People’s Republic of China—Hong Kong Special Administrative Region: Staff Report for the 2017 Article IV Consultation Discussions

International Monetary Fund

doi:10.5089/9781484338346.002.A001

Author: International Monetary Fund

Publication Date:: 22 Jan 2018

eISBN:: 9781484338346

Language:: English

Keywords:: ISCR; CR; staff appraisal; assessment of policy issue; Hong Kong SAR economy; assessment; report; Hong Kong SAR; fiscal policy; U.S. dollar; Mainland market; nonbank Mainland corporate; Housing prices; Housing; Income; Global; output gap

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2017 Article IV Consultation-Press Release; Staff Report; Statement by the Executive Director for People's Republic of China--Hong Kong Special Administrative Region

Abstract

2017 Article IV Consultation-Press Release; Staff Report; Statement by the Executive Director for People's Republic of China--Hong Kong Special Administrative Region

Context: Opportunities and Challenges

1. Hong Kong SAR—a highly open economy with a globally integrated financial services sector—has successfully navigated challenging global tides over the last decade. Economic growth remained robust after the global financial crisis, benefitting from ultra-low global interest rates and strong growth in Mainland China. Growth has been supported by Hong Kong SAR’s role as a trading and financial gateway between Mainland China and the rest of the world. However, amid low interest rates, housing prices more than tripled over the past decade as rising demand outpaced supply despite a series of government measures, leading to deteriorating housing affordability and contributing to rising social tensions. Also, while income inequality has narrowed slightly, it remains high. The new government assumed office in July 2017, on the 20^th anniversary of the handover, amid public concerns regarding income inequality and high and rising housing costs, both of which are at the center of the new administration’s agenda.

2. Going forward, the economy faces both opportunities and challenges. The global economic recovery is on track, Mainland China’s growth is projected to remain robust and its Belt and Road Initiative (BRI), which aims to foster global and regional cooperation in infrastructure, trade and finance, and plans for the development of the Guangdong-Hong Kong SAR-Macao SAR Bay Area create opportunities for Hong Kong SAR given its unique position as a gateway to Mainland China and a global financial center. At the same time, challenges could stem from tightening global financial conditions amid rising U.S. rates, bumps in Mainland China’s transition to a more sustainable growth, retreat from cross-border integration, and the risk of a disorderly domestic property market adjustment. In a longer-term perspective, high income inequality, rising social discontent and an aging population could weigh on Hong Kong SAR’s prospects. Strong policy frameworks and ample buffers are in place, but they need to be further strengthened to maximize benefits from tailwinds while managing risks from those headwinds.

Recent Developments and Outlook: Solid Recovery on Track

3. The economy bottomed out in mid-2016 and momentum accelerated in 2017 amid the global recovery, robust Mainland China growth, booming housing prices, and rebounding credit growth.

Activity. Economic activity has gained momentum after bottoming out in the second half of 2016, with GDP growth rising to 0.9 percent (q/q sa) on average for 2016Q3-2017Q3 from 0.5 percent (q/q sa) for 2015Q1-2016Q2. Private consumption remained robust and contributed 1.0 percentage point to growth in 2016Q3-2017Q3; the labor market remained tight, with the 3-month average unemployment rate edging further down to 3.0 percent in November. Strong construction activity on the resumption of planned public investment projects and ongoing housing supply projects contributed to a strong recovery of investment. External demand picked up in line with the global trade recovery, and tourist arrivals have rebounded since late 2016 driven by Mainland Chinese visitors. The composite PMI for November remained in expansionary territory, suggesting continued momentum in 2017Q4.
Inflation and output gap. Inflation remained contained at below 2 percent. The output gap turned modestly positive in 2017Q3 (0.2 percent) with the rebound in economic activity.
Financial conditions. Overall financial conditions remain accommodative. Despite increasing policy rates amid rising US rates, average funding costs have remained low and stable. Notwithstanding modest increases in interest rates, asset prices witnessed robust gains, while liquidity remained abundant. As ample liquidity kept HKD Hibor rates low, its spread against USD Libor widened and the HK dollar depreciated vis-à-vis the US dollar in 2017H1. Since then, the HKD-USD interest rate spread has narrowed and the HK dollar remains around the mid-point of the Convertibility Undertaking range. The Hang Seng Index rose 53 percent from February 2016 through November 2017. Credit growth also picked up to around 21 percent (y/y) in October 2017, after slowing to near zero in mid-2016, as domestic loans rose in line with the growth recovery; loans for use outside Hong Kong SAR also rebounded reflecting a rise in funding demand by multinational corporations. Accordingly, the credit-to-GDP gap—a measure of the deviation of actual credit-to-GDP ratio from its historical trend, developed by the Bank for International Settlements—widened and remained high at 45 percent of GDP in 2017Q2.
Property sector. After a fall of 9.2 percent in late 2015 and early 2016 (in seasonally adjusted terms), housing prices resumed rising since 2016Q2 amid expectations of a slower pace of U.S. rate hikes. Notwithstanding the tightening of macroprudential measures, residential property prices rose by 24 percent between March 2016 and June 2017. Early signs of stabilization in housing prices are emerging as growth moderated to 12.8 percent (y/y) in October, from 21.6 percent in June. Residential property transactions volume declined by about 24.7 percent (y/y) in the period from July to October. The household debt-to-GDP ratio increased driven by ample liquidity, low interest rates, and the rise in house prices.
External position. There has been an overall improvement in external conditions in 2017. Trade remained strong, after rebounding in mid-2016, in line with global trade. The current account surplus stood at 2.7 percent of GDP in 2017H1, similar to the same period in 2016. Capital inflows resumed in 2017H1 after the largest net outflows since the GFC in 2016, reflecting an improved Mainland China outlook and expectations of slower monetary tightening in the U.S. The REER, following the U.S. dollar, depreciated by 1.4 percent through November after appreciating by 5 percent in 2016.
Fiscal. The overall fiscal surplus rose to 4.5 percent of GDP in FY2016/17, much larger than the post-GFC average of 2.5 percent and the budgeted surplus of 0.5 percent. Buoyant property markets contributed to the large fiscal surplus, with stamp duties and the land premium accounting for two-thirds of the overperformance, while the remaining was due to delayed infrastructure projects.

4. Strong growth momentum is expected to continue in the near term. Growth picked up strongly in 2017, amid robust domestic demand and recovering external demand. It is expected to moderate somewhat in 2017Q4 and over the course of 2018, though remain robust (with average growth rate of ¾ percent (q/q)). Annual growth is projected to rise to 3.7 percent in 2017 and remain strong at 2.8 percent in 2018, up from 2 percent in 2016. Underlying assumptions for the baseline projections are:

Global economic recovery continues and Mainland China’s growth remains robust at about 6½ percent in the near term.
Global trade picks up with global growth, but the pace is still below pre-GFC rates.
Interest rates rise in line with a gradual U.S. rate tightening cycle.
A supportive fiscal stance, excluding one-off revenue gains from higher-than-projected property prices.
Credit growth remains strong in 2017, and then moderates in 2018 due to tighter macroprudential measures and higher borrowing costs.
Private consumption continues to be supported by a tight labor market, while investment remains strong, with major infrastructure and housing projects in the pipeline.

