People’s Republic of China—Hong Kong Special Administrative Region: 2016 Article IV Consultation—Press Release and Staff Report

International Monetary Fund. Asia and Pacific Dept

doi:10.5089/9781475566031.002.A001

Author: International Monetary Fund. Asia and Pacific Dept

Publication Date:: 12 Jan 2017

eISBN:: 9781475566031

ISBN:: 9781475566031

Language:: English

Keywords:: ISCR; CR; GDP; authority; discussion; China; open economy; lending share Mainland China corporate; property market; housing market; Hong Kong dollar; Housing; Housing prices; Global

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The vibrant Hong Kong SAR economy has been supported by low interest rates and mainland China's economic development over the past decade. But the external outlook is now more challenging. Long-term issues such as aging and a housing supply shortage also loom. Strong policy frameworks and ample buffers are in place to weather a less favorable environment. Prudent fiscal policy and intensive supervision of the financial system have built buffers that can be drawn on when needed.

Abstract

Context: Testing Times After a Decade of Robust Growth

1. Hong Kong SAR is a vibrant trading and financial gateway between mainland China and the rest of the world. Traditionally the economy was mainly driven by the United States, the global economic cycle and financial conditions; but over time it has become increasingly linked to mainland China’s rapidly evolving economy. The financial services industry ranks fourth in the Global Financial Centers Index and fourth by scale of foreign exchange turnover. Four industries—financial services, tourism, trading and logistics, and professional and other producer services—account for over half of GDP and employ just under half of the workforce. Financial services accounts for around 18 percent of value added but just 7 percent of employment.

2. Prolonged low interest rates and mainland China’s economic development have supported growth and credit over the past decade. With positive spillovers from mainland China, growth has averaged 4.1 percent between 2005 and 2013 and unemployment has remained low. Credit grew rapidly, house prices nearly tripled between 2008 and 2015 for the mass market and doubled for the luxury segment.

3. But growth has slowed since 2015 and the outlook is more challenging. The U.S. rate cycle has turned up, global trade growth is tepid and mainland China is rebalancing. Post-election uncertainty about U.S. economic policies has been accompanied by market volatility which may also weigh on trade and financial conditions. Domestically, the tide also appears to be turning with the financial cycle past its peak and swings in the housing market—with a price correction in the early part of the year followed by resurgent demand. In a longer perspective (though no less urgent), the economy needs to adapt to population aging and mainland China’s move up the value chain and a shortage of housing supply relative to demand needs to be addressed.

4. Strong policy frameworks and ample buffers are in place to weather a less favorable environment. Prudent fiscal policy and intensive supervision of the financial system have built buffers that can be drawn on when needed. The Linked Exchange Rate System (LERS) provides a credible anchor for a small open economy with a large globally-integrated financial services industry that is exposed to cross-border portfolio shifts. Fiscal buffers and a positive net international investment position (35 percent and 315 percent of GDP, respectively) enable the economy to navigate shocks. Wage and price flexibility allows the economy to adapt quickly to cyclical conditions and structural changes. The strong regulatory and supervisory framework is aimed at limiting the build-up of systemic vulnerabilities.

Recent Developments

5. The real economy has been operating below trend:

Subpar growth. Growth has been below potential since the beginning of 2015 and is expected to be around 1.5 percent in 2016. An anemic global trade environment and a sharp downturn in tourism arrivals from mainland China over the past two years have depressed retail spending, private investment and exports. The decline in tourism has shown signs of bottoming out since the middle of the year and consumption has turned around alongside rebounding house prices. Nonetheless, business activity indicators, retail sales, and consumer confidence continue to point to a slow recovery (Figure 1).
Labor market steady. Labor market quantity indicators have been resilient to slower growth. The unemployment rate stayed at 3.4 percent in Q3 and employment has remained robust, though vacancies have declined. Public construction investment appears to have supported employment. Earnings growth has adjusted, slowing to 3.8 percent in 2016:H1 from 4.3 percent in 2015:H1. CPI inflation has remained contained at 2.1 percent (y/y) in October.
Subdued external sector. The real exchange rate has appreciated at a more moderate pace in 2016, in line with the U.S. dollar. After January’s volatile external financial conditions, market sentiment improved and the Hong Kong dollar returned to the strong side of the convertibility undertaking. The current account surplus narrowed to around 2.6 percent of GDP in 2016:H1, and goods trade remained subdued in Q3.
Equity markets. The Hang Seng index fell to a four-year low in February 2016 following concerns about China’s growth outlook. More recently, Brexit, post-U.S. election volatility and December’s Fed rate hike, and the imposition of higher property stamp duties also triggered brief market declines, but equities are currently 20 percent higher than February’s trough.
Capital flows moved with market volatility. Portfolio investment outflows increased substantially in 2015 as residents and nonresidents reduced their equity and investment fund holdings following the stock market decline. This reversed in 2016:H1 as markets stabilized, and equity and bond inflows have increased since August. However, the shift in expectations from RMB appreciation to depreciation has continued to lead to a sharp reduction in offshore RMB liquidity with deposits down by about 35 percent from the 2014 peak.
Fiscal position. With a softer economic outlook, the 2016/17 Budget included measures to support small and medium-sized enterprises, incentives for the tourism industry, tax cuts and an increase in social security allowances. A fiscal impulse of 1.6 percent of GDP is projected by the authorities for 2016/17, although the actual impulse may fall short of this, as revenues usually out-perform forecasts.

6. Signals from the financial cycle are mixed (Figure 2):

Credit growth has slowed. Lending for use outside Hong Kong SAR fell back in 2016:H1 as mainland Chinese residents repaid external debt, but has since recovered. Domestic lending for wholesale, retail and manufacturing contracted while mortgages and personal loan growth was relatively subdued until the summer. Measures of the credit cycle point to a still positive but narrower credit gap. And respondents to the HKMA Opinion Survey expect a further decline in loan demand.
But the property market has rebounded. Residential house prices fell by more than 10 percent in the early part of the year following the first Fed rate hike and amid uncertainty about mainland China’s growth prospects. But prices have since recovered and were just 3.3 percent off the peak in September. Transactions also bounced back with the monthly average in August to October almost doubling compared to the first seven months of this year (Figure 3). The rebound followed growing market conviction, post Brexit, that the pace of U.S. rate tightening would be gradual. House price valuations still look over stretched—with staff models and user cost measures pointing to overvaluation of around 10–20 percent. To contain speculation, in November, the authorities sharply raised the ad valorem stamp duty for residential property transactions to a flat rate of 15 percent from a scale of 1.5–8.5 percent, affecting all nonresidents and residents owning more than one property (see Appendix IV). This took steam out of the market, with shares in property developers falling on the news.
The cost of credit is compressed. Price indicators are liquid and competition among mortgage lenders has resulted in mortgage rates being lowered in 2016 and are currently about 2 percent.

7. Strict macroprudential measures have contained bank exposure to the property boom. Since 2009 limits on loan-to-value ratios, debt service-to-income ratios, higher risk weight floors on property loans, and interest rate buffer stress tests have helped contain exposures. Banks continue to maintain healthy liquidity profiles (the liquidity cover ratio rose to 158 percent in 2016:Q2) and high capital buffers with a CET1 ratio of 15.8 percent. In line with Basel III, The HKMA will raise the countercyclical capital buffer (CCYB) to 1.25 percent of total risk weighted assets from January 2017. The HKMA’s assessment is that indicators still point to a positive credit gap and a need to continue to raise the CCYB towards the Basel III maximum of 2.5 percent.

Macroeconomic Outlook

8. With soft external conditions, the growth recovery is likely to be gradual. Private consumption will remain the main driver in the near term, accounting for more than a half of overall growth, supported by a steady labor market. Overall growth is projected to pick up from 1.5 percent in 2016 to 1.9 percent in 2017; the output gap closes slowly.

Interest rates rise in line with a gradual U.S. rate tightening cycle.
World trade picks up with global growth, but is unlikely to achieve pre-crisis rates.
Growth in mainland China in the near term is steady but moderates over the medium term.
Credit growth remains moderate and following the increase in stamp duties, house prices ease back in an orderly manner, steadily reducing the overvaluation gap. With a small correction in house prices in 2017, credit growth is likely to remain at around 4 percent in 2017.
Consumption is supported by a steady labor market, but is partly offset by falling house prices as the overvaluation gap erodes. Investment is supported by public infrastructure though the private investment outlook is subdued.
Based on the 2016/17 Budget, and adjusting for revenue performance in line with past trends, little additional fiscal support is projected for this year and next (Table 3, Appendix I). However, further fiscal measures and support may be needed in the 2017/2018 Budget if growth remains soft and the global external environment remains difficult (paragraph 28).

9. Medium-term potential output growth edges down.

Aging reduces estimates of potential growth over the medium term. Recent weaker growth outturns have reduced current potential growth estimates to around 2.5–2.7 percent.
The medium-term primary surplus is somewhat lower than in the past. But this still leaves fiscal reserves in a comfortable position in 2021. In the baseline (with zero fiscal impulse) fiscal reserves decline slightly from 35 percent of GDP in 2015 to 33 percent in 2021 (or to around 30 percent of GDP, if the authorities adopted the staff’s proposed near-term fiscal stance).

Authorities’ Views

10. Outlook. The authorities generally agreed with the staff’s assessment that the economy could attain further moderate growth next year, notwithstanding an outlook clouded by uncertainties. Fiscal stimulus in the last few budgets was able to provide relief to those at the lower end of the income scale and support small and medium-sized enterprises (SMEs) thereby alleviating uncertainty and creating a stable environment. Looking ahead, private consumption and ongoing infrastructure spending would help maintain momentum and support employment. In addition, the resilience of the economy, marked by highly efficient and flexible markets, robust regulatory framework, and sound macroeconomic policy, would enable Hong Kong SAR to sail through the challenges. The authorities were confident that the continuous rebalancing of the Mainland would lend further opportunities and stability to Hong Kong SAR’s economy. Over the medium-term, an aging population could impinge on growth, but continued development of Hong Kong SAR as a global financial center, investment in infrastructure and fiscal buffers would help offset the effects.

Risks to the Outlook

11. There are three main risks. Growing economic linkages mean that changes in mainland China’s growth prospects inevitably spillover to Hong Kong SAR’s financial and real sectors. With a large globally-integrated financial sector and a currency board, the economy is also exposed to U.S. developments and global market volatility. The property market is the main domestic source of downside risk. On the upside, the economy is highly flexible and large potential can be tapped from the further development as a global financial center (see Risk Assessment Matrix, Appendix II).

