national savings rate, requiring the real exchange rate to adjust to a more depreciated equilibrium level.

Table 5.

Macao SAR: Balance of Payments 1/

article image
Sources: CEIC; Haver Analytics; IMF, International Financial Statistics; national authorities; and IMF staff estimates and projections.

BPM6 methodology.

Majority of reserve asset build-up during projection period is likely to be reflected in fiscal reserves, which are managed separately since 2012.

23. The currency board linked to the Hong Kong dollar is the best arrangement for Macao SAR and should be maintained. Given its small and very open economy, the system has provided a crucial nominal anchor for Macao SAR, helped maintain economic and financial stability, and kept the real effective exchange rate broadly in equilibrium. It has also overseen generally good economic performance. Macao SAR meets the pre-requisites for sustaining a currency board, namely flexible labor and product markets that prevent sizable or persistent misalignments, fiscal discipline, prudent management of foreign exchange reserves, and robust financial sector regulation and supervision (Table 6). As with all currency board arrangements, adjustment to shocks has had to take place through price movements, such that both headline and property price inflation have been higher and more volatile than in economies with a more flexible exchange rate (Figure 4). Overall, though, the benefits of the arrangement far outweigh the costs. Pegging to the Hong Kong dollar remains sensible, given its wide circulation in Macao SAR (around two-thirds of loans and deposits), significant trade and financial integration between the two territories, and close co-movement in their output and inflation. Linking to the renminbi would not be appropriate given its lack of convertibility, and the Mainland’s significant capital account restrictions and different stage of development.

Table 6.

Macao SAR: Indicators of External Vulnerability

article image
Sources: CEIC; Haver Analytics; IMF, International Financial Statistics; national authorities; and IMF staff estimates and projections.

BPM6 methodology. Data for 2013 are staff projections.

Figure 4.
Figure 4.

Macao SAR’s Macroeconomic Performance: Does the Exchange Rate Regime Matter?

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: Bloomberg; CEIC; Haver Analytics; IMF, International Financial Statistics; IMF, WEO; and IMF staff calculations.1/ The average performance and volatility are estimated after controlling for a range of macroeconomic fundamentals (terms of trade, openness, investment, government revenue and spending, money supply, interest rates, population growth, population density) and exchange rate regimes.
A01ufig05

Real GDP Growth

(In percent, year-on-year)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: CEIC; IMF, World Economic Outlook; and IMF staff calculations

24. Authorities’ views. The authorities agreed that the currency board is the most desirable arrangement for Macao SAR. They also felt that the link with the Hong Kong dollar was appropriate, particularly given strong real and financial linkages with Hong Kong SAR. In terms of the renminbi, they concurred that the Mainland’s capital account restrictions complicate its viability as a peg, including in terms of honoring unlimited convertibility and as a store of value for absorbing Macao SAR’s large surpluses. The authorities also broadly shared staff’s external assessment, with the territory’s flexible prices keeping the real exchange rate in equilibrium and a medium-term current account surplus of around 40 percent of GDP justified by the present gaming boom.

Sustaining Fiscal Prudence

25. Macao SAR’s traditionally healthy fiscal position may face pressures over the longer term. Macao SAR has no public debt and holds significant fiscal reserves that should be sufficient to offset shocks without an accumulation of public debt. However, the government is heavily dependent on gaming revenues, which are volatile and will slow as the sector matures and faces greater competition from online gaming and other venues in Asia. At the same time, spending pressures will mount due to population aging—with the old-age dependency ratio forecast to rise from 10 to 30 percent by 2030—and the possibility of increased social spending and investments to diversify the economy (Figure 5). Currently, these are addressed through ad-hoc measures, such as cash transfers to citizens and public injections into the pension fund.

Figure 5.
Figure 5.

Fiscal Outlook

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: AMCM; CEIC; IMF, WEO; Macao Economic Association; Milanovic (2010); United Nation World Population Prospects: The 2010 Revolution; WIDER income inequality database; World Bank, PovcalNet database; World Bank, WDI; national authorities; and IMF staff calculations.

26. To ensure the best use of resources over time, consideration could be given to embedding a longer horizon into fiscal policy decisions.

  • Establishing a medium-term budget framework. Macao SAR currently has a one-year horizon in its budget, with limited forecasting of expenditure and revenue. The main items are for the most part based on the previous year’s budget and there is no multi-year costing of expenditure programs, such that outcomes tend to be significantly different. Moving toward a medium-term budget framework would help promote transparency, support fiscal discipline, and ensure that growth in spending is consistent with development and fiscal objectives. Without such a framework, there is a risk of procyclicality in spending that could exacerbate the impact of shocks and harm fiscal sustainability. Based on international experience, consideration could be given to building capacity for formulating forecasts for revenue, spending and the fiscal balance over a 3–5 year horizon that are embedded into the annual budget. These could be prepared by the Ministry of Finance in consultation with other government agencies. Over time, based on the experience of other countries facing population aging, a Long-term Fiscal Report covering the next few decades may also be a useful device to inform the public about future fiscal pressures, and develop and evaluate policy options. Both these exercises should incorporate the likely slowdown in gaming revenues as well as potential spending obligations associated with population aging, promoting economic diversification, and addressing inequality.