5. The gradual recovery will keep output close to potential over the medium term. Hong Kong SAR’s overall business cycle is still more in sync with the U.S. business cycle but Mainland China’s influence has increased. Under the baseline scenario with a gradual recovery of the global economy and orderly monetary tightening in the U.S., Hong Kong SAR is projected to continue to grow over the medium term at about 3 percent, its medium-term potential growth, as the drag from aging is partly offset by a smooth transition of Mainland China to a sustainable growth path.

Authorities’ View

6. Outlook. The authorities generally agreed with the mission’s assessment that Hong Kong SAR’s economy should maintain solid growth in the near term, considering the improvement in the balance of risks. The authorities also noted that growth in the Mainland Chinese economy should continue to remain on its medium-high growth track going forward, with continued supply-side structural reforms and policies to contain systemic financial risks. With Mainland China continuing to be a growth engine of the world, they expected that Hong Kong SAR would benefit from increasing ties with the Mainland, given its gateway position. They expected that the BRI and the Bay Area development would also bring large opportunities.

Risks: Clouds on the Horizon

7. The balance of risks has improved since last year. The implementation of fiscal stimulus in the U.S. as well as a stronger recovery in the euro area could drive stronger global growth. Faster-than-anticipated implementation of reforms in Mainland China could further improve Hong Kong SAR’s medium-term growth outlook. The BRI could also boost prospects for regional economies, including Hong Kong SAR, as associated projects aim to facilitate greater integration and generate positive spillovers.

8. However, overall risks are still tilted to the downside and arise from both external and domestic sources (Appendix I). Risks from external sources include tighter-than-expected global financial conditions, bumps in Mainland China’s transition including a sharp growth slowdown, and policy uncertainty in and increased inward-looking policies by major economies (retreat from cross-border integration). A potential disorderly adjustment following the ongoing housing boom in Hong Kong SAR is the main domestic downside risk.

A. Sharp Property Price Correction

9. Despite a series of government measures, property prices continue to rise amid the demand-supply imbalance. Staff analysis, based on various models, suggests that property prices were overvalued by about 25-35 percent as of 2017Q3.¹ Affordability has deteriorated as the housing price-to-income ratio has doubled since the GFC. Tighter financial conditions could lead to a slowdown in property price growth, as demand softens in response to higher borrowing costs, or even to a large correction if market sentiment deteriorates due to increased uncertainty.

10. A housing market correction could have a significant impact on private consumption and financial stability through a higher debt servicing burden and negative wealth effects. The sensitivity of households’ debt service burden to interest rate changes remains high as a significant portion of new mortgages are at floating rates and indexed to the Hibor. Analysis by the Hong Kong Monetary Authority (HKMA) indicates that households’ debt-servicing burden will increase significantly if interest rates were to rise by 3 percentage points.² Staff analysis suggests a potential asset price correction (housing and equities) by cumulative 35 percent could reduce private consumption, with overall growth falling by more than 2 percentage points. Experiences during previous episodes of housing price adjustment indicate that a sharp adjustment in the property market could lead to a significant slowdown in economic activity. Furthermore, amid increasing household debt, a disorderly housing price correction could trigger an adverse feedback loop between house prices, debt service ability, and lower consumption, with weakening growth leading to second-round effects on banks’ balance sheets. A large and disorderly housing market correction (such as the one experienced during the Asian Financial Crisis) would erode collateral values in banks’ balance sheets and pose systemic risks in the banking sector. Further, the presence of global systemically important financial institutions in Hong Kong SAR which are actively engaged in real estate lending poses additional risks to the financial system. These risks become more pressing the larger the deviation of house prices from fundamentals.

B. Global Financial Conditions

11. Financial conditions could tighten more than expected if volatility jumps as a result of monetary policy surprises in the U.S. or the Euro Area. A disorderly response to Fed normalization and tapering of the ECB balance sheet expansion could lead to higher global rates and term premia, stronger U.S. dollar and euro vis-à-vis other currencies, and a correction in market valuations. Given its highly globally-integrated financial sector, these developments could spillover rapidly to Hong Kong SAR, weighing on growth and creating financial stress.

12. Unanticipated tightening in financial conditions would weigh on domestic demand. Private sector credit increased by more than 100 percentage points of GDP since the GFC, exceeding 300 percent of GDP in 2016, leading to increased vulnerability to higher rates.

Households. Amid the decade-long property market boom, household debt has increased steadily from about 50 percent of GDP in 2007 to 67 percent in 2016. The share of new mortgages on floating rates with reference to Hibor increased sharply, from 3 percent in September 2012 to 93 percent in October 2017, reflecting a protracted period of low interest rates. Sharply rising interest rates are estimated to increase households’ debt service payments (by an estimated 5 percent of their income for a 1 percent increase in interest rates), and dampen private consumption. Staff analysis suggests that household consumption would slow by about 7-8 percent if mortgage rates rise by 300 basis points. In addition, elevated household debt could pose a macro-financial risk if interest rates increase or income growth slows down, which could trigger an adverse feedback loop between house prices, mortgage debt service ability, and banking sector balance sheets.
Corporates. Leverage of nonfinancial corporates has also been rising, with corporate debt increasing to about 235 percent of GDP in 2016, from about 130 percent in 2007. Hence, rising refinancing costs, as well as U.S. dollar appreciation, could weigh on private investment. Staff analysis suggests that the direct effect of a 300 basis points increase in interest rates would reduce corporate investment by ½-1 percent. The overall slowdown in domestic demand could be larger as it would impair asset quality and hurt banking sector profitability.
Capital flows. Risks from increased financial volatility and resulting capital outflows are particularly high in Hong Kong SAR due to the presence of globally active banks, the prominence of foreign currency loans (about 41 percent of total credit in October 2017), and the rapid expansion of the asset management industry. Funding strains at the bank group level could restrain the ability of local branches or locally-incorporated banks to expand domestic credit. As multinational firms have increased leverage during the period of low interest rates and used Hong Kong SAR as a financing platform, about a third of total credit is for external use, rendering banks vulnerable to currency mismatches (i.e., U.S. dollar loans to emerging market economies). Also, the asset management industry has grown rapidly, with total asset under management reaching HK$18.3 trillion in 2016 (about 90 percent of bank assets) with overseas investors accounting for two-thirds of funding, increasing the sensitivity to capital flow reversals.