A. Mainland China’s Bumpy Transition or Slow Reform

12. Connections with mainland China’s economy and the financial sector are important for future growth but also add risk transmission channels. A bumpy mainland China transition to sustainable growth would feed through the tourism, trade and financial channels.

13. Tourism and trade contribute significantly to activity and employment. A further slowdown in tourism and trade would dent retail sales, logistics and wholesale warehousing. SME links to mainland China are high, and a downturn in profitability combined with higher interest rates could stretch their debt servicing capacity.

14. Financial linkages have intensified over the past decade. Bank lending to mainland China plus trade finance account for around half of Hong Kong SAR banks’ lending. RMB internationalization, equities market linkages, securities issuance by mainland corporates and asset management activity have all grown.

Banking system exposure to mainland banks. External claims on onshore Chinese banks remain sizeable at HK$1.5trillion (62 percent of GDP) (Figure 4). The mainland is the largest systemically important source of potential shock to interbank markets. Banking sector exposure through lending and bond markets expanded rapidly over 2010–2014 as the offshore renminbi market developed and activity was spurred in part by steady gains from RMB appreciation plus the limited options for RMB investments. From late 2014, the change in RMB outlook, lower funding costs onshore, and a fall in RMB deposit pool offshore, led to a scale back in lending to mainland banks. However, the position stabilized in 2016:Q2 and more recent data points to modest pickup in lending to onshore banks once again.
Banking system exposure to mainland nonfinancial corporates. Hong Kong SAR banks’ nonbank China exposure—a broad measure including lending, off-balance sheet items and trade finance to mainland Chinese firms and overseas firms operating there—remains close to its historically-high level of HK$4.6 trillion (187 percent of GDP). After increasing rapidly since 2010, the rate of growth has eased since 2015 as mainland companies began to repay foreign currency debt, but the level of exposure is still high. HKMA analysis suggests that leverage has been increasing for nonlocal corporates (i.e., mainland China and overseas) since the Global Financial Crisis, and debt at risk is higher than for domestic firms. Still, the HKMA’s stress tests suggest that the potential credit loss for Hong Kong SAR banks from a China growth slowdown remains manageable. Staff’s analysis (Selected Issues Paper 1) provides support for this view, though banks should remain alert to rising credit risk.^1,2,
- Hong Kong SAR banks currently have less direct exposure to riskier mainland corporates than the average of A shares. Based on staff’s analysis, debt at risk could amount to 9 percent of Hong Kong SAR banks’ mainland China corporate loan book or 4.5 percent of their total loan book.
- The HKMA has required banks to maintain prudent lending standards. Hong Kong SAR banks’ focus on large state-owned enterprises (SOEs), multinationals operating in mainland China and Hong Kong SAR-based conglomerates suggests that they are also not lending to the weakest listed corporates. A significant proportion of the loan book is also backed by bank guarantees or secured by collateral.
- However, continued caution and monitoring remain warranted. Conditions across banks vary. Some banks are more exposed to mainland SOEs and others to the private sector. While SOEs may enjoy an implicit government guarantee, this may not always be available—for example, as a result of SOE reform in the mainland. The analysis is based on current rather than stressed conditions. If the global environment deteriorated, nonlocal corporates’ earnings would be hit and the impact on the real economy could be sizeable, with second-round knock-on effects on the banks.

Offshore RMB market. Hong Kong SAR is the premier offshore RMB center and the net provider of liquidity to other markets (Figure 5). Around 70 percent of the global value of RMB settlement is handled by banks in Hong Kong SAR. This has been facilitated by market infrastructure including an RMB real time gross settlement system, the provision of liquidity facilities, and CNH-HIBOR fixing. This market should continue to grow further over the medium term as RMB internationalization continues and mainland China opens up. However, RMB activity has contracted since August 2015 following the shift in expectations from RMB appreciation to depreciation and with lower cross-border trade settlement. Spikes in the CNH-HIBOR rates in January, September, and December 2016 illustrate the potential for volatility and pressures to emerge with thin liquidity or changes in mainland management of capital outflows.
Stock market connections. The Connect scheme allows individuals/institutions with brokerage accounts in Hong Kong SAR or Shanghai to trade stocks in the other market up to a limit—the new Hong Kong SAR-Shenzhen link (which opened in early December) has broadened access to hi-tech mainland stocks and increased the number of mainland small stocks covered from 560 to over 1000. The Mutual Recognition of Funds permits mutual funds in each location to mobilize investment from the other jurisdiction, subject to regulatory approval and an aggregate and daily quota. These schemes boost market activity and enhance liquidity in both markets, and they have prompted closer coordination between the regulators, but they also intensify possible risk transmission between the equities markets. With increased market connections, correlations and spillovers (on returns and volatilities) have been increasing over time across a broad range of sectors.
The asset management industry has expanded rapidly with total assets under management almost tripling over the past seven years, although values steadied in 2015. Combined fund management business amounted to HK$17.4 trillion in 2015 and the proportion of assets managed in Hong Kong SAR rose to 55.7 percent of the total, or equivalent to about 50 percent of total banking assets. The authorities are promoting the development of Hong Kong SAR as a global full-service asset management center to enable investors to manage complex risks—including from mainland onshore activity—through risk management products, hedging and derivatives. Legal and tax changes have been made to encourage global corporate treasuries, the private equity industry and open ended funds to domicile in Hong Kong SAR. Continued development of asset management is important for future growth (paragraph 46) but it will also heighten the sensitivity of capital flows to global shocks or shifts in Chinese investor sentiment.

Authorities’ views

15. Bank exposures to mainland China banks and corporates. The authorities viewed the mainland China-related risks as manageable. Their heightened attention to the risks introduced four years ago spurred the monitoring of a broad range of exposure indicators to capture all the mainland-related linkages, and had required banks to maintain prudent lending standards. Frequent credit reviews had allowed HKMA to remain attuned to possible vulnerabilities. They agreed that the downturn in the credit cycle and slowing in mainland China’s growth could prove to be a test over the next two years. Thus far, the classified loan ratio of mainland-related lending had remained low (less than 1 percent in June 2016). Mainland lending exposures were typically directed to large SOEs and multinational corporates whose income streams tended to be diversified and balance sheets more insulated from specific mainland China-related factors. Moreover, the introduction of the stable funding requirement and countercyclical buffers meant the banks were well positioned to absorb materializing risks.

16. RMB offshore business. The authorities attributed the decline in RMB activity to a temporary cyclical shift in expectations from RMB appreciation to depreciation. This resulted in a tightening of liquidity which had led to occasional temporary spikes in the CNH-HIBOR rates. While the episode in January was pronounced and related to uncertainty about the Mainland’s growth prospects, September and December’s spikes were more contained. In fact, the Hong Kong SAR market remained a net provider of liquidity in the offshore RMB market as a whole, lending RMB to banks in other centers such as Singapore and London. To facilitate the smooth and efficient operation of the offshore RMB money market in Hong Kong SAR, the HKMA had recently expanded the number of primary liquidity providers in the RMB offshore market and its scale; and had introduced disclosure of the usage of intraday and overnight RMB liquidity facilities. Over the longer term asset allocation to the RMB would continue to rise as mainland China continued to open up, and inclusion of the RMB in the SDR basket had been an important step in carrying this forward.

17. Asset management industry. The authorities viewed the orderly functioning of markets through episodes of turbulence in mainland China’s markets as an indication of the resilience of Hong Kong SAR’s financial system. More broadly, Hong Kong SAR’s economy would benefit by continuing to play its pivotal role as the financial hub and intermediary between mainland China and the rest of the world, as a place to manage onshore China risks, and as an international asset management and offshore RMB center. To make this a success, the authorities were focused on ensuring that the regulatory regime keeps pace and is resilient to fast moving and challenging market conditions. Work was underway to enhance asset management regulation in respect of securities lending and repurchase agreements, custody of fund assets, liquidity risk management and disclosure of leverage by fund managers.

B. U.S. Rate Cycle and Global Market Volatility

18. Rising U.S. interest rates. A gradual, anticipated rise in U.S. interest rates should not unduly dampen domestic demand; and the steepening of the U.S. yield curve following the presidential election has not affected confidence thus far, Hong Kong SAR interbank rates and major trading partner bilateral exchange rates have been broadly stable. Following Fed rate hikes, consumption typically grows at an orderly but slower pace. However, an unanticipated tightening of stance could have a bigger-than-usual adverse impact on consumption and domestic demand given the high level of household debt and low income growth. The leverage and debt service ratio of nonfinancial corporates in Hong Kong SAR has also been rising since 2010, and prolonged low interest rates may have encouraged them to take on excessive foreign exchange risk, with external debt by nonfinancial corporations rising from 30 percent of GDP in 2010 to 80 percent in 2015. U.S. rate hikes combined with U.S. dollar appreciation could result in significant losses, increasing default risks. The rising cost of refinancing and rolling over corporate debt could also inhibit investment.

19. European banks, Brexit or emerging market growth uncertainties could also tighten financial conditions. Market volatility has remained contained post-Brexit and lower than in previous stress episodes. Share prices of the major U.K. banks which have a large market presence in Hong Kong SAR quickly returned to pre-Brexit levels. However, high connectedness with the U.K. financial sector (with liabilities to the United Kingdom of 111 percent of GDP) means that shocks impinging on the U.K. financial system or on European banks could have large spillovers to Hong Kong SAR. Second-round effects could emerge from funding strains at bank group level, foreign exchange mismatch or from credit risks in locally incorporated banks’ overseas loan books.

C. Property Market

20. With a persistent housing supply shortage and high levels of demand, the property market has faced a number of boom bust cycles. The rebound in the housing market since the summer has further stretched valuations. Relatively high household debt levels (66 percent of GDP) and high income gearing heighten the risk of an accelerated house price adjustment should interest rates rise faster than expected. Sensitivity to interest rate changes is also likely to be high with over 90 percent of new mortgage loans on floating interest rates. While the debt service index eased to 44 percent in 2016:Q2, sensitivity tests show it would rise sharply to around 60 percent in response to a 300 basis point interest rate shock. Although the buffers built up following macroprudential tightening is likely to ensure that the financial system would be resilient to a sharp house price adjustment, there is a risk to the real economy from an adverse spiral of negative wealth effects, lower collateral values, slower credit growth and weaker household spending.

Authorities’ Views

21. Global financial conditions. While expecting a gradual pace of monetary policy tightening by the U.S. Fed, the authorities viewed the possibility of a faster-than-expected rise in Hong Kong SAR long yields as a material risk. If this resulted in capital flows out of emerging markets and a heightening in financial market volatility, it would have further knock-on effects to Hong Kong SAR’s domestic economy. In aggregate, banks’ liquidity coverage ratios were at a high level and had increased over time. Recent stress tests also showed that banks typically were holding highly liquid instruments, suggesting that they could withstand a sudden capital outflow. Banks’ asset quality was healthy and banking sector capital remained well above minimum international standards.