  • Setting up a sovereign wealth fund. There may be merit to allocating some part of the fiscal reserves to a sovereign wealth fund (SWF) with a clear mandate to achieve better risk-adjusted returns over a long-term horizon, including through a more diversified asset allocation strategy. This would help build sustainable buffers that could be used to offset the impact of potential adverse shocks and set money aside to fund long-term aging expenditures. International experience suggests that a variety of institutional arrangements are possible for a SWF, including having the monetary authority manage the assets, often with the help of external fund managers (Box 6 and text table). In terms of the governance of SWFs, the Santiago Principles developed in 2008 by the International Working Group of Sovereign Wealth Funds provide guidance on the best global practice for ensuring full accountability and transparency.

Key Features of Selected Sovereign Wealth Funds 1/

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Sources: Sovereign Wealth Fund Institute; Sovereign Wealth Fund websites; and IMF staff estimates.

The average return for: (a) Korea Investment Corporation is the annualized return for traditional asset portfolios during 2005-2012; (b) Government of Singapore Investment Corporation is the annualized 20-year real return till March 2013; and (c) Kazakhstan National Fund is the annualized return during 2000-2011.

27. Authorities’ views. In light of the impending aging of Macao SAR’s population, the authorities agreed with the need for incorporating a longer-term horizon into fiscal policy decisions. They noted that preserving fiscal discipline was of paramount importance, as enshrined in the Basic Law. In particular, they acknowledged the desirability of boosting returns on the fast rising fiscal reserves associated with the current gaming boom. From this year, the AMCM has decided to invest around 10 percent of the reserves in equities, including with the help of external managers. They were willing to contemplate further moves in this direction, such as by establishing a sovereign wealth fund under government control for part of the fiscal reserves. However, they emphasized that these would need to be backed by a clear increase in risk tolerance and willingness to judge performance over a long-term horizon.

Diversifying the Economy

28. Economic diversification is crucial for sustaining Macao SAR’s growth over the longer term. Much of the territory’s recent strong growth has been concentrated in the tourism sector. Even within tourism, it is predominantly considered a gaming center and a daytrip destination for residents of the Mainland and Hong Kong SAR. Looking forward, economic growth will likely moderate as the gaming sector slows to a more sustainable pace amid capacity constraints, government controls on expansion of gaming tables, and external competition. In addition, this narrow concentration leaves the territory vulnerable to external disturbances, as well as crowding out resources from the rest of the economy. Therefore, diversification is a key policy objective and could provide the economy with an additional growth engine. In this context, the following strategic options could be further explored:

  • Nurturing comparative advantages. Given Macao SAR’s small size, there are limits to how much the economy can be diversified, especially with respect to manufacturing since land and unit labor costs are high. Nevertheless, increasing public investments in infrastructure as well as in social sectors will help reduce capacity constraints, lower inequality, and build the human capital required for modern nongaming services. Public spending on health and education, as well as the percentage of the labor force with tertiary education—at around 1¾ and 2½ percent of GDP, and 25 percent, respectively—are relatively low by international standards. In addition, addressing labor shortages may call for some relaxation of policies related to importing workers and further facilitation of workers commuting from neighboring parts of the Mainland. Further financial development, including SME financing, could also help tap new service industries.

  • Broadening linkages with the Mainland. The Closer Economic Partnership Arrangement (CEPA, which applies zero tariff to virtually all goods of Macao SAR origin and provides Macao SAR service suppliers access to the Mainland market), the bridge connecting the territory to Hong Kong SAR and Zhuhai on the Mainland, and the joint development of neighboring Hengqin island will support greater integration. Looking ahead, as the Mainland rebalances its economy and liberalizes its capital account, further progress with financial integration and catering to new demands from its residents—including those related to education, health, and recreation as well as legal, accounting, and environmental services—represent promising avenues for Macao SAR to broaden its linkages.

A01ufig06

Linkages with China

(Share of China in percent of total)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: CEIC; and IMF staff calcualtions.

29. Authorities’ views. Diversification of the economy toward nongaming services is a key goal of the government. Key policy measures include promoting competition and diversification in existing industries, upgrading transportation and logistics, fostering a more favorable business environment, and encouraging development and growth of nongaming services. The Mainland’s 12th Five-Year Plan (2011–15) also supports Macao SAR’s development into a world tourism and leisure centre and as an economic and trade co-operation platform for China and Portuguese-speaking countries. Progress is being made in several areas. For instance, the transport network should improve in the coming years with the completion of light-rail system, labor and visitor flows from the Mainland are being facilitated through new cross-border checkpoints, and 5 km2 of land in Hengqin island has been reserved for joint development of an industrial park. The authorities hoped that further development of the nearly 100km2 Hengqin island could help alleviate Macao SAR’s significant land constraints. In addition, they saw opportunities for further RMB business, particularly capital raising by entities from Portuguese-speaking countries.