C. Mainland China’s Transition

13. The impact of a possible disorderly adjustment in Mainland China would be significant due to increasing integration through various channels. Hong Kong SAR has benefited from robust growth in Mainland China through strong real sector linkages (trade and tourism) as well as deepening financial linkages (cross-border bank lending, investment flows, RMB internationalization). However, a disorderly adjustment in Mainland China’s financial markets could unexpectedly expose underlying financial vulnerabilities, leading to a knock-on effect on growth. Over the medium term, high growth targets based on unsustainable policies in Mainland China could lead to increasing risks of a disorderly adjustment. Hong Kong SAR is vulnerable to a bumpy transition of Mainland China’s economy through the following channels:

Trade and tourism. Hong Kong SAR is a key trading gateway between Mainland China and the rest of the world. Mainland China is the destination for more than a half of its merchandise exports and more than three-quarters of its merchandise exports to other countries are originally from the Mainland. Similarly, three-quarters of tourists are from Mainland China, estimated to account for about 39 percent of retail sales. A sharp slowdown in Mainland China would hit the tourism, trading and logistics industries, which account for more than a quarter of GDP and employment in Hong Kong SAR.
Banking system exposure. With slowing growth in Mainland China and expectations for RMB depreciation, the Hong Kong SAR banking system’s exposure to Mainland China fell between 2015H1 and 2016Q1. Since mid-2016, this exposure has increased, amid strengthening growth and abating RMB depreciation pressures. As of 2017Q2, gross claims on onshore Chinese banks amounted to HK$2.1 trillion (about 80 percent of GDP) and total exposure to Mainland non-banks was HK$5.3 trillion (about 206 percent of GDP). Asset quality of exposures to nonbank Mainland corporates (NPL ratio of 0.8 percent as of 2017Q2) has remained broadly in line with overall asset quality in the Hong Kong SAR banking system (0.8 percent), and better than that of onshore Chinese banks (1.7 percent). Compared to all non-financial A share firms, staff analysis also suggests that Hong Kong SAR-based banks have a lower exposure to riskier Mainland corporates. The overall debt-at-risk ratio fell to 4.8 percent of their Mainland China corporate loan book in 2017Q2, from 8 percent in 2016Q1 amid rebounding Mainland Chinese firms’ profits. While risks are manageable, high and rising concentration in real estate and construction loans, which amounts to about 30 percent of total loans for use in Mainland China, remains a concern (Box 1).
Capital flows. In addition to existing channels for two-way investment flows between Hong Kong SAR and Mainland China,³ new channels have been opened in recent years: Hong Kong SAR-Shanghai Stock Connect Scheme (November 2014), Mutual Recognition of Funds (July 2015), Hong Kong SAR-Shenzhen Stock Connect Scheme (December 2016), and Bond Connect (July 2017). Stock Connect Schemes allow individuals and institutions to trade stocks in the other market while Mutual Recognition of Funds permits mutual funds in either location to mobilize investments from the other jurisdiction. The recently-launched Bond Connect allows international investors to access Mainland China’s bond market from Hong Kong SAR. Aggregate flows through these channels are still limited and small compared to the market sizes in Hong Kong SAR and Mainland China. Daily flows through the Stock Connects are less than 20 percent of the daily quota on most days, and the cumulative sales of mutual fund recognition in both Hong Kong SAR and Mainland markets amounted to around RMB 12 billion in September 2017 compared to the quota of RMB 300 billion each way. While these programs facilitate greater trading volumes and enhance market liquidity in both markets, they create new spillover channels for volatility and financial stress. Staff analysis shows that financial spillovers from Mainland China to Hong Kong SAR have increased in recent years with higher correlation of returns and volatilities for various assets, particularly equities.
Offshore RMB business. The international appeal and use of the RMB has grown since 2010 and Hong Kong SAR became the largest offshore RMB center and a net provider of liquidity to other markets. However, offshore RMB activity contracted since 2015 amid expectations for RMB depreciation and volatile funding conditions in the offshore CNH market. RMB deposits had declined by 48 percent from their peak in December 2014 through May 2017 and RMB bond issuance also declined sharply. Occasional spikes in the CNH-Hibor rates, combined with reduced liquidity, had discouraged active participation in the offshore market. Since 2017Q2, RMB deposits have stabilized with strengthening growth in Mainland China and much-reduced RMB depreciation expectations. Over the medium to long term, this market is expected to continue to grow with ongoing RMB internationalization and opening-up of Mainland China’s capital account.

D. Retreat from Cross-Border Integration

14. Hong Kong SAR is particularly vulnerable to a retreat from cross-border integration given its very high trade openness. The risk of a shift toward inward-looking policies, including protectionism, is rising in many advanced economies. Such policy shifts would reduce cross-border flows of trade, investment, and labor, which could dampen productivity and global growth. The near-term economic impact could vary substantially depending on the exact nature of the measures. An illustrative simulation in the IMF’s Global Integrated Monetary and Fiscal Model suggests that if the U.S. were to impose a 10-percent tariff on Mainland Chinese exports and Mainland China retaliated with similar tariffs, real GDP in Mainland China and U.S. would fall by about 0.8 and 0.1 percentage points in the first year, respectively. Hong Kong SAR would be negatively affected due to strong bilateral trade dependence on Mainland China and still-high degree of synchronicity with the U.S. business cycle.

15. Uncertainty associated with negotiating post-Brexit arrangements could also weigh on the business environment. Hong Kong SAR is closely connected with the U.K. financial sector due to the presence of large U.K. banks, with Hong Kong SAR’s financial sector liabilities to the U.K. at 116 percent of GDP as of 2016 (14 percent of total bank assets). Hence, shocks impinging on the U.K. financial system, for example due to protracted policy and economic uncertainty arising from Brexit negotiations, could have large spillovers to Hong Kong SAR. U.K-based banks and businesses could see a decline in profits and hold off on investments in Hong Kong SAR, triggering a knock-on effect on credit, investment and growth.

Authorities’ View

16. Risks. The authorities considered that various downside risks facing the economy remained beyond the short term, despite the improved balance of risks. These included an increasingly complicated global monetary environment as the US proceeded further with normalization and some other central banks in the advanced economies reduced their monetary stimuli, possibly resulting in sharp movements in asset markets and capital flows. Other risks included rising protectionist sentiment as well as heightened geopolitical tensions. While risks and uncertainties remained for the outlook beyond the near term, the authorities noted that Hong Kong SAR’s strong buffers and robust policy frameworks, including ample fiscal reserves, strong regulatory and supervisory frameworks as well as a well-capitalized banking system, would enable them to navigate through the challenges. The authorities’ views on specific risk factors were as follows.

Housing market correction. While a disorderly housing market adjustment could have a significant impact on aggregate demand through negative wealth effects, the authorities did not expect that it would lead to systemic risks as the banking system had large capital and liquidity buffers and banks’ mortgage borrowers were not overstretched, thanks to prudent banking supervision and the eight rounds of macroprudential measures. Also, they noted that a decline in transactions in the past few years meant that fewer people were entering the market during the boom period, and they were less leveraged as a result of the tighter LTV ratio requirement. Moreover, more than 60 percent of homeowners had no mortgages.
Liquidity risks. The authorities noted that, as the financial system had experienced a significant increase in liquidity since the GFC, a disorderly reversal, e.g. a tail-risk scenario of abrupt capital outflows, or financial market dislocations, could potentially pose a significant risk to the economy and the financial system. The authorities were stepping up preparedness for such adverse scenarios by various measures, including very conservative capital and liquidity stress tests. The authorities believed that Brexit would have a limited impact on Hong Kong SAR’s economy unless it triggered a global confidence shock.
Credit risks. The authorities noted that Mainland China-related risks were prudently monitored by banks and risks were manageable, with more than three quarters of exposures to large Mainland China SOEs and multinational corporations. They also noted that they were not complacent about the currently low NPL ratio, as the current credit cycle had not yet turned.
On upside risks, they concurred that various developments in the Mainland (e.g. the BRI and the Bay Area development) would be positive for Hong Kong SAR’s medium to long term growth prospects.