22. Property market risks. The authorities agreed that the financial sector was relatively well insulated from shocks to the housing market, following seven rounds of macroprudential measures and the use of stamp duties to curb speculative and external demand. A correction in the property market would have effects on the real economy but such effects would differ across economic and property market cycles and would be difficult to measure.

23. Spillovers from the U.K or Europe. Although the banking system had not been much affected by the Brexit vote, the role of the U.K. banking system in distributing international banking flows and the linkages between the financial systems of Hong Kong SAR and the United Kingdom meant that developments were being closely monitored in case of international spillover risks. Similarly, the authorities were monitoring developments in European banks.

D. Amplification of Risks

24. Under a severe low-probability scenario growth would fall sharply. In a low-probability scenario, heightened policy uncertainty in the U.S., Europe, and the United Kingdom could reduce global growth and be accompanied by a hard landing in mainland China.

Global shock. In these circumstances external demand could subtract up to 3 percentage points from growth relative to the baseline over the next few years, reflecting the large openness of the economy and close links to mainland China.
Domestic economy. Such an external shock would weigh on equities and the household sector, especially against a backdrop of already high household and corporate debt levels. HKMA work illustrates channels via which banks may rein in lending in response to macro shocks, further dampening growth and adding to the property price decline. Staff’s scenario of a cumulative 35 percent decline in stock and house prices could generate significant negative wealth effects on consumption and investment, reducing the contribution of domestic demand to growth by more than 2 percentage points in the near term.
Overall growth impact. Without a domestic policy response, overall growth could fall by 3.5–5.5 percentage points relative to baseline over the first two years after the shock. A downturn would also hit fiscal outturns, as they are relatively dependent on property-related revenues.

25. While vulnerability to shocks is high, there are large buffers to cope with adverse events. Fiscal reserves are 35 percent of GDP and foreign exchange reserves cover seven times currency in circulation and around 48 percent of Hong Kong dollar money supply. Banks’ liquidity and high capital buffers should help contain the exposure of the financial system to adverse shocks—although they do not neutralize the effect on the real economy. The IMF’s FSAP stress tests (2014) found that the banking sector was sufficiently capitalized and liquidity risks were low.

Authorities’ views

26. The authorities considered an adverse scenario a low probability event. Substantial buffers were in place to weather a severe shock. As a small open economy with a large financial sector, they had in place contingency planning to ensure crisis preparedness and they were well placed to coordinate both domestically and internationally (see paragraph 43). The financial system was significantly better placed to cope with external shocks than it was at the time of the Asian Financial Crisis, although overall economic activity would inevitably slow.

Policies to Support The Recovery

A. Fiscal Policy: Near-Term Space, Longer-Run Challenge

27. Context. Fiscal policy is the main demand management tool, since monetary policy is determined through the direct link to U.S. interest rates through the currency board (LERS). Fiscal policy therefore needs to support economic stabilization, when there is a sizeable output gap and when external demand is weak. With a comfortable level of fiscal reserves, there is scope for near-term support which can be removed as the economy recovers (Figure 6). However, over the longer run the structural fiscal position will weaken as the economy faces rapid population aging with one in six people currently 65 or above rising to one in three by 2034. Pensioner poverty and inequality are also issues that the government is tackling. Fiscal policy needs to balance near-term needs against the longer-term weakening of the structural fiscal position and the commitment, enshrined in the Basic Law, to preserve low taxes and fiscal prudence. This can be achieved by aligning short-term fiscal measures to long-term goals and shifting spending forward to help ensure that cyclical support does not exacerbate the long-term fiscal trend.

Near-Term Fiscal Policy

28. There is a case for a fiscal stimulus given the soft economic outlook, sizeable output gap, and difficult external environment. The planned fiscal impulse of around 1.6 percent of GDP in the 2016–17 Budget is therefore appropriate and there would be room for further easing in 2017/18, possibly to total a cumulative 2 percent of GDP over the two fiscal years. However, based on past conservative performance, staff’s baseline projection is that the actual fiscal impulse will turn out to be lower than this and close to zero in 2016/17 as a result of both overachievement of revenues (which has been a persistent trend, given conservative forecasts) and underachievement of expenditures. If growth remains weak, additional discretionary stimulus would be needed in 2017–18. A fiscal package in line with staff’s proposal would still leave fiscal reserves at a comfortable level of around 30 percent of GDP in 2021 and public debt close to zero. Measures could comprise:

support to vulnerable households, and the elderly, in the lower income deciles, for example through allowances, rental relief and measures to help keep women and elderly workers connected to the workforce (which would also help the long-run position);
support for small businesses which has been effective in previous Budgets; and
bringing forward capital spending to boost housing supply and accelerate urban renewal, to the extent feasible.

Long-Term Fiscal Challenge

29. An aging population could lead to structural fiscal deficits within a decade. The labor force will start declining after 2018 and population aging is most marked through to 2045. Rapid population aging will create rising demands for social expenditure and could potentially lower growth and fiscal revenues. Without policy changes, the structural fiscal balance is likely to weaken and deplete the fiscal reserves buffer. These challenging demographics set in against a backdrop of already slowing potential growth in a maturing economy that is close to the knowledge frontier.

30. These pressures will test the fiscal framework. The Basic Law stipulates that (i) expenditure must be kept within the limits of revenue; (ii) fiscal deficits should be avoided; (iii) the budget should be kept commensurate with the growth rate of GDP. Early action is needed before fiscal reserves start depleting rapidly. In 2013, the authorities established a working group on long-term fiscal planning (WGLTFP) which issued a report studying the impact of aging on fiscal outlays. The report found that under current policies reserves would be depleted by 2035–40 with the start of structural deficits at around 2025–2030. That leaves some time to implement corrective measures, although implementation should start as soon as possible since the demographic transition will be frontloaded. Moreover, early measures will have the largest cushioning effect as they rein in spending at lower levels.

31. Efforts should concentrate on tackling the impending structural deficits. Under current policies, structural deficits could set in soon and remain in place beyond the end of the demographic transition. Recurrent spending tied to aging could represent an additional cost of 155 percent of GDP over the next 85 years, or 1.9 percent of GDP in constant equivalent flow per year.

On the expenditure side, fundamental expenditure reviews to rein in expenditure growth should be accompanied by a reprioritization towards measures that boost labor force participation and promote growth. The June 2015 change in civil service retirement age for new recruits (from 60 to 65) is a welcome step.
Revenue raising measures should also be considered, including reinforcing user-pay fees, better administration, avoiding overreliance on direct taxation, and extending revenue expenditure measures tied to labor participation such as tax deductions for child bearing and education.

32. Long-run fiscal anchor. The aim for fiscal balance and keeping overall government expenditure growth in line with GDP growth over the medium term is appropriate, while taking early action to alleviate the structural deficit problem. A drawdown of fiscal reserves could be accommodated as the economy adjusts, but a positive fiscal buffer is desirable to cope with adverse shocks, provide room for countercyclical fiscal policy, and sustain confidence in fiscal strength, the Hong Kong dollar and monetary stability.

33. Measures to boost GDP growth can also help stem the deterioration in the fiscal position. A recommendation of the WGLTFP was to set up a Future Fund, to allow a portion of fiscal reserves to be directed to longer-dated, higher-return investments. Rather than conducting purely financial investments, the Future Fund could also be channeled to local real investments in physical and human capital. Tax policies to encourage labor participation, particularly among women and the elderly and to promote active aging are also key. Sustaining a flexible economy and continuing to have an “open doors” policy and integrate foreign workers are also important. Directing more resources towards the provision of land for construction could have a large impact on growth, although current constraints are often not financial but at the regulatory, procedural and planning stages.

34. Monitoring and communication of the long-term fiscal challenge should be stepped up. Producing an independent report every three to five years that updates projections, takes stock of measures undertaken and discusses options, would help demonstrate progress and educate the public on the long run fiscal challenge. It would also illustrate how the authorities balance out long-term concerns against the justified short-term concerns of providing support to the economy and helping those at the bottom of the income distribution. The report could follow the model of Australia’s intergenerational reports or the European Union’s Aging Report.

Authorities’ Views

35. The authorities agreed that fiscal policy must balance short-term needs with longer-term structural headwinds from population aging.

Near term. The last few budgets had featured considerable supporting measures—in particular, infrastructure investment and transfers to households in particular—that successfully shielded the economy from growing uncertainty and helped to sustain high employment, while inflation remained contained. The fiscal impulse in the current budget was seen as appropriate, but further easing could be considered in the forthcoming 2017/2018 Budget if external conditions remained challenging.
Longer term. The authorities were considering policy options to address population aging, while adhering to the principles for fiscal policy set out in the Basic Law. The establishment of the Future Fund would also help generate higher returns on investment. An important part of the policy response to aging would be to maintain economic flexibility and open to foreign workers and to creating incentives to encourage higher labor participation. With respect to fiscal policy, they had already initiated a program within the government to contain the growth of government expenditure and would proceed with expenditure reviews and a reprioritization of spending. Measures to broaden the tax base could also be considered. Maintaining a positive fiscal reserve position was important to retain the credibility needed to operate countercyclical fiscal policy. They were open to the idea of periodic reporting on long-run fiscal sustainability but noted that this would be an intensive exercise and they would need to consider the resource costs, frequency and the scale.

B. Preserving Strengths

36. The exchange rate regime has been supported by coherent and strong policy frameworks that help the economy adapt to changing global conditions. The LERS is underpinned by the flexible economy, ample fiscal and reserve buffers and strong financial regulation and supervision. These features anchor the stability of Hong Kong SAR’s small open economy and its large, globally integrated financial services industry.

Exchange rate regime. The LERS has been in place for thirty-three years, has been tested through crises, and remains the best arrangement for Hong Kong SAR. The supporting institutional and policy frameworks, including the preservation of fiscal and reserves buffers, ensure the smooth functioning of the currency board. The link to the U.S. dollar is appropriate, given that Hong Kong SAR is most affected by trade and financial flows between advanced economies and mainland China rather than just the fluctuations of the Mainland economy.
Flexibility—through labor, product and asset markets—is critical to the successful operation of the LERS, enabling speedy adjustment through relative prices in the absence of the nominal exchange rate channel. This is important given that U.S. dollar appreciation may initially reduce Hong Kong SAR’s competitiveness. Staff’s study shows that at an aggregate level Hong Kong SAR’s prices and wages adjust more strongly than in either the United States or the United Kingdom (selected Issues Paper 2).³ The industry level evidence also points to flexible adjustment with downward wage rigidity less binding in Hong Kong SAR than in the United States.