Staff Appraisal

30. Macao SAR has come a long way since its handover to China in 1999. Prudent macroeconomic management—anchored by a currency board, flexible markets, and a commitment to fiscal discipline and financial stability—has seen the territory make significant strides. Together with a gaming boom, it has lifted average living standards to among the highest in the world and enabled Macao SAR to successfully weather external shocks, including the recent global crisis. However, inflationary pressures have picked up and inequality remains a concern.

31. As the global recovery gains momentum, Macao SAR will need to adapt to a shifting external backdrop. Macao SAR’s rebound from the global crisis benefited from the loosening of monetary conditions in the United States, which led a corresponding fall in domestic interest rates and facilitated rapid credit growth, as well as strong growth in the Mainland. With this benign landscape shifting as the United States withdraws from unconventional monetary policy and the Mainland engages in major structural reforms to transform its economy, Macao SAR will face both opportunities and challenges. Looking ahead, preserving Macao SAR’s traditional strengths by bolstering financial soundness, ensuring external stability, maintaining fiscal prudence, and diversifying the economy will be critical for stable growth.

32. The outlook is strong but the economy’s narrow base leaves it vulnerable to external shocks. Growth should stay at 8–10 percent over the next few years buoyed by gaming exports and investment, with inflation remaining around 5–5½ percent. However, growth rates are vulnerable to external shocks. Risks mainly stem from a slowdown in tourism, due to shocks in the Mainland or Hong Kong SAR or other setbacks to the global recovery, or a fall in visitors due to visa policy changes in the Mainland or any weaknesses in Macao SAR’s AML/CFT framework. The main domestic risk is a sharp property market correction if demand fundamentals shift or interest rates rise sharply, reflecting faster-than-anticipated withdrawal of unconventional monetary policy abroad or increased financial market volatility in its wake.

33. The current macroeconomic policy stance is appropriate. The fiscal stance envisaged for 2014 and recent surpluses are sensible, with fiscal reserves providing a cushion to withstand any future downturns. This is especially important given the absence of discretionary monetary policy. There is scope for a further tightening of housing-related taxes and macroprudential policies if property prices continue to rise sharply. The currency board arrangement with the Hong Kong dollar link has served Macao SAR well and should be maintained. Given its small and very open economy, the system provides a crucial nominal anchor and has overseen good economic performance, including keeping the real exchange rate broadly in equilibrium.

34. Fiscal and prudential policies will need to be recalibrated if shocks hit the economy. If downside risks materialize, automatic stabilizers and targeted fiscal stimulus could be used to shore up growth. To ease any significant financial strains, liquidity and capital support could temporarily be made available to banks. In the event of a severe property downturn, countercyclical measures enacted in recent years could also be cautiously unwound, without undermining prudent management of financial and systemic risks.

35. Financial stability has been bolstered in recent years, and attention must now be focused on strengthening the resilience of the banking system to potential risks from the gaming and property sectors, as well as from cross-border financial spillovers. Progress in implementing the 2011 FSAP recommendations and further strengthening the AML/CFT framework is welcome, and remaining work should be expedited. Prudential measures to manage credit and liquidity risks from a gaming slowdown and the property sector are particularly important. Banks are in a relatively strong position and the supervisory framework is sound. To further mitigate these risks and identify potential weak points, industry-wide stress testing and dynamic provisioning should be established. Given significant lending to the Mainland, Hong Kong SAR, and Portugal, it will also be important to manage spillovers from potential shocks in these jurisdictions. To identify emerging risks, the AMCM should stress test and closely monitor banks’ foreign exposures, including through closer cooperation with home supervisors and an assessment of financial stability developments in those jurisdictions. Publicizing more details about the nature of these exposures would also be useful.

36. To ensure that public finances remain on a sound footing in the coming years, a medium-term budget framework and sovereign wealth fund could be useful. Looking ahead, Macao SAR’s public finances confront a likely slowdown in gaming revenues and a rise in spending needs from population aging. To help secure sustainability, promote transparency and ensure that growth in spending is consistent with development and fiscal objectives, a medium-term budget framework could be useful. In addition, the authorities are appropriately devoting more attention to the sound management of the territory’s fiscal reserves. In this context, consideration could also be given to allocating some part of the reserves to a sovereign wealth fund with a clear mandate to achieve better risk-adjusted returns over a long-term horizon, including through a more diversified asset allocation strategy. As in some other countries, such a fund could continue to be managed by the AMCM, with the help of external managers for parts of the portfolio.

37. Over the longer term, diversification will help provide an additional growth engine and bolster the economy’s resilience. Growth could slow over time as the gaming matures and faces greater competition from other jurisdictions. The economy’s narrow concentration would also leave Macao SAR susceptible to external shocks. Therefore, diversification—particularly into nongaming services—will be key for stable growth over the long term. The authorities are taking several important steps in this regard and there is scope for exploring further opportunities, including through broader integration with the Mainland, financial development, and public investments in infrastructure and human capital.