Strong Buffers in Place

17. Strong policy frameworks and ample buffers have been built and strengthened further over the last decade, which will help to weather challenges.

External. Cross-border capital flows are large and volatile reflecting the nature of a major global financial center, but vulnerabilities in the international investment position are low with net foreign assets of 368 percent of GDP and foreign exchange reserves of US$386 billion (or 120 percent of GDP) as of end-2016.
Fiscal. Conservative fiscal management over the past decades and strong real estate-related revenues have helped build buffers against the expected structural weakening of the fiscal position arising from aging. Fiscal reserves amounted to 38 percent of GDP in 2017Q1 (or about 25 months of total government expenditure) and gross government debt is less than 0.1 percent of GDP (Appendix II).
Banks. Banks have built up strong capital buffers and ample liquidity thanks to enhanced regulatory and supervisory frameworks. The capitalization of the banking sector remains strong and well above international standards.⁴ In light of the HKMA’s assessment of the credit-to-GDP and property price-to-rent gaps, a countercyclical capital buffer (CCyB) was introduced (currently at 1.25 percent) and will be further raised to 1.875 percent in 2018. Banks have ample liquidity with liquidity coverage ratio of category 1 institutions at 144.2 percent and liquidity maintenance ratio of category 2 institutions at around 50 percent in 2017Q2, both well above their respective international minimum standards. Policy efforts have enhanced resilience of the banking system to property price shocks with progressive tightening of macroprudential measures since 2009.⁵ Thus, asset quality remains very strong, with the NPL ratio at only 0.8 percent as of 2017Q2. However, amid tight prudential regulations on banks, property market developers, which receive financing from banks, have been rapidly increasing lending to households, though their share relative to banks’ mortgage lending remains low. Banks are thus exposed to substantial systemic financial risk given the high and increasing exposure to Mainland China and to the overvalued property market, stemming from rising household leverage. In addition, these risks are likely to be highly correlated, making the aggregate risk exposure of the system larger than the sum of individual risks would suggest.

Policies: Navigating Challenges and Securing Sustained and Inclusive Growth

18. Policy frameworks need to be further strengthened to address near-term challenges and secure sustained growth over the medium term. The currently strong buffers need to be further built up and be used effectively if needed.

A. Fiscal Policy: Ensuring Long-Term Sustainability and Short-Term Flexibility

19. Fiscal policy continued to be conservative in FY2016/17, but the contractionary impulse of about 1¼ percentage points of GDP is projected to be more than reversed in FY17/18. The current fiscal stance is assessed to be appropriate and additional fiscal stimulus is not needed due to the economy’s cyclical position.

FY2016/17. In FY2016/17, the larger-than-expected fiscal surplus, of about 4½ percent of GDP, was driven by slower non-recurrent spending due to delayed implementation of infrastructure projects and the strong rebound in property markets, with stamp duties and land premium accounting for two-thirds of the overperformance relative to the budget. Consequently, fiscal reserves increased further and were around 38 percent of GDP in 2017Q1.
FY2017/18. Staff projects the overall fiscal surplus in FY2017/18 to narrow to 2½ percent of GDP, larger than budgeted by about 2 percent of GDP, due to stronger-than-expected revenues from rising property prices and overall economic strength. The structural fiscal balance is expected to decline by around 1½ percent of GDP, implying an expansionary fiscal stance, which is appropriate despite the near-zero output gap, because its composition mostly reflects carry over of delayed implementation of infrastructure and land supply projects from the previous year and strengthening of social safety nets, in line with past staff advice. As a robust recovery is expected to continue in the near term with a close-to-zero output gap, there is little need for additional fiscal stimulus in FY2018/19 and beyond, and several temporary tax relief measures could be phased out. The focus should be on implementing planned projects, particularly boosting housing and land supply, as well as infrastructure projects. Over the medium term, there is little need for additional fiscal support.

20. In the past, fiscal policy could have been more cyclically supportive. As the main demand management tool under the currency board arrangement, fiscal policy should support aggregate demand to a greater extent when cyclical conditions worsen, and vice versa. In the past, fiscal policy has been mostly acyclical in part due to weak expenditure-side automatic stabilizers, and often asymmetric reflecting a bias towards fiscal savings.

21. There would be benefits from greater countercyclicality in the face of negative shocks. The current fiscal rule of adherence to at least budget balance should be implemented flexibly and symmetrically over the cycle, rather than strictly every year. In particular, if downside risks materialize, the government should actively use fiscal policy to support domestic demand with the size of stimulus depending on the severity of the shock. Short-term countercyclical measures should be aligned with long-term goals to ensure that they do not exacerbate unfavorable long-term fiscal trends, and could include: (i) expediting the implementation of capital projects that are already identified and seeking final approval (i.e. already appraised through a rigorous economic, financial and technical analysis and selected through a transparent process); (ii) supporting small businesses including with targeted and temporary subsidized access to funding through credit guarantee schemes as done in past downturns; (iii) bringing forward spending on healthcare and retirement protection schemes which are earmarked for the medium term; and (iv) expanding relief measures for vulnerable households, including extra allowances for the elderly and physically challenged, and higher thresholds for providing rental relief to families in public housing. Automatic stabilizers of appropriate sizes should work smoothly when needed, also through actively strengthening means-tested social safety nets.

22. The authorities should consider possible adjustments to the fiscal framework in the face of medium- to long-term challenges to ensure fiscal sustainability. Aging will lead to higher pension and healthcare spending (estimated to rise by 2½ percentage points of GDP by 2030), as well as social spending. Also, education and capital spending should be preserved as investment in both physical and “soft” infrastructure is essential to maintain and boost competitiveness. Against that, in the event of house price moderation, it would be difficult to maintain the current level of revenues. Hence, it is important to further strengthen the current fiscal framework to ensure long-term sustainability (See Selected Issues Paper 1):

A structural deficit will emerge by 2030 unless additional revenues are mobilized or social safety nets are scaled back significantly, with associated social and economic costs. Aging will result in higher public spending. Efforts to rein in non-essential expenditure growth through expenditure reviews and reprioritizing overall spending should continue but are likely insufficient to offset the additional long-term spending needs. Thus, the authorities will face the choice of compressing current expenditures, which could strain social stability and undermine inclusive growth, or allow the expenditure-to-GDP ratio to rise over the medium to long term. In addition, revenues could decline by at least 3 percentage points of GDP as the real estate market stabilizes.
Preserving Hong Kong SAR’s sound fiscal position over the longer term thus would require revenue mobilization. The current taxation regime, predicated on a narrow tax base and low tax rates, while supporting Hong Kong SAR’s competitiveness in the financial and services industries, has resulted in a low tax revenue-to-GDP ratio of 13.8 percent in FY2016/17, lower than other financial centers. But the emergence of structural deficits over the long term requires early analysis and consideration of options to raise revenues while maintaining competitiveness. Options identified through international benchmarking, relative to other global financial centers, include introducing/raising indirect taxes (such as VAT and excises) to avoid overreliance on direct taxation and increasing top marginal income tax rates modestly. In this context, the establishment of a new tax policy unit to review possible broadening of the tax base is welcome. This unit should study the relative distributional, efficiency and growth impacts of these and other revenue measures for the medium to long term.