37. External sector assessment. The structure of Hong Kong SAR’s trade has been adapting to the shift in China’s trade patterns and capital account liberalization, with the trade-in-goods surplus switching to a deficit and the trade-in-services deficit to a surplus (Figure 7). The structural current account surplus is now significantly lower (a current account surplus norm of around 1—1 percent of GDP), and the current account surplus is projected to remain in the 2–4 percent of GDP range over the medium term (Selected Issues Paper 3).⁴ The July 2016 External Sector Report concluded that the external position was broadly in line with medium term fundamentals and desirable policy settings. Since then the real effective exchange rate has remained broadly stable, and analysis through October 2016 delivers the same results (see Appendix III).

Authorities’ Views

38. The authorities emphasized that the LERS remained the cornerstone of the financial system and the best monetary arrangement for Hong Kong SAR. Stability played an important role in supporting Hong Kong SAR’s role as a trading and financial center. The credibility of the LERS had stood the test of time through a number of global crises and was supported by a sizable net international investment position, prudent fiscal policy and a flexible economy. The anchor to the U.S. dollar remained most appropriate as it is the most commonly used currency in international trade and for cross border financial transactions, and given the depth, breadth and liquidity of U.S. dollar denominated transactions and low inflation track record. They viewed the exchange rate as being in line with fundamentals. They noted that the current account surplus had narrowed since the GFC not because of a loss in competitiveness arising from the currency board but because of several structural factors including subdued global trade flows and the external rebalancing of mainland China. The authorities concurred with staff’s work which showed that wages and prices were flexible when compared with international peers. Following the introduction of the statutory minimum wage in May 2011 the labor market had still remained broadly stable. Wage and price flexibility had enabled the reallocation of resources across sectors without costly disruptions to activity.

Protecting Financial System Resilience

A. Financial System

39. The robust regulatory and supervisory framework should help limit the build-up of systemic vulnerabilities. The authorities have a track record as a global standard setter in regulation and supervision and in addressing data gaps. Substantial progress has been made on implementing the 2014 FSAP recommendations (see Appendix V). An independent insurance authority has been established and the new risk-based capital regime for insurance companies is being put in place which will take two to three years to complete. The process of strengthening standards for securities listing is underway. Legislation has been put in place for a resolution framework for financial institutions which is designed to implement the Financial Stability Board’s Key Attributes—an impressive step forward. The HKMA has stepped up guidance and monitoring of bank lending activities, including to mainland China and for property-related activities; is closely checking liquidity risks; and is encouraging banks to reinforce cyber security. Coordination among Government and regulators in the Financial Stability Committee promotes discussion of risks that could transmit across the financial system. The authorities have close links with mainland regulators and are active in international fora, including supervisory colleges for cross-border banking and insurance groups, for global systemically important financial institutions, and in crisis management groups.

40. Countercyclical prudential policy. Although credit growth has slowed, there is still a positive credit gap. Risks from high corporate leverage and the housing market have not subsided but may actually increase as U.S. interest rates rise. Thus the authorities’ plan to raise the countercyclical buffer (CCYB) to 1.25 percent from January 2017 and up to the Basel III maximum appears appropriate. The CCYB could be paused or reversed only once the credit gap is eliminated and it becomes apparent that there has been a clearly established change of trend and financial cycle downturn.

41. While the financial system is resilient and prudential policy settings are appropriate, with an uncertain external setting, heightened attention is advisable in several areas:

Completing the strengthening of the nonbank oversight regime.
Further enhancing stress testing and risk analysis across the financial system. This could include complementing the individual risk analyses of the HKMA, the Securities and Futures Commission and the Insurance Authority, with coordinated work in line with emerging best practices.
Continuing to increase coordination among regulators, especially on liquidity monitoring, as new markets grow.
Reviewing financial institutions’ plans in response to stress events globally or in mainland China.
Continued efforts to enhance transparency related to legal persons and trusts and effective implementation of anti-money laundering and countering the financing of terrorism controls in line with the 2012 Anti-Money Laundering Ordinance (AMLO) and international standards underpin Hong Kong SAR’s reputation as a premier global financial center.

42. Contingency planning. In the event of a large adverse shock, a comprehensive and coordinated policy approach similar to the 2008/9 response would be appropriate, combining fiscal stimulus, loosening of macroprudential policies, expanded credit guarantees and HKMA emergency liquidity assistance. Strong collaboration among regulators and counterparts in other jurisdictions would be needed to monitor cross-border risks and provide liquidity support and backstopping of liabilities. The recently introduced crisis resolution framework is strengthening the availability of tools and ability to respond to strains in the banking, corporate and household sectors.

Authorities’ Views

43. The authorities’ welcomed the positive assessment of the progress made on implementing the 2014 FSAP recommendations. Approaches to the risk-based capital regime for insurance companies were being put in place and would take two to three years to complete formulating the regulatory framework—mainly due to establishing detailed capital requirements and carrying out quantitative impact studies for each company based on its risk exposure. Coordination among the regulators and government in the Financial Stability Committee promoted discussion of risks that could transmit across the financial system, closely following the emergence of best practices on stress testing and risk analysis emerging from leading central banks, the FSB and IOSCO.

B. Property Market Related Measures

44. With renewed signs of overheating in the property market, the three-pronged approach to limiting risks is as important as ever. This involves boosting housing supply to match demand, macroprudential measures to limit stability risks, and stamp duties to contain speculative activity and external demand.

Tackling housing supply shortage. The Long-Term Housing Strategy and Hong Kong 2030+ are aimed at addressing the housing shortage in an integrated manner by guiding land, planning and infrastructure development (see Box 1). Beyond the ten-year rolling target, continued efforts are needed over a longer horizon to keep pace with household formation and the need for urban renewal. Accelerating plans to increase supply faces a number of obstacles—such as the lack of ready projects, planning restrictions and legal and community objections. Nonetheless, to the extent possible, speeding up processes, making land available, and bringing forward public investment would be a double win—tackling the housing problem and supporting the economy at a time of soft growth.
Macroprudential measures for housing. Current settings have done their job of limiting financial system exposure to the asset price boom. With house prices rising once more, and valuations stretched, a further orderly house-price adjustment would be helpful. Loan to value (LTV) or debt service to income (DSI) ratio settings should remain fixed. Only once it is clear that the trend has firmly turned down, the overvaluation gap is eliminated, credit conditions tighten and an undervaluation gap opens up together with lower new housing transactions, would there be a case to ease LTV and DSI limits (which are conservative by international standards).
Stamp duties have helped contain speculative demand and curbed demand from cash buyers. November’s increase in ad valorem stamp duty for residential property transactions had an immediate impact on sentiment and appears to have curbed market exuberance. Stamp duties can be an effective part of the toolkit to stem excessive price increases and speculation in the real estate market. However, as the distorting costs of duties become more significant the higher they are, they should be rolled back once the trend has shifted towards reduced price and speculative pressures. The authorities should also monitor their effects to make sure it does not negatively affect the supply of smaller housing units, given the need to encourage relatively high density housing and provide affordable housing.

Box 1.

Housing and Land Supply, and the Development Strategy ^1/

Housing supply dropped sharply in the 2000s, leading to an acute housing shortage which the authorities are now seeking to address.

Household formation increased by 40 percent over the past twenty years but the supply of housing was cut sharply following the early 2000s-housing market downturn. New public housing was cut from an average of about 50,000 a year in the early 2000s to less than 15,000 in recent years and private housing was cut from 25,000 to 10–15,000. The private domestic vacancy rate almost halved. Land reclamation and site formation also slowed. This led to a growing demand supply imbalance. Projections point to a further expansion of households by 20 percent through to 2044. Compounding this, the housing stock is aging with close to 20 percent of it expected to reach aged 70 or above by 2046.

Tackling the housing shortage is now an important goal of government policy:

The Long-Term Housing Strategy plans to build 460,000 units over the next ten years from 2017/18 to 2026/27 with a public/private split of 60:40. The strategy includes building more public rental units; expanding subsidized home ownership; and steady provision of land supply for private residential properties and tenancy, keeping supply in sync with demand.
The longer-term development strategy is being revised in Hong Kong 2030+. It has been issued for public consultation and is expected to be finalized in 2018. It contains a vision to become a livable, high-density city in an environmentally friendly way.

Development of Hong Kong SAR’s land area is challenging with only a quarter of the land supply already developed. Up to 30 percent of the land area is planned or under study for development, other areas face major development, environmental or geographical constraints or are country parks or special areas. Land development typically takes 11–14 years from the preliminary stage to final construction and requires the development of ancillary transport and community services.

To push forward a pipeline of land supply the authorities adopted a multi-pronged strategy:

Near and medium term. (i) increasing development density if the traffic and environment conditions permit, (ii) changing land use if the provision of public/community facilities and open space is adequate, and (iii) reviewing land use of currently vacant government land and green belt sites
Medium to long term. (i) developing five new areas and (ii) extending new towns adding around 200,000 units starting from 2023–2026 (towards the end of the ten-year plan).
Longer term. (i) developing Lantau island and New Territory North, (ii) reclamations, and (iii) developing cavern and underground spaces.

^1/ Prepared by Joong Shik Kang.

Authorities’ Views: Property Market

Raising housing supply. This was a central focus for policy and supply was being increased as quickly as possible without compromising planning principles. The authorities were skeptical that there was much scope to bring forward investment given long time lags for development. The long-term housing strategy aims to gradually avert the supply-demand imbalance in housing, while Hong Kong 2030+ would address the need to step up urban regeneration efforts and result in sustained economic development and better quality living.
Macroprudential measures. The authorities viewed the current settings of macroprudential policies as appropriate. Since macroprudential measures were first introduced, at an early stage in 2009, the average LTV on new loans had fallen back from 64 percent immediately before the imposition of tightening measures to around 52 percent in 2016. The measures ensured that banks had sufficient buffers to handle potential shocks matching the worst cycles of the past.
Stamp duties. Alongside the HKMA’s imposition of macroprudential measures, the government had used stamp duties to contain speculative and external demand for property. The recent increase in the ad valorem stamp duty rate for residential property transactions had been necessary to manage demand, particularly from investors, in an overheated market.

Securing Long-Term Potential

45. Opportunities and challenges. In addition to the long-term fiscal challenge, the economy will need to adapt to mainland China’s rebalancing and move up the value added chain. This will bring vast opportunities but also requires the same adept flexibility that has helped Hong Kong SAR to successfully navigate change over the course of its history. Reducing inequality (especially from aging and pensioner poverty) and supporting labor participation will also be important for an aging population.