38. It is recommended that the next Article IV consultation discussions take place on a 24–month cycle.

Is There a Housing Bubble in Macao SAR?

Macao SAR’s property price growth path has been steeper than in a number of regional and international comparators. Between 2008 and 2013 alone residential property prices more than tripled, while household disposable income is estimated to have increased by about 1.5 times. As discussed below, two empirical approaches were used to relate residential property prices in Macao SAR to a set of fundamentals.

A01ufig07

Residential Property Price Growth

(Index, 2008=100)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: AMCM; CEIC; Haver Analytics; and IMF staff calculations

User-Cost Model. The first approach is an asset pricing model that compares the market price with a benchmark based on an equilibrium relationship between prices, rents, and cost of ownership. The model assumes that in a housing market with well-functioning rental and credit markets, the cost of owning a house should be in line with the cost of renting a similar property. Consequently, in a “no arbitrage” situation, the annual market rent would be equal to the annual cost of owning a property (imputed rent). If a deviation occurs between the market rent and the cost of ownership, the model suggests that the market price should move gradually toward the benchmark. By this measure, house prices in Macao SAR may currently be above the benchmark.

A01ufig08

Benchmark and Actual Price

(In MOP/Sq. m.; SA)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Source: IMF staff estimates.

Regression-based Approach. The second approach is based on a regression linking house prices to a set of macroeconomic fundamentals affecting demand (income growth, credit growth, and real interest rates) and supply (construction activity and costs). The baseline results suggest a current overvaluation broadly in line with the ‘user cost model.’ To illustrate the potential impact of an abrupt tightening of global monetary conditions, the regression estimates were used to calculate what would happen to the equilibrium price if credit growth and the real interest rate were to suddenly return to their 2002–07 average. This exercise also suggests that housing prices would need to adjust downward.

A01ufig09

Macao SAR: Real Residential Property Price

(In MOP thousand/Sq m, 2002 prices, SA)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Source: IMF staff estimates.1 2002-2007 average growth rates.

Macroprudential Policies: What Can Asian Experiences Imply for Macao SAR?

Macroprudential policy measures (MPPs) are aimed at promoting systemic financial stability by constraining the incentives for excessive risk-taking. They are usually classified into three types: credit-related (e.g., caps on the loan-to-value (LTV) ratio), liquidity-related (e.g., reserve requirements), and capital-related (e.g., countercyclical/time-varying capital requirements). Their objective is to limit the risk of widespread disruptions to the provision of financial services and thereby minimize the impact of such disruptions on the wider economy. The focus is on the financial system as a whole as opposed to individual components.

Asian countries stand out globally as heavy users of MPPs in recent years, with the bulk of measures focused on stability risks arising from overheating property markets. In particular, LTV caps for mortgage loans and debt-to-income limits have been used in China, Hong Kong SAR, India, Indonesia, Korea, Malaysia, Singapore, and Thailand, often together with other real estate lending restrictions and real estate taxes. To address broader-based banking system risks, several economies have also imposed capital measures (Australia), and tightened provisioning rules (India and Sri Lanka), and reserve requirements (China, India, and Sri Lanka).

The choice of instruments depends on country circumstances—notably the degree of economic and financial development, the exchange rate regime, vulnerability to certain shocks, and accompanying macroeconomic policies. For instances, countries with fixed or managed exchange rates tend to use these tools more since the exchange rate arrangement limits the room for conventional interest rate policy.

Among the various macroprudential measures, housing-related instruments have generally had a tangible impact—particularly caps on LTV ratios and the taxation of housing transactions. In particular, such instruments have helped lower credit growth, slow house price inflation and dampen bank leverage in Asia (April 2014 Asia and Pacific Regional Economic Outlook).

Policymakers in Macao SAR have also used some policy tools explicitly focused on system-wide risks. Macroprudential guidelines on mortgage lending were established in December 2010, including lower caps on LTV and debt service ratios. Their coverage was extended and a special stamp duty (10–20 percent) imposed in April 2011 and the LTV ratio recommended in the guideline further tightened in October 2012, especially for nonresidents. More recent macroprudential measures include curbs on developer presales, an extension of the special stamp duty to commercial properties and parking spaces, and an additional stamp duty (10 percent) on corporate and nonresident buyers.

These measures helped to somewhat cool the local property market. The market moderated in the first quarter of 2013 and trading activity shrank visibly in the third quarter both on a quarterly and yearly basis. Transactions by nonresidents contracted relatively more sharply, and the LTV ratio witnessed gradual declines. Nevertheless, prices have continued to trend up.

Given the ongoing withdrawal of UMP, policymakers could at some point reconsider these measures to prevent excessive deleveraging in the downward phase of the financial cycle, particularly if it coincides with a weak phase of the economic cycle. Preserving financial stability should be the primary criterion in deciding whether to unwind counter-cyclical prudential measures. Timely easing of MPPs may reduce the likelihood of, and damage from, credit or house price collapses. On the other hand, easing regulation as the economy enters a downturn could lower resilience and jeopardize financial stability going forward. Ultimately, the scope for rolling back will depend on the severity of the financial cycle downswing, the soundness of bank and borrower balance sheets, and the specific MPPs in place. In the case of housing-related tools, the case is stronger if there is adequate capacity for servicing household debt, taking into account likely mortgage rate normalization in the medium term.