Authorities’ View

23. The authorities viewed that an important aspect of enhancing fiscal sustainability in the long term was to raise Hong Kong SAR’s economic growth capacity so as to meet increasing expenditure due to population aging in the future. They noted that significant efforts had been put on this front through, for instance, investment in infrastructure and education, increase in land supply and the promotion of research and development. The authorities also highlighted the efforts recently announced in the Chief Executive’s Policy Address to boost growth through the introduction of a two-tiered profits tax rates regime and enhanced tax deduction for R&D expenditure. Boosting the growth potential and improving preventive health care for the elderly were seen as key to solving the fiscal long-term challenges outlined by the staff.

24. Regarding revenue mobilization, the authorities noted that Hong Kong SAR’s simple and low tax regime was one of the core attributes of being an international financial center. They considered it necessary to maintain and plan to further enhance Hong Kong SAR’s competitiveness and economic development, by the strategic use of tax measures. The authorities agreed that supportive fiscal policy would help tide the economy over short-term difficulties amid the challenging global economic environment, and that public resources had been effectively and actively deployed in the past to render support to domestic demand at a time of weak external demand.

B. Deflating the Housing Boom Safely

25. Amid the booming and overvalued property market, the three-pronged approach to limiting risks should continue. Since 2009, the HKMA has introduced a series of macroprudential measures to limit the financial system’s exposure to the asset price boom, which have been complemented by various stamp duties introduced by the government to stem excessive price increases and safeguard financial stability (Appendix III). Further tightening of macroprudential policies could exacerbate leakages to non-bank institutions outside the regulatory perimeter (such as property developers offering financing schemes to potential buyers). In this context, and amid surging housing prices, the government increased the ad valorem stamp duty for residential properties from the Doubled Ad Valorem Stamp Duty (DSD) rates to a flat rate of 15 percent in November 2016 (also known as New Residential Stamp Duty (NRSD)), and removed the stamp duty exemption for “acquisition of multiple residential properties under 1 instrument” in April 2017. Measures have also been taken to boost housing supply but were insufficient to meet rising demand. Indeed, housing prices and household indebtedness continue to rise, increasing the risk of a disorderly adjustment as well as exacerbating unaffordability.

26. Sustained increases in housing supply are critical to resolving the structural supply-demand imbalance. Housing supply increases declined to an annual average of 25,000 units between 2006 and 2015, compared to more than 50,000 units in the previous decade, contributing to strong house price growth. Housing supply has been rising with the implementation of the government’s Long-Term Housing Strategy which was adopted in 2014 and targets providing 460,000 units of housing over the next decade. To complement this, the government is finalizing Hong Kong 2030+, which is a longer-term development strategy to provide land and housing on a more sustainable basis. It is important to meet the housing supply target set by the Strategy to cement public expectations about sustained increases in supply. However, given various obstacles to further increasing supply in the near term, including the lack of ready sites and relevant development restrictions, it will be difficult to meet the ten-year housing supply target under the Strategy. Thus, there is benefit to expediting the process for identifying land and building sites, together with conducting the relevant environmental, transport, and community facility assessments.

27. Macroprudential measures have been effective in building buffers in the financial system against possible housing market adjustments. Since 2009, the authorities have introduced a series of macroprudential measures, including tighter ceilings on loan-to-value (LTV) and debt service-to-income (DSR) ratios, stress testing the DSR, and imposing a floor on risk weights on property loans. On continued increases in housing prices, in May 2017, the HKMA lowered the LTV ratio for second property mortgages and lowered the DSR limit for borrowers whose income is mainly derived from outside Hong Kong SAR. These policies have helped limit financial system exposure to the housing boom and strengthened banks’ mortgage loan origination standards. Staff analysis finds that macroprudential policies were effective in building buffers, but played only a minor role in containing house price appreciation (see Selected Issues Paper 2). As housing prices continue to rise and a disorderly adjustment could pose significant macro-financial risks, these measures should remain in place to protect the financial system. However, amid tight prudential regulations on banks, lending to households by property developers (which are partly financed by banks) has been rising rapidly, though their share relative to banks’ mortgage lending remains low. In response, the HKMA also further tightened the capital requirement for banks on their lending to property developers, to rein in these practices. Adjustment of the macroprudential measures should be considered based on evolving financial stability risks, with due attention to the emerging risk of regulatory leakages to the non-bank sector.

28. Stamp duties have helped contain house prices by curbing excess demand, especially by cash buyers. Three stamp duties are currently in place: Special Stamp Duty (SSD) on resale of residential properties within 36 months of purchase; Buyer’s Stamp Duty (BSD) on purchases by nonresidents; and DSD/NRSD on all residential property purchases except primary residences of permanent residents.⁶ Staff analysis shows that stamp duties have been effective in stemming price increases, and that house prices would have been higher by about 9 percent without them. By stemming house price increases, these measures have also helped contain household leverage and systemic risk. However, the higher the rates the greater the possible distortions as high stamp duty rates may render the housing market less liquid and exacerbate any future correction.

29. While stamp duties have helped contain systemic risks, they should be phased out when these risks dissipate. The BSD was introduced in 2012 in response to a capital inflow surge into the housing market, to address demand pressures from non-resident buyers. The BSD complements macro-prudential policies and helps contain house prices and excessive household leverage. Similarly, a second surge in 2016 led to an increase in the ad valorem stamp duty from the DSD rates to a flat rate of 15 percent in November 2016 (also known as the NRSD). The BSD and the DSD/NRSD are assessed to be capital flow management measures and macro-prudential measures under the IMF’s Institutional View on the Liberalization and Management of Capital Flows. While they are intended to contain housing price overvaluation and systemic financial risk, they discriminate between residents and non-residents. The discriminatory feature is designed to contain excess demand from non-resident buyers. Both stamp duties are assessed to be appropriate because: (i) they were put in place amid a surge of capital flows into the property market; (ii) they were not used to substitute for necessary macroeconomic adjustment as monetary and exchange rate policies are constrained under the currency board arrangement, and fiscal policy has been conservative; and (iii) additional tightening of macro-prudential policies, which are very tight by international standards and do not apply to cash buyers, could exacerbate leakages to non-bank financial institutions outside the regulatory perimeter. Going forward, once systemic risks from the housing market dissipate, staff recommends phasing out and replacing the stamp duties with alternative non-discriminatory measures. In addition, the authorities could phase out mortgage interest deductibility as it boosts demand for housing and encourages higher leverage.

Authorities’ View

30. The authorities agreed that increasing housing supply would help alleviate affordability concerns in the long run. They also stated that in the short run macro-prudential measures and various demand-side management measures in the form of stamp duties would remain in place. The authorities explained that while they envisaged considerable challenges in meeting the ten-year housing supply target under the Long-Term Housing Strategy, they would continue to spare no efforts in increasing housing production. The authorities agreed that the macroprudential stance was very tight, but indicated that they stood ready to modify the measures appropriately when necessary. They also shared staff concerns that some borrowers obtained credit through property developers, and were monitoring the situation closely. They explained that the demand-side management measures were meant to be stop-gap measures while the Government strived to increase housing supply, and that they had been effective in containing systemic financial risk. The authorities underscored that when the market normalizes, there might be room to review the need for these measures, but at this point they could not remove them. On the recommendation on phasing out mortgage interest deductibility, the authorities noted that this served a social policy purpose of helping people own their homes and hence they had no plan to remove this tax deduction.