46. Building on Hong Kong’s role as a global financial center will be critical for growth. Hong Kong SAR has comparative advantages of geographical location, skilled and well educated workforce, high legal standards and a common language with its main trading partners. Leveraging its strong position as a regional financial hub, opportunities can be tapped from mainland China’s growth, global integration and capital account liberalization. As well as maintaining its position as the leading RMB offshore center, the authorities have a strategy of developing the asset management industry, encouraging corporate treasury centers to domicile in Hong Kong SAR and enabling healthy development of Fintech without compromising consumer and investor protection. There will be opportunities for global companies to conduct business through Hong Kong SAR, both to continue to establish Hong Kong SAR as a financial center for mainland China but also to become more of a global center for finance broadening international activity. The HKMA’s Infrastructure Financing Facilitation Office should help facilitate Hong Kong SAR’s role as a financing center for regional infrastructure investment, and mainland China’s “One Belt One Road initiative” will help expand activity. There is also scope to further develop professional services exports. Innovation should continue to be accompanied by strong regulation and supervision over the whole financial system.

47. Inequality, aging, and labor force participation. A number of the authorities’ policies are targeted to supporting those at the bottom end of the income deciles (Box 2) including through increasing the supply of public housing and increasing labor force participation. The low income Working Family

Box 2.

Inequality in Hong Kong SAR ^1/

Hong Kong’s income inequality as measured by the Gini index appears high in international comparisons, but may have declined recently as the authorities targeted policies at supporting the bottom of the income distribution.

Hong Kong SAR’s inequality looks high when comparing Gini indices across economies. The market Gini index measures inequality in market outcomes prior to taxes and transfers, while the net Gini index measures inequality in post-tax and post-transfers outcomes. Hong Kong SAR’s market index and net index of 54 and 44, respectively, in 2011 look relatively high when compared with other economies.

However, comparisons of Gini indices across economies are not straightforward. National statistics offices compute different concepts of the Gini, for example, based on market or net basis, on full income or just wage income, on consumption or income, adjusting for household size or not, and other ad hoc adjustments. When comparing across economies, one needs to use the same concept, which at times may not be possible. Beyond that, comparing Hong Kong’s Gini index to large countries with different urban and economic structures may not be appropriate. For example, Hong Kong SAR’s market Gini index seems in line with that of other cities with a sizable financial sector.

Inequality has declined recently as the authorities implemented policies targeted at the bottom of the income distribution. The net Gini index has come down from above 50 in 2002–03 to 44 in 2011, the last year for which data are available. ^2/ It has likely declined further as income has grown more rapidly at the bottom of the income distribution compared to the top since 2010. The authorities have implemented targeted policies like the introduction of a statutory minimum wage in 2011 and subsequent increases, the implementation of the Low-Income Working Family and Old-Age Living Allowances, transport subsidy, and expanding the supply of public rental housing. They also established a Commission on Poverty that devised Hong Kong SAR’s first official poverty line. These policies and increased scrutiny explain why Hong Kong SAR has a larger degree of redistribution compared to the Asia region.

Public housing provision will continue to be a major policy priority to alleviate inequality. Public housing provision has long been a policy priority in Hong Kong SAR, as illustrated by the fact that almost half of all households lived in public housing. The 2014 Long-Term Housing strategy renews and reinforces this long-standing effort, by setting a supply target of completing 460,000 units in the next 10 years, more than 60 percent of which public. ^3/ Public expenditure in housing has increased steadily and reached about 7 percent of total public expenditure in 2015/16. These efforts are essential to curb the supply-demand imbalance as well as allow access to affordable housing to lower income households.

Going forward, structural changes in the economy may not lead necessarily to higher inequality because of offsetting shifts in the labor force… The pattern of wage growth across industries varies widely: while some have seen high growth in pay per worker, others have not. The latter are mostly tied to the “old” economy and thus have underperformed due to the ongoing structural rebalance. At face value this could be driving income inequality, given that industries that have had low pay growth still account for more than half of the labor force in the private sector. However, at the same time, the labor force has shifted away from some these industries, likely a reflection of the flexible labor market. These patterns are expected to continue as the economy transforms and moves up the value chain. Maintaining flexibility in the labor market is therefore crucial.

…but a low growth environment has been accompanied by an increase in inequality in the past. Hong Kong SAR’s recent economic history can be divided into three main periods. From the 1960s to early 1990s, income per capita grew rapidly while inequality, measured by the net Gini index, remained stable. Between the early nineties and early 2000s, Hong Kong SAR’s per capita income growth declined and inequality increased rapidly. Since the early 2000s, income growth has picked markedly up and inequality has declined significantly. Income growth is slowing once more, which raises the concern that inequality may also rise.

^1/ Prepared by Rui Mano.^2/ New data should be available in 2017 using the results of the 2016 census.^3/ Initial target of 480,000 (of which 290,000 public provision) for 2015/16 to 2024/25 was changed to 460,000 for 2017/18 to 2026/27 due to revised demand estimates, see Box 1 for further details.

Allowance Scheme provides supplementary income to individuals and families with income and assets under a certain threshold and is targeted to encourage those on low incomes to stay in or reconnect to the workforce. The statutory minimum wage has helped boost labor supply without damaging wage flexibility and a further moderate increase could be accommodated. Working hours and overtime pay policy could also help encourage participation by those at the lower end of the income and skills distribution, but would need to take into account other pressures on the labor market. Policies that encourage active aging can also improve the fiscal position and help reduce health spending relative to a counterfactual.

Staff Appraisal

48. Growth and outlook. Growth has slowed since 2015 and the external outlook is more challenging with the U.S. rate cycle is edging up, global trade growth tepid and mainland China rebalancing. With soft external conditions, the growth recovery is likely to be gradual with the output gap closing slowly. Over the medium-term population aging pressures may affect potential growth and weaken the structural fiscal position. On the upside, the economy is highly flexible and large potential can be tapped from the further development of Hong Kong SAR as a global financial center. Strong policy frameworks and ample buffers are in place to weather a less favorable environment. Prudent fiscal policy and intensive supervision of the financial system have built buffers that can be drawn on when needed. The Linked Exchange Rate System (LERS), provides a credible anchor for a small open economy with a large globally integrated financial services industry.

49. There are three main risks. Growing economic linkages mean that changes in mainland China’s growth prospects spill over to Hong Kong SAR’s financial and real sectors. With a large globally-integrated financial sector and a currency board arrangement, the economy is exposed to U.S. developments and global market volatility. The property market is also a source of downside risk. With strong buffers in place these risks are manageable and should not adversely affect the economy provided that, as anticipated, interest rates rise at a moderate pace and mainland China’s transition to a more sustainable growth path remains orderly.

50. Fiscal policy. As the main demand management lever, fiscal policy needs to strike a balance between supporting aggregate demand and preserving a buffer for the longer-run challenge posed by aging. In the near term with a significant and persistent output gap, a difficult external environment, and weak automatic stabilizers, there is a case for further fiscal impetus which can be removed as the economy recovers. The planned impulse in the 2016–17 Budget is appropriate but if it undershoots and growth remains weak, additional stimulus will be needed in fiscal year 2017–18. Aligning short-term fiscal measures to long-term goals and shifting spending forward would help ensure that cyclical support does not exacerbate the long-term fiscal trend.

51. Long-term fiscal challenges. Early follow-through on the recommendations of the 2014 Report on Long-Term Fiscal Planning—reviewing and reprioritizing expenditures to measures that boost labor participation and support growth, raising revenues and managing assets—would help alleviate the fiscal impact of aging. Measures to broaden the tax base may also be needed. The aim for balance and keeping overall government expenditure growth in line with GDP growth over the medium term is appropriate, while taking early action to alleviate the structural deficit problem. A drawdown of the fiscal reserves could be accommodated as the economy adjusts, but a positive fiscal buffer is desirable to cope with adverse shocks, provide room for countercyclical fiscal policy, and sustain confidence.

52. Property market measures. With renewed signs of overheating in the property market, the three-pronged approach to limiting risks—boosting housing supply, macroprudential measures to limit stability risks, and stamp duties to contain speculative activity and external demand—is well placed. Current macroprudential settings have done their job of limiting financial system exposure to the asset price boom and LTV and DSI settings should remain unchanged. Stamp duties can be an effective part of the toolkit to stem excessive price increases and speculation in the real estate market. As the distorting costs of duties become more significant the higher they are, they should be rolled back once the trend has shifted toward reduced price and speculative pressures.

53. Housing supply. The Long-Term Housing Strategy and Hong Kong 2030+ are aimed at addressing the housing shortage in an integrated manner by guiding land, planning and infrastructure development. Accelerating plans to increase supply, speeding up processes, making land available, bringing forward public investment would be a double win—tackling the housing problem and supporting the economy at a time of soft growth.

54. Financial sector policies. The robust regulatory and supervisory framework should help limit the build-up of systemic vulnerabilities. The authorities have a track record as a global standard setter in regulation and supervision and in addressing data gaps. Substantial progress has been made on implementing the 2014 FSAP recommendations. An independent insurance authority has been established, strengthened standards for securities listing have been implemented, and legislation has been put in place for a resolution framework for financial institutions which is designed to implement the Financial Stability Board’s Key Attributes. There is substantial coordination among government and regulators domestically, there are close links with mainland regulators and the authorities are active in international fora, including in supervisory colleges for cross-border banking and insurance groups, on global systemically important financial institutions, and in crisis management groups. Areas for continued attention include further enhancing stress testing and reviewing financial institutions’ plans in response to stress events.

55. Exchange rate regime and external position. The LERS remains the best arrangement for Hong Kong SAR backed by the credibility built up over three decades and tested through crises. The LERS is underpinned by the flexible economy, ample reserves buffers and strong financial regulation and supervision. Wage and price flexibility allows the economy to adapt quickly to cyclical conditions and structural change. The external position is broadly in line with medium-term fundamentals and desirable policies.

56. Contingency planning. As a trading hub and global financial center, the economy is inevitably exposed to global external shocks. In the event of an adverse shock, a comprehensive and coordinated policy approach similar to the 2008/9 response would be appropriate: including large fiscal stimulus, loosening of macroprudential policies, expanded credit guarantees, emergency liquidity provision and close international supervisory coordination. The recently introduced crisis resolution framework is strengthening the ability to respond to strains in the banking, corporate and household sectors.

57. It is recommended that the next Article IV consultation discussions take place on the standard 12-month cycle.

Table 1.

Hong Kong SAR: Selected Economic and Financial Indicators, 2011–21

Sources: CEIC; HKSAR Census and Statistics Department; and IMF staff estimates.

^{^1/}For 2016, average for the first 10 months

^{^2/}For 2016, as of September

^{^3/}CentaData, HIBOR-based for all households

^{^4/}For 2016, as of October

^{^5/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 1.