Progress on Key Recommendations of 2011 FSAP Assessment

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How Vulnerable is Macao SAR to Financial Spillovers?

Network analysis is used to identify systemically important banking systems for the domestic banking sector in an economy. Based on the methodology of Espinosa-Vega and Sole (2011), it assumes extreme tail risks, that is, the failure of the banking system of a country, in tracking the contagion paths of hypothetical shocks across countries in the global banking network. It exploits data on cross-border claims and economy-specific measures of banking system resilience.

The analysis models the domino effects of two types of shocks: a credit shock triggered by the default of a banking system’s interbank obligations, and a funding shock triggered by the distress of a banking system that leads to a liquidity squeeze and associated fire sale losses in countries dependent on funding from the distressed system.

Despite its extreme assumptions, network analysis is useful in ranking risks from different banking systems and identifying channels of potential spillovers. The analysis considers scenarios that allow for interbank exposures. The analysis performed for Macao SAR banks includes 27 banking systems, using BIS data on cross-border interbank exposures.1 For the credit shock, a loss given default rate of 80 percent is assumed. For the funding shock, 35 percent of the lost funding is assumed to be irreplaceable and a loss of 80 percent from fire sales is assumed. The results suggest that:

  • Credit shocks from the Mainland, Hong Kong SAR, and Portugal represent by far the three biggest potential risks for the Macao SAR banking system. This is not surprising given the rapid expansion in Macao SAR banks’ exposure to these three jurisdictions. Australia represents another tier of risk to the Macao SAR banking system.

  • Compared with a credit shock, the potential capital loss from a funding shock is smaller, reflecting Macao SAR banks’ relatively limited dependence on offshore funding. Nevertheless, Hong Kong SAR and Mainland China represent the biggest risks from a funding shock.

Network analysis can also be used to estimate the outward spillovers of a credit or funding shock originating in Macao SAR. Similar to the case of inward spillovers, the impact of a credit shock is larger than that of a funding shock. For credit shocks originating in Macao SAR, the impact seems greatest on Hong Kong SAR. For funding shocks originating in Macao SAR, the impact would be largest for Portugal, followed by Hong Kong SAR.

Several policy implications can be drawn from this analysis:

  • Cross-border collaboration—especially with Mainland China, Hong Kong SAR, and Portugal supervisors—is important. Due to large exposures and potential spillover risks detected in our analysis, continued close collaboration with Mainland, Hong Kong SAR, and Portuguese supervisors would be especially useful. Collaboration with Australia is also important.

  • Ensuring financial stability in Macao SAR will require continued careful surveillance of potential vulnerabilities overseas, especially in the Mainland and Hong Kong SAR. Financial spillover risks from Chinese and Hong Kong banks are already large, and are likely to increase as Macao SAR banks expand in this region.

  • Strengthening data availability for cross-border exposures. Network analysis illustrates financial linkages and spillovers based on foreign claims of banking system. Data on the maturity, funding bases, and sectoral allocation of such foreign claims are not available from the BIS. Strengthening data collection and application would be key for effective macroprudential oversight.

A01ufig10
Source: IMF staff estimates.
1 Bilateral exposure data come from the BIS consolidated banking statistics and are available as of end-September 2013 (Table 9D of BIS statistics) except for three countries—China, Korea, and New Zealand, who do not report consolidated banking statistics to the BIS. Their exposures are inferred from the foreign claims and liabilities of other countries. Data on banking sector capital are obtained mainly from IMF’s Financial Soundness Indicators database (www.fsi.org) and country authorities. A consistent definition of capital (Tier I) is used, as of end-September 2013 or latest available data.

External Sector Assessment

Staff assesses Macao SAR’s external position to be broadly consistent with medium-term fundamentals and desirable policies. This finding is supported by empirical estimates of the real exchange rate, as well as consideration of the balance of payments and the dynamics of its net foreign assets position.

International asset position and foreign reserves. Macao SAR has significant net foreign assets of around 170 percent of GDP. External sector sustainability is likely to be maintained owing to the persistent balance of payments surplus over the medium term. As in other financial centers, Macao SAR has large gross external financial assets (over two times GDP) and liabilities (around the same size as GDP). A slight valuation change could affect NFA levels without hampering external sustainability. At the same time, Macao SAR has built up reserves (around 30 percent of GDP) in a nondiscretionary manner through the operation of the currency board. This build-up also helps provide cover against volatile shocks, to which the economy is highly vulnerable due to its openness and narrow base. In addition, the government has fiscal reserves of about 60 percent of GDP, sufficient to cover 50 months of public spending. Part of the fiscal reserves could be set aside for meeting future spending needs.