C. Preserving an Anchor of Stability

31. The Linked Exchange Rate System (LERS) remains the best arrangement for Hong Kong SAR. The US dollar is still the most commonly used international currency in trade and financial transactions and Hong Kong SAR’s economic cycles and financial conditions are, to a large extent, influenced by the U.S. and the global economic/financial environment. The currency board arrangement has been supported by the flexible economy, ample fiscal and reserve buffers, and strong financial regulation and supervision. LERS anchors the stability of Hong Kong SAR’s highly-open economy with its large and globally integrated financial services industry. Even during the recent global financial stress episodes (U.S. taper tantrum, China stock market correction, RMB depreciation), the HK dollar continued to trade close to the strong side of convertibility undertaking range while other regional currencies depreciated sharply. Recently, it depreciated to the mid-point of the range on widening spreads between HKD Hibor and USD Libor rates. Over the medium term, as U.S. monetary policy normalizes, the HK dollar could resume appreciation in line with the U.S. dollar, raising concerns of diminishing competitiveness. Hong Kong SAR’s flexible product and labor markets should allow rapid adjustment and help ensure that departures from the equilibrium REER do not persist.

32. Staff assesses that the external position in 2016 was broadly consistent with medium-term fundamentals and desirable policy settings. As noted in the July 2017 External Sector Report, the cyclically-adjusted current account surplus narrowed to 2½ percent of GDP in 2016 while the current account norm is estimated to range between 1 and 4 percent of GDP. The real effective exchange rate was also assessed to be at a level consistent with medium-term fundamentals and desirable policy (within a range of -5 to +5 percent). Since then, the REER has depreciated by 1.4 percent, and analysis through November 2017 delivers the same results (Appendix IV).

Authorities’ View

33. The authorities welcomed staff’s positive assessment of the LERS’ role in anchoring Hong Kong SAR’s economy and financial system. In response to anticipated increases of the Federal Funds rate, the authorities expected local interbank interest rates to increase further in the long run under the LERS. Although some market participants interpreted the increase in HKMA bill issuance in recent months as efforts by the HKMA to narrow the gap between the Hibor and Libor, the authorities explained that such increases were conducted in response to strong demand from banks for high-quality assets and they had had little impact on abundant market liquidity.

D. Maintaining Financial Stability

34. The financial system is well placed to cope with challenges thanks to the robust regulatory and supervisory framework.

Potential systemic vulnerabilities and regulatory arbitrage are closely monitored and addressed through coordination among the government and the regulators in the Financial Stability Committee, close dialogue with Mainland China regulators, and active participation in global fora.
Banks have ample loss absorption buffers and limited vulnerabilities to short-term funding. Mainland China-related exposures are being closely monitored with quarterly updates and staff assesses the risks as manageable.
Considering the large credit-to-GDP gap and overvalued housing prices, the introduction and progressive increase of the CCyB is appropriate.
Substantial progress has also been made on implementing the 2014 FSAP recommendations (Appendix V). A comprehensive framework for recovery and resolution, which was established under the Financial Institutions (Resolution) Ordinance, commenced operation in July 2017. The HKMA, the Securities and Futures Commission, and the Insurance Authority will take actions to orderly resolve non-viable systemically important financial institutions to mitigate systematic risks and minimize losses of public funds by imposing losses on shareholders and creditors.

35. Hong Kong SAR is rightly working continuously to tap new opportunities as a global financial center. Leveraging its position as a well-established international financial center with comparative advantages such as skilled labor, high legal standards and common languages with its main trading partners, the authorities are further developing the asset management industry as well as encouraging corporate treasury centers to domicile in Hong Kong SAR. It is well positioned to contribute to, and benefit from, increasing regional connectivity and cooperation in investment, trade, and finance (including under the BRI and the Bay Area), as it can provide a platform for developing multiple channels for funding. To do so, the HKMA’s establishment of the Infrastructure Financing Facilitation Office is welcome.

36. The authorities’ continued strengthening of the regulatory and supervisory framework is welcome and crucial for maintaining financial stability. Further strengthening the oversight regime for non-bank institutions (including securities markets, broker dealers and asset managers) would prevent risks, including those arising from new channels connecting Hong Kong SAR and Mainland China. Recent efforts to enhance coordination among different regulators, including coordination platforms for new fintech businesses, is a welcome development. High standards for securities listing should be maintained for financial stability. The development of the new risk-based capital regime for insurance companies is in “Phase 2,” focusing on detailed rules for quantitative requirements. Continued close and regular monitoring of risks arising from Mainland China exposures will allow Hong Kong SAR to reap the benefits of closer integration while mitigating potential risks. Enhanced oversight of cybersecurity risks by the authorities is welcome. Continued efforts to enhance transparency related to legal persons and trusts, including enacting the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) (Amendment) Bill and Companies (Amendment) Bill and ensuring their effective implementation in line with the international standards, underpin Hong Kong SAR’s reputation as a key global financial center.

37. The authorities need to balance carefully the tradeoff between greater efficiency and maintaining stability in the face of rapid developments in fintech. The authorities’ support for fintech business developments through various channels, including establishing the Fintech Facilitation Office, the Fintech Innovation Hub, a central bank digital currency project, closer cross-border collaboration with Singapore and Shenzhen on fintech development (including the recently announced initiative with Singapore on Distributed Ledger Technology-based trade finance platform), is welcome and will help preserve its role as a key global financial center. Technological progress can promote the development and adoption of new financial services as well as affect the existing market structure by reducing the need for some traditional financial intermediaries, while encouraging innovation and potential new market entrants. Keeping up with such progress, financial regulation must adapt to remain effective and ensure that risks to stability and integrity—including from cyberattacks, money-laundering and terrorism financing—can be effectively managed while not unduly stifling innovation. The authorities are using “regulatory sandboxes,” which allow firms to test new technologies and business models in a controlled environment and enable regulators to address the potential risks from new technologies without curbing innovation. Going forward, the authorities should continue to review and enhance the regulatory framework for fintech to ensure that it remains effective (see Selected Issues Paper 3).

Authorities’ View

38. The authorities welcomed the staff’s positive assessment of Hong Kong SAR’s regulatory and supervisory framework and ample buffers. They noted that ongoing efforts to implement a risk-based capital regime for insurance companies are in place, as they were undertaking quantitative assessments and moving forward with legislative proposals. Meanwhile, the newly-independent Insurance Authority is preparing to directly oversee licensing of intermediaries by mid-2019, in line with FSAP recommendations. On the regulation and supervision of fintech, the authorities noted that regulation would be technology neutral. Further, they noted that they would continue to keep abreast of the dynamic fintech landscape, and ensure an appropriate balance between market innovation and investor protection.