Hong Kong SAR: Selected Economic and Financial Indicators, 2011–21

									Proj.
				2011	2012	2013	2014	2015	2016	2017	2018	2019	2020	2021
NATIONAL ACCOUNTS
Real GDP (percent change)				4.8	1.7	3.1	2.7	2.4	1.5	1.9	2.4	3.0	3.0	3.1
	Contribution
		Domestic demand		6.1	3.7	4.0	2.9	1.6	2.2	2.4	2.4	3.4	3.6	3.7
			Private consumption	5.2	2.6	3.0	2.2	3.1	0.8	1.3	1.8	2.5	2.6	2.6
			Government consumption	0.2	0.3	0.2	0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3
			Gross fixed capital formation	2.2	1.6	0.7	0.0	−0.5	−0.2	0.2	0.3	0.5	0.6	0.8
			Inventories	−1.5	−0.8	0.1	0.4	−1.3	1.4	0.7	0.0	0.0	0.0	0.0
		Net exports		−1.3	−2.0	−0.9	−0.2	0.8	−0.7	−0.5	0.0	−0.3	−0.5	−0.6
	Potential GDP growth			3.4	3.1	3.0	2.8	2.7	2.7	2.7	2.7	2.6	2.5	2.5
	Output gap (in percent of potential)			1.5	0.1	0.2	0.1	−0.2	−1.2	−2.0	−2.2	−1.8	−1.2	−0.5
Saving and investment (percent of GDP)
	Gross national saving			29.7	26.8	25.5	25.1	24.8	25.4	25.7	25.6	25.3	25.1	25.0
	Gross domestic investment			24.1	25.2	24.0	23.8	21.7	22.7	22.8	22.3	22.0	21.7	21.6
	Saving-investment balance			5.6	1.6	1.5	1.3	3.1	2.8	2.9	3.2	3.3	3.4	3.4
LABOR MARKET
Employment (percent change)				2.9	2.4	1.8	0.6	0.8	0.5	0.9	0.7	0.7	0.8	0.7
Unemployment rate (percent, period average)				3.4	3.3	3.4	3.3	3.3	3.3	3.2	3.2	3.2	3.1	3.1
Real wages (percent change)				2.7	1.6	0.1	−2.4	0.6	0.6	0.9	1.1	1.3	1.5	1.6
PRICES
Inflation (percent change)
	Consumer prices			5.3	4.1	4.3	4.4	3.0	2.5	2.6	2.7	2.8	2.9	3.0
	GDP deflator			3.9	3.5	1.8	2.9	3.6	1.8	2.0	2.1	1.4	1.3	1.6
GENERAL GOVERNMENT
Consolidated budget balance				3.8	3.2	1.0	3.7	0.6	1.6	1.5	0.1	0.6	1.4	1.4
	Revenue			22.6	21.7	21.3	21.2	18.8	21.1	20.4	20.3	20.3	20.3	20.3
	Expenditure			18.8	18.5	20.3	17.5	18.2	19.5	18.9	20.2	19.7	18.9	18.9
Fiscal reserves as of March 31				34.6	36.0	35.3	36.7	35.2	35.6	35.8	34.3	33.4	33.4	33.2
FINANCIAL
Interest rates (percent, end-period)
Best lending rate ^1/				5.0	5.0	5.0	5.0	5.0	5.0	…	…	…	…	…
Three-month HIBOR ^1/				0.4	0.4	0.4	0.4	0.4	0.6	…	…	…	…	…
10-year Treasury bond yield ^1/				1.5	0.9	2.7	2.0	1.7	1.2	…	…	…	…	…
MACRO-FINANCIAL
Loans for use in Hong Kong SAR (not including trade financing) ^2/				12.5	7.0	10.6	13.5	6.3	6.3	4.0	4.5	5.5	6.0	6.0
House prices (end of period, percent change)				11.1	25.7	7.7	13.5	2.4	−4.0	−5.0	−3.0	−3.0	0.0	2.0
Mortgage payment to income ratio ^3/				39.9	43.6	45.7	44.7	48.9	44.3	46.4	47.1	47.4	45.4	43.5
Household debt (in percent of GDP)				58.4	60.6	61.9	64.9	66.5	64.4	61.2	59.4	57.6	57.6	58.7
Non-financial corporate debt (in percent of GDP)				175.5	195.7	212.1	224.6	213.7	205.7	202.8	198.4	197.0	196.1	198.0
Hang Seng stock index (percent change) ^4/				−20.0	22.9	2.9	1.3	−7.2	1.3	…	…	…	…	…
EXTERNAL SECTOR
Merchandise trade (percent change)
	Export volume			3.5	1.9	6.5	0.8	−1.9	0.3	2.1	2.7	2.8	2.6	2.6
		Domestic exports		−0.6	10.1	−1.6	2.3	−12.9	14.2	2.1	2.7	2.8	2.6	2.6
		Reexports		3.6	1.7	6.8	0.8	−1.6	0.6	2.1	2.7	2.8	2.6	2.6
	Import volume			4.7	3.0	7.2	0.9	−2.7	−0.3	2.6	2.7	2.9	2.8	2.8
	Export value			11.5	5.0	6.3	1.6	−2.5	0.4	2.8	3.9	3.7	3.2	2.8
	Import value			13.3	7.0	6.8	1.7	−4.1	0.3	3.7	3.9	4.0	3.6	3.4
	Terms of trade			−0.1	0.1	0.4	0.1	0.5	−0.4	−0.3	0.0	−0.2	−0.2	−0.3
Current account balance (percent of GDP) ^5/				5.6	1.6	1.5	1.3	3.1	2.8	2.9	3.2	3.3	3.4	3.4
Foreign exchange reserves ^5/
	In billions of U.S. dollars, end-of-period			285.4	317.4	311.2	328.5	358.8	390.1	418.9	431.3	446.2	457.8	466.7
	In percent of GDP			114.6	121.3	112.9	112.8	116.1	122.0	126.3	124.2	122.8	119.6	115.7
Net international investment position (percent of GDP)				285.5	274.5	274.9	298.9	316.6	309.0	300.3	290.3	281.3	272.9	264.0
Linked rate (fixed)
	Market rate (HK$/US$1, period average)			7.784	7.756	7.756	7.754	7.752	7.757	…	…	…	…	…
	Real effective rate (period average, 2010=100)			96.6	98.7	102.2	105.6	113.9	117.3	…	…	…	…	…

Sources: CEIC; HKSAR Census and Statistics Department; and IMF staff estimates.

^{^1/}For 2016, average for the first 10 months

^{^2/}For 2016, as of September

^{^3/}CentaData, HIBOR-based for all households

^{^4/}For 2016, as of October

^{^5/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 1.

Hong Kong SAR: Selected Economic and Financial Indicators, 2011–21

									Proj.
				2011	2012	2013	2014	2015	2016	2017	2018	2019	2020	2021
NATIONAL ACCOUNTS
Real GDP (percent change)				4.8	1.7	3.1	2.7	2.4	1.5	1.9	2.4	3.0	3.0	3.1
	Contribution
		Domestic demand		6.1	3.7	4.0	2.9	1.6	2.2	2.4	2.4	3.4	3.6	3.7
			Private consumption	5.2	2.6	3.0	2.2	3.1	0.8	1.3	1.8	2.5	2.6	2.6
			Government consumption	0.2	0.3	0.2	0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3
			Gross fixed capital formation	2.2	1.6	0.7	0.0	−0.5	−0.2	0.2	0.3	0.5	0.6	0.8
			Inventories	−1.5	−0.8	0.1	0.4	−1.3	1.4	0.7	0.0	0.0	0.0	0.0
		Net exports		−1.3	−2.0	−0.9	−0.2	0.8	−0.7	−0.5	0.0	−0.3	−0.5	−0.6
	Potential GDP growth			3.4	3.1	3.0	2.8	2.7	2.7	2.7	2.7	2.6	2.5	2.5
	Output gap (in percent of potential)			1.5	0.1	0.2	0.1	−0.2	−1.2	−2.0	−2.2	−1.8	−1.2	−0.5
Saving and investment (percent of GDP)
	Gross national saving			29.7	26.8	25.5	25.1	24.8	25.4	25.7	25.6	25.3	25.1	25.0
	Gross domestic investment			24.1	25.2	24.0	23.8	21.7	22.7	22.8	22.3	22.0	21.7	21.6
	Saving-investment balance			5.6	1.6	1.5	1.3	3.1	2.8	2.9	3.2	3.3	3.4	3.4
LABOR MARKET
Employment (percent change)				2.9	2.4	1.8	0.6	0.8	0.5	0.9	0.7	0.7	0.8	0.7
Unemployment rate (percent, period average)				3.4	3.3	3.4	3.3	3.3	3.3	3.2	3.2	3.2	3.1	3.1
Real wages (percent change)				2.7	1.6	0.1	−2.4	0.6	0.6	0.9	1.1	1.3	1.5	1.6
PRICES
Inflation (percent change)
	Consumer prices			5.3	4.1	4.3	4.4	3.0	2.5	2.6	2.7	2.8	2.9	3.0
	GDP deflator			3.9	3.5	1.8	2.9	3.6	1.8	2.0	2.1	1.4	1.3	1.6
GENERAL GOVERNMENT
Consolidated budget balance				3.8	3.2	1.0	3.7	0.6	1.6	1.5	0.1	0.6	1.4	1.4
	Revenue			22.6	21.7	21.3	21.2	18.8	21.1	20.4	20.3	20.3	20.3	20.3
	Expenditure			18.8	18.5	20.3	17.5	18.2	19.5	18.9	20.2	19.7	18.9	18.9
Fiscal reserves as of March 31				34.6	36.0	35.3	36.7	35.2	35.6	35.8	34.3	33.4	33.4	33.2
FINANCIAL
Interest rates (percent, end-period)
Best lending rate ^1/				5.0	5.0	5.0	5.0	5.0	5.0	…	…	…	…	…
Three-month HIBOR ^1/				0.4	0.4	0.4	0.4	0.4	0.6	…	…	…	…	…
10-year Treasury bond yield ^1/				1.5	0.9	2.7	2.0	1.7	1.2	…	…	…	…	…
MACRO-FINANCIAL
Loans for use in Hong Kong SAR (not including trade financing) ^2/				12.5	7.0	10.6	13.5	6.3	6.3	4.0	4.5	5.5	6.0	6.0
House prices (end of period, percent change)				11.1	25.7	7.7	13.5	2.4	−4.0	−5.0	−3.0	−3.0	0.0	2.0
Mortgage payment to income ratio ^3/				39.9	43.6	45.7	44.7	48.9	44.3	46.4	47.1	47.4	45.4	43.5
Household debt (in percent of GDP)				58.4	60.6	61.9	64.9	66.5	64.4	61.2	59.4	57.6	57.6	58.7
Non-financial corporate debt (in percent of GDP)				175.5	195.7	212.1	224.6	213.7	205.7	202.8	198.4	197.0	196.1	198.0
Hang Seng stock index (percent change) ^4/				−20.0	22.9	2.9	1.3	−7.2	1.3	…	…	…	…	…
EXTERNAL SECTOR
Merchandise trade (percent change)
	Export volume			3.5	1.9	6.5	0.8	−1.9	0.3	2.1	2.7	2.8	2.6	2.6
		Domestic exports		−0.6	10.1	−1.6	2.3	−12.9	14.2	2.1	2.7	2.8	2.6	2.6
		Reexports		3.6	1.7	6.8	0.8	−1.6	0.6	2.1	2.7	2.8	2.6	2.6
	Import volume			4.7	3.0	7.2	0.9	−2.7	−0.3	2.6	2.7	2.9	2.8	2.8
	Export value			11.5	5.0	6.3	1.6	−2.5	0.4	2.8	3.9	3.7	3.2	2.8
	Import value			13.3	7.0	6.8	1.7	−4.1	0.3	3.7	3.9	4.0	3.6	3.4
	Terms of trade			−0.1	0.1	0.4	0.1	0.5	−0.4	−0.3	0.0	−0.2	−0.2	−0.3
Current account balance (percent of GDP) ^5/				5.6	1.6	1.5	1.3	3.1	2.8	2.9	3.2	3.3	3.4	3.4
Foreign exchange reserves ^5/
	In billions of U.S. dollars, end-of-period			285.4	317.4	311.2	328.5	358.8	390.1	418.9	431.3	446.2	457.8	466.7
	In percent of GDP			114.6	121.3	112.9	112.8	116.1	122.0	126.3	124.2	122.8	119.6	115.7
Net international investment position (percent of GDP)				285.5	274.5	274.9	298.9	316.6	309.0	300.3	290.3	281.3	272.9	264.0
Linked rate (fixed)
	Market rate (HK$/US$1, period average)			7.784	7.756	7.756	7.754	7.752	7.757	…	…	…	…	…
	Real effective rate (period average, 2010=100)			96.6	98.7	102.2	105.6	113.9	117.3	…	…	…	…	…