Real exchange rate. The REER appreciated by 5½ percent in 2012 and 3½ percent in 2013. Three techniques are used to assess the real exchange rate—Macrobalance (MB), Equilibrium Real Exchange Rate (ERER), and External Sustainability (ES). The estimation of MB and ERER are based on a sample of 56 developed and emerging economies, and a separate sample of 14 offshore and international financial centers.1 Empirical results point to a wide range of estimates both within and across techniques, which is not surprising because financial centers are more prone to valuation changes, given their large gross external asset and liabilities positions. Based on these considerations, the real exchange rate is assessed to be broadly consistent with medium-term fundamentals and desirable policies.

Macao SAR: Exchange Rate Assessment

(Misalignment from medium-term fundamental, in percent)

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Source: IMF staff estimates.

Balance of payments flows.

  • Current account. The current account surplus briefly fell below 20 percent of GDP on income repatriation and a drop in tourist arrivals following the global financial crisis but has since recovered to around 44 percent of GDP, reflecting strong gaming exports. As the gaming sector slows to a more sustainable pace and domestic demand continues to grow, the current account surplus is expected to moderate toward 35 percent of GDP. The merchandise trade deficit should rise and the income balance remain in deficit, reflecting the strong profits of (nonresident) casino operators.

  • Capital and financial accounts. As a small open economy and offshore center, gross inflows and outflows are large relative to the economy (at over 15 and 50 percent of GDP, respectively). However, Macao SAR is a large net exporter of capital and has not experienced major non-FDI capital inflows, owing to the persistent surplus position of the public and private sectors and lack of domestic money or capital market instruments. Macao SAR’s strong financial institutions, together with robust regulation and supervision, help contain risks from capital flows. As a result, Macao SAR has been able to maintain external sustainability with a fully open capital account and its currency board regime.

1 Techniques employed in the External Balance Assessment (EBA) are acknowledged not to be well suited for offshore financial centers.

Sovereign Wealth Funds: What Could International Experience Imply for Macao SAR?

Over the past decade, Macao SAR has experienced a rapid accumulation of foreign exchange and fiscal reserves. This reserves buildup, its sources, and future outlook raise important policy questions in terms of making appropriate investment decisions that are in line with Macao SAR’s macroeconomic goals.

Sovereign Wealth Funds: International Experiences

International experiences show that foreign exchange and fiscal reserves are most often managed in two major ways. One option is to manage reserves on the central bank balance sheet with a long-term perspective. Often reserves are split into tranches, such as a liquidity tranche and an investment tranche, and the latter could be amplified and its mandate expanded to a longer horizon. For instance, the Hong Kong Monetary Authority separates foreign reserves into two portfolios, the Backing Portfolio and the Investment Portfolio. Another option is to set up Sovereign Wealth Funds (SWFs), which are special-purpose investment funds or arrangements that are owned by the general government for macroeconomic purposes. SWFs hold, manage, or administer assets to achieve financial objectives, and employ a set of investment strategies that include investing in foreign financial assets.

SWFs have been created by governments for different objectives. Five types of SWFs can be broadly distinguished based on their main objective: (i) stabilization funds, where the primary objective is to insulate the budget and the economy against commodity (usually oil) price swings; (ii) savings funds for future generations, which aim to set aside funds for the future needs of the economy, or of specific groups such as pensioners, or for future generations; (iii) reserve investment corporations, whose assets are often still counted as reserve assets, and are established to improve the potential return; (iv) development funds, which typically help fund socioeconomic projects or promote industrial policies that might raise a country’s potential output growth; and (v) pension reserve funds, which provide (from sources other than individual pension contributions) for contingent pension liabilities on the government’s balance sheet.

The asset allocation of SWFs varies widely depending on many factors, such as the objectives, type, investment horizon, funding source, and asset-liability management framework. For instance, stabilization funds should generally have conservative asset allocation, using shorter investment horizons and low risk-return profiles. By contrast, saving funds may seek to maximize return by having longer investment horizons and riskier investment strategies, and pension reserve funds can derive their investment horizons from the timing of the future anticipated liabilities falling due, which can be decades in the future.

SWFs may diversify their asset across two spectra: asset class and geography. Assets can be diversified to four classes: cash, fixed income, equities, and alternative assets. On average, SWFs tend to have a portfolio with a split of about 45:25:30 between equities, bonds, and alternative assets. Geographically, SWFs gradually have begun to shift assets away from investments in industrial economies and toward those in emerging economies.

A variety of institutional arrangements are possible for SWFs. SWFs could be established simply as central government accounts managed by the central bank (as in Norway and Kazakhstan), or as agencies managing international reserves under the government’s direction (Government of Singapore Investment Corporation, Korea Investment Corporation), or set up as separate public entities (Temasek in Singapore, Kuwait Investment Authority). Regardless of the institutional arrangements, the operational management of the SWFs should be conducted on an independent basis to minimize potential political influence or interference that could hinder the achievement of its objectives.