E. Ensuring Sustained and Inclusive Growth

39. Population aging is the key medium- to long-term challenge and will weigh on growth. According to the latest UN population projections, the population will start shrinking from 2045 but the labor force (ages 20-64) will start to contract very soon. Thus, the old age dependency ratio, which has already risen from 17.2 in 2010 to 20.6 in 2015, will rise sharply to 26.5 in 2020 and 50.1 in 2035. The government working group on long-term fiscal planning assessed, in 2014, that under current policies, fiscal reserves would be depleted by 2035-40, with the start of structural deficits around 2025-30. Aging will strain public finances due to rising spending pressures on pensions and healthcare. Also, staff analysis confirms the negative impact of population aging on growth: the shrinking labor force will lower annual real GDP growth by about ¾ percentage points during 2020-50, and lower average total factor productivity growth could pose a further modest drag on growth.

40. Despite recent improvement, Hong Kong SAR’s income inequality remains high compared to peers. The latest study on household income distribution revealed that government policies, including various social benefits, helped improve income distribution over the past five years. The net Gini index, based on post-tax post-social transfers monthly household income, fell to 47.3 in 2016 (from 47.5 in 2011). Despite this improvement, Hong Kong SAR’s inequality remains high compared to peers. In addition, on continued increase in housing prices, housing affordability is deteriorating further, with the housing price-to-income ratio doubling over the last decade (to more than 16 years) and exceeding the previous peak. Together, these factors could limit consumption and impair growth prospects over the medium term.

41. The authorities have taken steps to address high inequality and prepare for the needs of an aging population. They have introduced several policies, and spending on social welfare, housing and health has increased to around 33 percent of public spending. Provision of public housing, amid deteriorating housing affordability, has long been a policy priority as almost half of all households live in subsidized housing. The statutory minimum wage, introduced in 2011 and increased three times, has helped boost labor supply without damaging wage flexibility. The plans to enhance the Low-Income Working Family Allowance (LIFA) Scheme, including by boosting monthly payments and relaxing the income and working hour requirements, are welcome. The authorities are moving forward to enhance the existing multi-pillar retirement protection system, including strengthening social security for the elderly with more financial needs and developing financial products to convert assets into stable post-retirement income.

42. The authorities should continue to promote sharing the benefits of economic growth. As high and persistent inequality can undermine the sustainability of growth, policies should continue to foster inclusive growth and further build social safety nets, such as by maintaining housing support for the most vulnerable. Changes to the Mandatory Provident Fund (MPF) system, including the abolition of the arrangement for “offsetting” severance payment and long service payment, should be implemented. Working hours policy should strike a balance between equality and inducing labor force participation, while not compromising competitiveness and, especially, the flexible labor market. In the context of reviewing the existing social safety net, consideration should be given to consolidating and strengthening means-testing of the programs geared to serve the elderly. In view of the projected decline in the labor force over the medium term, consideration should be given to providing childcare for young children, which will boost female labor force participation, as well as increase fertility.

Authorities’ View

43. The authorities agreed that achieving inclusive growth was of paramount importance and a key challenge in the years to come. Aiming to contain inequality, the authorities continued to prioritize boosting labor force participation and supporting the aged and working families. They noted that the introduction and subsequent increases in the statutory minimum wage helped attract more older female workers to enter or re-enter the labor market. Child care policies were under review to further boost female labor force participation. After the introduction of the poverty line, the authorities indicated that they wanted to better target working families with children and increase the level of support through the introduction of the LIFA Scheme. They had recently announced a series of improvements to the Scheme. Old age support would also be strengthened so as to meet the challenges arising from the aging population. The authorities agreed that changes to the MPF system were necessary, while balancing needs of employees and employers.

Staff Appraisal

44. Outlook. Growth momentum accelerated since mid-2016 and over the course of 2017 amid the global recovery, robust Mainland China growth, booming housing prices, and rebounding credit growth. The strong growth momentum is expected to continue in the near term. Under the baseline, with the continued gradual global recovery, orderly monetary tightening in the U.S., and a smooth transition of Mainland China to a sustainable growth path, Hong Kong SAR should grow close to its medium-term potential.

45. Risks. The balance of risks has improved since last year. Going forward, stronger-than-expected global growth and faster-than-anticipated implementation of reforms in Mainland China could further improve Hong Kong SAR’s growth outlook. Also, Mainland China’s BRI and plans for the development of the Bay Area create opportunities for Hong Kong SAR over the medium term. Even so, overall risks are still tilted to the downside, from both external and domestic sources, and include a correction in property prices, tighter-than-expected global financial conditions, disorderly adjustment in Mainland China, and a global retreat from cross-border integration.

46. Fiscal policy. The current fiscal stance is assessed to be appropriate and additional fiscal stimulus is not needed due to the economy’s cyclical position. In the event of negative shocks, there would be benefits from greater countercyclicality, as fiscal policy is the main demand management tool under the currency board arrangement. The current fiscal rule of adherence to at least budget balance should be implemented flexibly and symmetrically over the cycle, rather than every year. In particular, if downside risks materialize, the government should actively use fiscal policy to support domestic demand. Short-term countercyclical measures should be aligned with long-term goals to ensure they do not exacerbate unfavorable long-term fiscal trends.

47. Long-term fiscal challenges. The authorities should consider possible adjustments to the fiscal framework to ensure fiscal sustainability in the face of medium- to long-term challenges. Efforts to rein in non-essential expenditure growth through expenditure reviews and reprioritizing overall spending should continue, though additional efforts are likely needed to offset the additional long-term spending needs. The emergence of structural deficits over the long term requires early analysis and consideration of options to raise revenues while maintaining competitiveness. Options identified through international benchmarking, relative to other global financial centers, include introducing/raising indirect taxes (such as VAT and excises) and increasing top marginal income tax rates modestly. The newly established tax policy unit should study the relative distributional, efficiency and growth impacts of these and other revenue measures for the medium to long term.

48. Housing policy. Amid the booming and overvalued property market, the three-pronged approach to limiting risks should continue. Sustained increases in housing supply are critical to resolving the structural supply-demand imbalance. Macroprudential measures have been effective in building buffers in the financial system against possible housing market adjustments. Adjusting macroprudential measures should be considered based on evolving financial stability risks, with due attention to the emerging risk of regulatory leakages to the non-bank sector. Stamp duties have helped contain house prices and associated systemic financial risks by curbing excess demand, especially by cash buyers. The Buyer’s Stamp Duty and the Double Ad-Valorem/New Residential Stamp Duty are assessed to be capital flow management measures and macro-prudential measures under the IMF’s Institutional View on the Liberalization and Management of Capital Flows. Going forward, once systemic risks from the housing market dissipate, both stamp duties should be phased out and replaced with alternative, non-discriminatory measures.

49. Exchange rate regime and external position. The LERS remains the best arrangement for Hong Kong SAR. The currency board arrangement has been supported by the flexible economy, ample fiscal and reserve buffers, and strong financial regulation and supervision. The LERS anchors the stability of Hong Kong SAR’s highly-open economy with its large and globally integrated financial sector. The external position in 2016 is assessed to be broadly consistent with medium-term fundamentals and desirable policy settings, and developments through November 2017 do not change this assessment.