Sources: CEIC; HKSAR Census and Statistics Department; and IMF staff estimates.

^{^1/}For 2016, average for the first 10 months

^{^2/}For 2016, as of September

^{^3/}CentaData, HIBOR-based for all households

^{^4/}For 2016, as of October

^{^5/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 2.

Hong Kong SAR: Balance of Payments, 2011–17 ^1/

Sources: CEIC and HKSAR Census and Statistics Department.

^{^1/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 2.

Hong Kong SAR: Balance of Payments, 2011–17 ^1/

								Proj.
				2011	2012	2013	2014	2015	2016	2017
				(In billions of U.S. dollars)
Current account				13.8	4.1	4.1	3.8	9.6	8.8	9.5
	Goods balance			−7.5	−18.9	−27.9	−32.4	−22.8	−22.1	−27.5
	Services balance			17.0	21.9	29.5	32.7	30.0	27.2	32.6
	Income balance			4.2	1.2	2.5	3.5	2.4	3.7	4.5
		Primary income balance		6.8	3.8	5.2	6.0	5.1	6.6	7.5
		Secondary income balance		−2.5	−2.6	−2.7	−2.6	−2.7	−2.9	−3.0
Capital and financial account				−14.5	−8.7	−11.1	−9.5	−17.0	−8.8	−9.5
	Capital account			−0.3	−0.2	−0.2	−0.1	0.0	0.0	0.0
	Financial account			−14.3	−8.5	−10.9	−9.4	−17.0	−8.8	−9.5
		Net direct investment		0.2	−13.2	−6.5	−11.1	119.7	15.7	11.5
			Assets	−95.9	−88.1	−83.3	−140.9	−61.1	−128.1	−138.0
			Liabilities	96.1	74.9	76.9	129.8	180.9	143.8	149.5
		Portfolio investment		−1.4	−4.1	−49.8	−8.3	−141.2	−9.2	−9.6
			Assets	−20.0	−40.1	−66.4	−35.6	−99.2	−39.3	−40.9
			Liabilities	18.6	36.0	16.6	27.3	−42.0	30.1	29.0
		Financial derivatives		2.7	2.0	7.0	15.3	15.2	2.9	3.1
			Assets	46.2	39.7	54.8	57.9	73.4	65.5	70.6
			Liabilities	−43.5	−37.8	−47.7	−42.7	−58.3	−62.6	−64.1
		Other investment		−4.7	31.2	45.8	12.6	25.7	13.6	13.9
			Assets	−100.3	−17.1	−82.4	−119.3	26.6	−114.4	−116.6
			Liabilities	95.7	48.2	128.2	131.9	−0.8	128.0	130.5
		Reserve assets (net change)		−11.1	−24.4	−7.5	−17.9	−36.4	−31.8	−28.4
Net errors and omissions				0.7	4.6	7.0	5.7	7.3	0.0	0.0
Memorandum item:
Nominal GDP				248.5	262.6	275.7	291.2	309.2	319.6	331.7
				(In percent of GDP)
Current account				5.6	1.6	1.5	1.3	3.1	2.8	2.9
	Goods balance			−3.0	−7.2	−10.1	−11.1	−7.4	−6.9	−8.3
	Services balance			6.9	8.3	10.7	11.2	9.7	8.5	9.8
	Income balance			1.7	0.4	0.9	1.2	0.8	1.2	1.3
Capital and financial account				−5.9	−3.3	−4.0	−3.3	−5.5	−2.8	−2.9
	Capital account			−0.1	−0.1	−0.1	0.0	0.0	0.0	0.0
	Financial account			−5.7	−3.3	−4.0	−3.2	−5.5	−2.8	−2.9
		Net direct investment		0.1	−5.0	−2.3	−3.8	38.7	4.9	3.5
		Portfolio investment		−0.6	−1.6	−18.1	−2.9	−45.7	−2.9	−2.9
		Financial derivatives		1.1	0.7	2.6	5.2	4.9	0.9	0.9
		Other investment		−1.9	11.9	16.6	4.3	8.3	4.3	4.2
		Reserve assets (net change)		−4.5	−9.3	−2.7	−6.2	−11.8	−10.0	−8.6
Net errors and omissions				0.3	1.7	2.5	2.0	2.4	0.0	0.0

Sources: CEIC and HKSAR Census and Statistics Department.

^{^1/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 2.

Hong Kong SAR: Balance of Payments, 2011–17 ^1/

								Proj.
				2011	2012	2013	2014	2015	2016	2017
				(In billions of U.S. dollars)
Current account				13.8	4.1	4.1	3.8	9.6	8.8	9.5
	Goods balance			−7.5	−18.9	−27.9	−32.4	−22.8	−22.1	−27.5
	Services balance			17.0	21.9	29.5	32.7	30.0	27.2	32.6
	Income balance			4.2	1.2	2.5	3.5	2.4	3.7	4.5
		Primary income balance		6.8	3.8	5.2	6.0	5.1	6.6	7.5
		Secondary income balance		−2.5	−2.6	−2.7	−2.6	−2.7	−2.9	−3.0
Capital and financial account				−14.5	−8.7	−11.1	−9.5	−17.0	−8.8	−9.5
	Capital account			−0.3	−0.2	−0.2	−0.1	0.0	0.0	0.0
	Financial account			−14.3	−8.5	−10.9	−9.4	−17.0	−8.8	−9.5
		Net direct investment		0.2	−13.2	−6.5	−11.1	119.7	15.7	11.5
			Assets	−95.9	−88.1	−83.3	−140.9	−61.1	−128.1	−138.0
			Liabilities	96.1	74.9	76.9	129.8	180.9	143.8	149.5
		Portfolio investment		−1.4	−4.1	−49.8	−8.3	−141.2	−9.2	−9.6
			Assets	−20.0	−40.1	−66.4	−35.6	−99.2	−39.3	−40.9
			Liabilities	18.6	36.0	16.6	27.3	−42.0	30.1	29.0
		Financial derivatives		2.7	2.0	7.0	15.3	15.2	2.9	3.1
			Assets	46.2	39.7	54.8	57.9	73.4	65.5	70.6
			Liabilities	−43.5	−37.8	−47.7	−42.7	−58.3	−62.6	−64.1
		Other investment		−4.7	31.2	45.8	12.6	25.7	13.6	13.9
			Assets	−100.3	−17.1	−82.4	−119.3	26.6	−114.4	−116.6
			Liabilities	95.7	48.2	128.2	131.9	−0.8	128.0	130.5
		Reserve assets (net change)		−11.1	−24.4	−7.5	−17.9	−36.4	−31.8	−28.4
Net errors and omissions				0.7	4.6	7.0	5.7	7.3	0.0	0.0
Memorandum item:
Nominal GDP				248.5	262.6	275.7	291.2	309.2	319.6	331.7
				(In percent of GDP)
Current account				5.6	1.6	1.5	1.3	3.1	2.8	2.9
	Goods balance			−3.0	−7.2	−10.1	−11.1	−7.4	−6.9	−8.3
	Services balance			6.9	8.3	10.7	11.2	9.7	8.5	9.8
	Income balance			1.7	0.4	0.9	1.2	0.8	1.2	1.3
Capital and financial account				−5.9	−3.3	−4.0	−3.3	−5.5	−2.8	−2.9
	Capital account			−0.1	−0.1	−0.1	0.0	0.0	0.0	0.0
	Financial account			−5.7	−3.3	−4.0	−3.2	−5.5	−2.8	−2.9
		Net direct investment		0.1	−5.0	−2.3	−3.8	38.7	4.9	3.5
		Portfolio investment		−0.6	−1.6	−18.1	−2.9	−45.7	−2.9	−2.9
		Financial derivatives		1.1	0.7	2.6	5.2	4.9	0.9	0.9
		Other investment		−1.9	11.9	16.6	4.3	8.3	4.3	4.2
		Reserve assets (net change)		−4.5	−9.3	−2.7	−6.2	−11.8	−10.0	−8.6
Net errors and omissions				0.3	1.7	2.5	2.0	2.4	0.0	0.0

Sources: CEIC and HKSAR Census and Statistics Department.

^{^1/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 3.

Hong Kong SAR: Consolidated Government Account, 2012/13–2021/22 ^1/

(In percent of fiscal year GDP, unless otherwise stated)

Sources: CEIC; and IMF staff estimates.