Implications for Macao SAR

Supported by a growing service-trade surplus associated with the gaming boom, Macao SAR has rapidly accumulated international and fiscal reserves over the past decade. By 2011, Macao SAR’s foreign exchange reserves reached US$ 34 billion, equivalent to over 90 percent of GDP. In 2012, Macao SAR adopted the fiscal reserve law and transferred some international reserves to fiscal reserves, which reached US$30 billion as of January 2014, or nearly 60 percent of GDP. Fiscal reserves are split into a basic reserve and excess reserves, with the former meant as a buffer to cover 18 months of central government expenditure and the latter’s mandate being expanded to a longer horizon.

The foreign exchange and fiscal reserves have achieved a relatively good return since the handover. During 1999-2013, the average return of the Macao SAR foreign reserve and reserve funds has been higher than Macao SAR’s inflation and the average inflation in the United States, euro area and Hong Kong SAR. Illustrating the trade-off between risk and yield, returns since the onset of the global crisis in 2008 have been less volatile but, at annual average of 1½ percent, somewhat lower than for a number of sovereign wealth funds worldwide. To further improve reserves management, the AMCM has taken a more proactive approach to investing fiscal reserves. The AMCM introduced more investment vehicles and diversified asset allocations, such as holding RMB bonds and obtaining Qualified Foreign Institutional Investor (QFII) status for investment in the Mainland. Since this year, the AMCM has decided to invest around 10 percent of the fiscal reserves in equities by exploring further investment opportunities in the Mainland and overseas equity markets, diversifying asset allocations, and optimizing the portfolio weights to increase the medium- and long-term investment return.

Looking ahead, the ongoing reserves accumulation, increasing aging-related expenditures and the possibility of a prolonged period of low global real interest rates may impose more pressure to improve investment return. First, further accumulation of fiscal reserves, along with the gaming boom, would necessitate more effective management of the incoming resources. Second, increasing aging-related expenditures creates a need to secure future welfare or finance the future obligations. Third, according to IMF staff research in the April 2014 World Economic Outlook, global real interest rates could stay low in the medium term, which would place a further premium on undertaking a prudent search for yield.

In this context, one option may be to assign a portion of the excess fiscal reserves to a SWF, which could continue to be managed by the AMCM. Setting up a SWF with a clear mandate to improve risk-adjusted returns over a long horizon, subject to a well-defined tolerance for risk, would help to better smooth intertemporal consumption and redistribute wealth across generations. The long-term investment horizon should help diversify strategic asset allocations and achieve higher risk-adjusted returns over the medium term, albeit at the cost of periods of short-term volatility. In the case of Macao SAR, it may be more cost-efficient to have such a fund managed by the AMCM. This institutional arrangement would not impact the AMCM’s income and balance sheet, and could make use of existing infrastructure and human resources, including experience in hiring and monitoring external managers.

Operation, accountability, and reporting lines should be clear and consistent with international best practice, as outlined in the “Santiago Principles.” Regardless of the institutional arrangements, operational independence should be embedded in a clear legal foundation and internal governance structure, where the decision making framework and oversight function are clear and the relationship between the principal (owner) and its agent is well established. Moreover, timely and accurate reporting of investment activities to the owner helps ensure that the operation is integrated into the macroeconomic policy making process with full accountability and transparency.

Appendix I. Risk Assessment Matrix 1/ 2/

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Nonmutually exclusive risks may interact and materialize jointly.

Downside risks are represented by red arrows, upside risks by blue ones.

Appendix II. The Gaming Industry in Macao SAR

As the world’s biggest gaming market by revenue, the economy of Macao SAR is heavily reliant on the gaming industry. Gaming revenue in 2013 rose by nearly 19 percent to MOP 360.7 billion or 87 percent of GDP, around seven times larger than in Las Vegas. The tax collected from the gaming sector in 2012 accounted for 83 percent of total government revenue.

A01app02ufig01

Casino Markets Revenue

(In USD million)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: American Gaming Association; CEIC; and IMF staff calculations.

Macao SAR’s gaming boom started with the end of a 40-year monopoly in 2002. The government undertook a bidding process for gaming concessions, which were granted to one local incumbent and five new gaming operators (all foreign-owned or with foreign partners): SJM Holdings, Galaxy, Sands, Wynn, MGM and Melco Crown. Today, Macao SAR has 35 casinos, 5,750 gaming tables and around 13,106 slot machines. The only part of China where gaming is legal, almost 87percent of the clientele originates from the Mainland and Hong Kong SAR.

Gaming companies pay a special gaming tax equivalent to 35 percent of their gross revenue. In addition, they also pay 1.6 percent of gross revenue to the Macao Foundation for social, cultural, and economic development, and 1.4 to 2.4 percent of gross revenue for the development of urban construction, tourism, and the Social Security Fund.

Their profits rely heavily on gaming activities. Nongaming activities only contribute about 10 percent of total revenue, significantly lower than casinos in other jurisdictions. This can be attributed to the business model of casinos in Macao SAR that relies on operation of VIP rooms targeting high roller customers and involving junket promoters, who can lend to and gamble with customers directly. Furthermore, junket promoters could be associated with a dense network of collaborators or agents located in and outside Macao SAR, which adds to the challenge of overseeing their activities. Although the Individual Traveler Scheme introduced by the Mainland government in 2003 helped boost the mass market, the VIP or significant players continues to contribute around two-thirds of total revenues.