^{^1/}Assuming expenditure as in the latest medium-term budget document and staff adjusted revenue. Fiscal year begins April 1.

^{^2/}Expenditure in 2016/20 is temporarily higher due to additional provisions for healthcare reform and retirement protection.

^{^3/}Operating balance, as defined by the authorities, is akin to the current balance.

^{^4/}Balance excluding investment income and interest expenditure.

^{^5/}Primary balance adjusted to exclude one-off provisions for healthcare reform and retirement protection.

Table 3.

Hong Kong SAR: Consolidated Government Account, 2012/13–2021/22 ^1/

(In percent of fiscal year GDP, unless otherwise stated)

							Prov.	Proj.
				2012/13	2013/14	2014/15	015/16	2016/17	2017/18	2018/19	2019/20	2020/21	2021/22
Consolidated revenue				21.4	21.0	20.9	18.7	20.8	20.2	20.1	20.1	20.0	20.0
	Operating revenue			16.7	16.4	17.2	15.8	16.7	17.2	16.7	16.7	16.7	16.7
	Capital revenue			4.7	4.7	3.8	2.9	4.2	3.1	3.4	3.4	3.4	3.4
	Taxes			13.6	13.3	15.4	14.3	15.9	15.5	15.4	15.4	15.3	15.3
		Of which:
			Salaries tax	2.4	2.6	2.6	…	…	…	…	…	…	…
			Profits tax	6.1	5.6	6.0	…	…	…	…	…	…	…
			Stamp duties	2.1	1.9	3.3	…	…	…	…	…	…	…
	Nontax			7.9	7.7	5.4	4.4	4.9	4.7	4.7	4.7	4.7	4.7
		Of which:
		Land premium		3.4	3.9	3.4	2.5	3.7	2.7	3.0	3.0	3.0	3.0
		Investment income		1.8	1.7	0.0	0.0	0.8	0.7	0.8	0.6	0.5	0.5
Consolidated expenditure				18.3	20.0	17.3	18.1	19.3	18.7	20.0	19.5	18.7	18.7
	Operating expenditure ^2/			14.7	15.6	13.8	14.4	15.0	14.7	15.8	15.1	14.4	14.4
		Of which:
			Personnel related (including pensions)	4.1	4.1	4.2	4.3	4.3	4.3	4.3	4.3	4.3	4.3
			Capital expenditure	3.6	4.4	3.5	3.7	4.2	4.0	4.2	4.4	4.3	4.3
		Of which:
			Interest expenditure	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Overall balance				3.1	1.0	3.6	0.6	1.6	1.5	0.1	0.6	1.3	1.3
Memorandum items:
	Operating balance ^3/			2.0	0.8	3.4	1.4	1.7	2.5	0.9	1.7	2.3	2.3
	Primary balance ^4/			1.3	−0.7	3.6	0.6	0.7	0.8	−0.7	0.0	0.8	0.9
	Structural balance			0.4	−1.8	2.8	0.0	0.5	0.9	0.5	0.4	0.3	0.2
	Cyclically adjusted primary balance ^5/			1.3	−0.7	3.6	0.6	0.4	0.8	0.4	0.2	0.3	0.2
	Fiscal reserves			35.6	34.9	36.1	34.9	35.2	35.4	33.9	33.0	33.0	32.9
		(Months of spending)		23.3	20.9	25.1	23.2	22.0	22.7	20.4	20.3	21.2	21.1

Sources: CEIC; and IMF staff estimates.

^{^1/}Assuming expenditure as in the latest medium-term budget document and staff adjusted revenue. Fiscal year begins April 1.

^{^2/}Expenditure in 2016/20 is temporarily higher due to additional provisions for healthcare reform and retirement protection.

^{^3/}Operating balance, as defined by the authorities, is akin to the current balance.

^{^4/}Balance excluding investment income and interest expenditure.

^{^5/}Primary balance adjusted to exclude one-off provisions for healthcare reform and retirement protection.

Table 3.

Hong Kong SAR: Consolidated Government Account, 2012/13–2021/22 ^1/

(In percent of fiscal year GDP, unless otherwise stated)

							Prov.	Proj.
				2012/13	2013/14	2014/15	015/16	2016/17	2017/18	2018/19	2019/20	2020/21	2021/22
Consolidated revenue				21.4	21.0	20.9	18.7	20.8	20.2	20.1	20.1	20.0	20.0
	Operating revenue			16.7	16.4	17.2	15.8	16.7	17.2	16.7	16.7	16.7	16.7
	Capital revenue			4.7	4.7	3.8	2.9	4.2	3.1	3.4	3.4	3.4	3.4
	Taxes			13.6	13.3	15.4	14.3	15.9	15.5	15.4	15.4	15.3	15.3
		Of which:
			Salaries tax	2.4	2.6	2.6	…	…	…	…	…	…	…
			Profits tax	6.1	5.6	6.0	…	…	…	…	…	…	…
			Stamp duties	2.1	1.9	3.3	…	…	…	…	…	…	…
	Nontax			7.9	7.7	5.4	4.4	4.9	4.7	4.7	4.7	4.7	4.7
		Of which:
		Land premium		3.4	3.9	3.4	2.5	3.7	2.7	3.0	3.0	3.0	3.0
		Investment income		1.8	1.7	0.0	0.0	0.8	0.7	0.8	0.6	0.5	0.5
Consolidated expenditure				18.3	20.0	17.3	18.1	19.3	18.7	20.0	19.5	18.7	18.7
	Operating expenditure ^2/			14.7	15.6	13.8	14.4	15.0	14.7	15.8	15.1	14.4	14.4
		Of which:
			Personnel related (including pensions)	4.1	4.1	4.2	4.3	4.3	4.3	4.3	4.3	4.3	4.3
			Capital expenditure	3.6	4.4	3.5	3.7	4.2	4.0	4.2	4.4	4.3	4.3
		Of which:
			Interest expenditure	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Overall balance				3.1	1.0	3.6	0.6	1.6	1.5	0.1	0.6	1.3	1.3
Memorandum items:
	Operating balance ^3/			2.0	0.8	3.4	1.4	1.7	2.5	0.9	1.7	2.3	2.3
	Primary balance ^4/			1.3	−0.7	3.6	0.6	0.7	0.8	−0.7	0.0	0.8	0.9
	Structural balance			0.4	−1.8	2.8	0.0	0.5	0.9	0.5	0.4	0.3	0.2
	Cyclically adjusted primary balance ^5/			1.3	−0.7	3.6	0.6	0.4	0.8	0.4	0.2	0.3	0.2
	Fiscal reserves			35.6	34.9	36.1	34.9	35.2	35.4	33.9	33.0	33.0	32.9
		(Months of spending)		23.3	20.9	25.1	23.2	22.0	22.7	20.4	20.3	21.2	21.1

Sources: CEIC; and IMF staff estimates.

^{^1/}Assuming expenditure as in the latest medium-term budget document and staff adjusted revenue. Fiscal year begins April 1.

^{^2/}Expenditure in 2016/20 is temporarily higher due to additional provisions for healthcare reform and retirement protection.

^{^3/}Operating balance, as defined by the authorities, is akin to the current balance.

^{^4/}Balance excluding investment income and interest expenditure.

^{^5/}Primary balance adjusted to exclude one-off provisions for healthcare reform and retirement protection.

Table 4.

Hong Kong SAR: Monetary Survey, 2011–17

Sources: IMF, International Financial Statistics ; Haver Analytics, and staff calculation.

^{^1/}Includes savings, time, demand, and negotiable certificates of deposits.

Table 4.

Hong Kong SAR: Monetary Survey, 2011–17

							Proj.
		2011	2012	2013	2014	2015	2016	2017
		(In billions of Hong Kong dollars)
Net foreign assets		3975	4447	4866	5064	4991	5923	7014
	Monetary authorities	2178	2431	2582	2792	3051	3723	4764
	Banks	1797	2016	2285	2272	1940	2200	2250
Domestic credit		4007	4097	4760	5333	5082	5009	4913
	Claims on private sector	3913	4044	4665	5271	4987	4912	4814
	Claims on government	94	52	95	63	95	97	99
Other items (net)		76	406	431	614	1545	1500	1500
M2		8058	8950	10056	11011	11618	12432	13426
	Of which:
	Deposits in HKD ^1/	3798	4256	4481	4896	5416	…	…
	Deposits in foreign currencies ^1/	4011	4413	5261	5786	5853	…	…
	Notes and coins in circulation	248	282	314	330	349	…	…
		(Annual percentage change)
Domestic credit		15.5	2.2	16.2	12.1	−4.7	−1.4	−1.9
	Claims on private sector	18.7	3.3	15.3	13.0	−5.4	−1.5	−2.0
M2		12.9	11.1	12.4	9.5	5.5	7.0	8.0
		(Contribution to M2 growth, in percent)
Net foreign assets		2.7	5.9	4.7	2.0	−0.7	8.0	8.8
Domestic credit		7.5	1.1	7.4	5.7	−2.3	−0.6	−0.8
	Claims on private sector	8.6	1.6	6.9	6.0	−2.6	−0.6	−0.8
	Claims on government	−1.1	−0.5	0.5	−0.3	0.3	0.0	0.0
Other items (net)		2.7	4.1	0.3	1.8	8.5	−0.4	0.0
		(In percent of GDP)
Net foreign assets		205.5	218.3	227.6	224.3	208.2	239.0	272.5
Domestic credit		207.1	201.1	222.6	236.2	212.0	202.2	190.8
Other items (net)		3.9	19.9	20.1	27.2	64.5	60.5	58.3
M2		416.5	439.4	470.4	487.6	484.7	501.7	521.6

Sources: IMF, International Financial Statistics ; Haver Analytics, and staff calculation.

^{^1/}Includes savings, time, demand, and negotiable certificates of deposits.

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About

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Abstract

Context: Testing Times After a Decade of Robust Growth

Recent Developments

Macroeconomic Outlook

Authorities’ Views

Risks to the Outlook

A. Mainland China’s Bumpy Transition or Slow Reform

Authorities’ views

B. U.S. Rate Cycle and Global Market Volatility

C. Property Market

Authorities’ Views

D. Amplification of Risks

Authorities’ views

Policies to Support The Recovery

A. Fiscal Policy: Near-Term Space, Longer-Run Challenge

Near-Term Fiscal Policy

Long-Term Fiscal Challenge

Authorities’ Views

B. Preserving Strengths

Authorities’ Views

Protecting Financial System Resilience

A. Financial System

Authorities’ Views

B. Property Market Related Measures

Authorities’ Views: Property Market

Securing Long-Term Potential

Staff Appraisal