The authorities are looking to encourage more nongaming elements. Responding to concerns about the economy’s reliance on gaming and the lack of alternative employment options for Macao SAR residents, the authorities have required the concessionaires to devote most of their property to nongaming segments such as restaurants, hotels, retail and event space in the context of the mid-term review of the effective concessions, which will expire in 2020-2022.

Appendix III. External Sector Debt Sustainability Analysis

Macao SAR has no public debt. All of the economy’s external debt is private, with the majority of loans undertaken by the gaming industry. At 102 percent of GDP, external debt is around two-fifths of gross foreign assets. It is expected to remain sustainable given the moderate expected increase in interest rate costs as global rates normalize and the continued strong growth of the tourism industry. Under the baseline scenario, external debt is expected to decline to around 70 percent of GDP by 2019, close to pre-crisis levels. Even under the most stressed scenarios, external debt would remain on a downward trajectory or—under the growth shock and combined shock scenarios—remain relatively unchanged as a share of GDP over the forecast horizon.

Under the baseline scenario, external debt is expected to decline steadily over the medium term. Owing to the boom in the gaming sector, Macao SAR’s external debt—all of which is private—reached 102 percent of GDP in 2013. External debt financing grew in the aftermath of the liberalization of the gaming industry. About three-fourths of total external loans are related to gaming, with the remaining portion undertaken primarily by the real estate and hotel sectors. New debt issuance picked up after the global financial crisis amid low interest rates. Given the expected normalization of global interest rates in the medium term to near pre-crisis levels, the slowdown in construction projects by the tourism industry after 2017, and relatively short average loan maturity, Macao SAR’s external debt is expected to decline to about 70 percent of GDP by 2019.

A01app03ufig01

Total Private External Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: AMCM; and IMF staff estimates and calculations.1 External private debt by nonbank entities may be underestimated.

The projected improvement in external debt is primarily attributable to Macao SAR’s large current account surpluses, and holds even under stress scenarios. Macao SAR faces favorable prospects, as the global recovery is expected to strengthen the demand for its service exports. Several expansion projects are planned for 2015–17 by the hotel and entertainment industries, which are likely to generate additional debt liabilities. However, given land and labor supply constraints in the tourism sector, private gross fixed capital formation along with new debt accumulation is expected to decline by 2019. Despite the expected moderation of the current account surplus, it should continue to remain well above 30 percent of GDP. The economy also maintains large gross foreign assets, whose build-up partly explains the residuals in Table 1. Thus, amid continued current account surpluses, large fiscal and foreign reserve accumulation, and a slowing number of expansion projects undertaken by the tourism industry, external debt is likely to follow a downward trajectory. Even under the most stressed scenarios, debt would fall or—under the growth shock and combined shock scenarios—remain relatively unchanged as a share of GDP over the forecast horizon.

Table 1.

Macao SAR: External Debt Sustainability Framework, 2009–2019

(In percent of GDP, unless otherwise indicated)

article image
Sources: AMCM; Dealogic; IMF, country desk data; and IMF staff estimates.

Derived as [r - g - ρ(l+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(l+g) + εα(l+r)]/(1+g+ρ+gρ) times previous period debt stock. p increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure 1.
Figure 1.

Macao SAR: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2014, 229; 10.5089/9781498365000.002.A001

Sources: AMCM; Dealogic; IMF, country desk data; and IMF staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent ¼ standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2015.

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Cover IMF Staff Country Reports
People’s Republic of China—Macao Special Administrative Region: Staff Report for the 2014 Article IV Consultation Discussions
Author:
International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2014: Issue 229
Publisher:
International Monetary Fund
ISBN:
9781498365000
ISSN:
1934-7685
Pages:
57
DOI:
https://doi.org/10.5089/9781498365000.002
Figure 1.

Key Economic Features
Figure 2.

External Position
Figure 3.

Banking Sector Developments

Property Market Indicators

(In percent)

Housing Affordability

(Price-to-income ratio1)

Asia: Housing Prices and Macroprudential Policies (MPPs)1

(Average across all episodes; year-over-year percentage change in housing prices)

Macao SAR: Financial Stability Map1
Figure 4.

Macao SAR’s Macroeconomic Performance: Does the Exchange Rate Regime Matter?

Real GDP Growth

(In percent, year-on-year)
Figure 5.

Fiscal Outlook

Linkages with China

(Share of China in percent of total)

Residential Property Price Growth

(Index, 2008=100)

Benchmark and Actual Price

(In MOP/Sq. m.; SA)

Macao SAR: Real Residential Property Price

(In MOP thousand/Sq m, 2002 prices, SA)

Casino Markets Revenue

(In USD million)

Total Private External Debt

(In percent of GDP)
Figure 1.

Macao SAR: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)