50. Financial sector policies. The authorities’ continued strengthening of the regulatory and supervisory framework is welcome and crucial for maintaining financial stability. Potential systemic vulnerabilities and regulatory arbitrage are closely monitored and addressed through coordination among the government and the regulators in the Financial Stability Committee, close dialogue with the Mainland China regulators, and active participation in global fora. Substantial progress has also been made in implementing the 2014 FSAP recommendations, including a comprehensive framework for recovery and resolution. Hong Kong SAR is right to work continuously to tap new opportunities as a global financial center. The authorities need to balance carefully the tradeoff between greater efficiency and maintaining stability in the face of rapid developments in fintech.

51. Inclusive growth. The authorities should continue to promote sharing of the benefits of economic growth. Changes to the MPF system, including the abolition of the arrangement for “offsetting” severance payment and long service payment, should be implemented. Working hours policy should strike a balance between equity and inducing labor force participation while not compromising competitiveness, especially the flexible labor market. In the context of reviewing the existing social safety net, consideration should be given to consolidating and strengthening means-testing of the programs geared to serve the elderly.

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

Box 1.

Hong Kong SAR Banks’ Mainland China Exposure¹

Over the past year, Hong Kong SAR banks’ non-bank China exposures continued to rise on Chinese corporates’ higher investment demand amid better growth prospects and overseas expansion. However, vulnerabilities, as measured by debt-at-risk ratio, fell amid improved profitability. Strong prudential measures remain a crucial bulwark safeguarding Hong Kong SAR banks.

Hong Kong SAR banks’ mainland China exposures have risen to a record level, driven by strengthening growth in China and the global recovery. Non-bank Mainland China exposure² recovered from HK$4.4 trillion in 2016Q1 to HK$5.3 trillion in 2017Q2, representing 206 percent of GDP and 24 percent of banking assets. The growth is not only driven by funding needs in Mainland China, on improving growth prospects, but also investment demand of Mainland Chinese corporates fueled by the global recovery and Mainland Chinese firms’ overseas expansion.

Mainland Chinese corporates’ improved profitability has reduced risks to Hong Kong SAR banks’ balance sheets, though banks’ exposures remained concentrated in real estate. The debt-at-risk ratio fell from 8 percent of total loan exposure in 2016Q1,³ to about 4.8 percent (or 0.9 percent of banking assets) in 2017Q2. The fall in debt-at-risk is primarily a result of improved corporate profits, which grew 13 percent yoy. Also, the ratio of bad loans to total loans fell to 0.8 percent in 2017Q3 (from 0.9 percent in 2016Q1). The composition of lending remains largely unchanged: lending to property developers and construction remained high, while that to “old” industries, such as mining, was low.

While individual bank exposures remained varied, exposure to higher-risk Chinese local state-owned enterprises (SOEs) appeared low. Of the banks analyzed⁴, the debt-at-risk ratio ranged between 4 to 6 percent in 2016, falling from 7 to 11 percent in 2015. Individual banks with higher debt-at-risk ratios are usually more exposed to private Mainland Chinese firms. However, the financials of A-share firms showed the highest risk for local SOEs, followed by private firms and central SOEs. Exposure to local SOEs was low while some banks were either concentrated in lending to central SOEs or private firms.

In stressed scenarios, Hong Kong SAR banks remain sensitive to a sharp downturn in Mainland China, but vulnerabilities appear manageable. In a stress scenario in line with losses suffered during the Asian Financial Crisis, we assume corporate profits fall by 26 percent and interest expenses rise by 14 percent. In such a scenario, debt-at-risk rises to 1.8 percent of banking assets. Under a separate scenario in which the Hibor rises by 300 basis points following Fed rate hikes (like in 2005H2), debt-at-risk accounts for 1.1 percent of banking assets, still less than 1.40 percent in 2016Q1 when Mainland China suffered its slowest growth since 2009Q1.

The authorities remain prudent and vigilant. The HKMA has maintained strong guidance and close monitoring of lending activities, including stable funding requirements to curb rapid loan growth since October 2013 and guidance to tighten corporate loan approval in 2014. Under such guidance, banks have focused lending to large SOEs and multinationals operating in Mainland China to mitigate risks

¹ Prepared by Daniel Law.² Non-bank Mainland China exposure is a broad indicator that includes loans for use in Mainland China by Mainland Chinese and foreign firms and loans for use outside Mainland China by Mainland Chinese firms, which account for about three-quarters of total nonbank exposure.³ Debt-at-risk is estimated using the interest coverage ratio, which is considered “at risk” when income is insufficient to cover interest associated with outstanding debt. The debt-at-risk ratio in each sector in A shares traded onshore, which is the share of debt-at-risk in each sector’s liabilities, is used to calculate the entire system’s weighted average according to the composition of the loan exposure.⁴ These banks include global banks, Mainland Chinese banks’ subsidiaries in Hong Kong SAR and large local banks.

Table 1.

Hong Kong SAR: Selected Economic and Financial Indicators, 2012-22

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

^{^1/}For 2017, average for first 11 months

^{^2/}CentaData, HIBOR-based for all households

^{^3/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 1.

Hong Kong SAR: Selected Economic and Financial Indicators, 2012-22

									Proj.
				2012	2013	2014	2015	2016	2017	2018	2019	2020	2021	2022
NATIONAL ACCOUNTS
Real GDP (percent change)				1.7	3.1	2.8	2.4	2.0	3.7	2.8	2.8	2.9	3.0	3.1
	Contribution
		Domestic demand		3.7	3.9	2.8	1.5	2.6	4.6	3.8	3.2	3.3	3.5	3.4
			Private consumption	2.5	2.9	2.2	3.1	1.2	3.7	3.1	2.1	2.2	2.4	2.3
			Government consumption	0.3	0.2	0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3
			Gross fixed capital formation	1.6	0.7	0.0	-0.8	-0.1	0.3	0.4	0.7	0.8	0.8	0.8
			Inventories	-0.8	0.1	0.4	-1.2	1.1	0.1	0.0	0.0	0.0	0.0	0.0
		Net exports		-1.9	-0.8	-0.1	0.8	-0.5	-0.9	-0.9	-0.4	-0.4	-0.5	-0.4
	Potential GDP growth			2.9	2.8	2.7	2.7	2.8	2.8	2.9	2.9	2.9	3.0	3.0
	Output gap (in percent of potential)			0.1	0.4	0.4	0.1	-0.6	0.2	0.1	0.0	0.0	0.0	0.0
Saving and investment (percent of GDP)
	Gross national saving			26.8	25.5	25.2	24.9	26.4	24.4	24.1	24.4	24.5	24.6	24.7
	Gross domestic investment			25.2	24.0	23.8	21.5	21.7	21.4	21.1	21.1	21.2	21.2	21.2
	Saving-investment balance			1.6	1.5	1.4	3.3	4.6	3.0	3.1	3.2	3.3	3.4	3.5
LABOR MARKET
Employment (percent change)				2.1	1.9	0.4	0.9	0.2	0.5	0.3	0.2	0.2	0.2	0.1
Unemployment rate (percent, period average)				3.3	3.4	3.3	3.3	3.4	3.2	3.2	3.2	3.2	3.2	3.2
Real wages (percent change)				1.6	0.2	-2.4	0.5	1.2	0.6	0.8	0.9	1.2	1.3	1.4
PRICES
Inflation (percent change)
	Consumer prices			4.1	4.3	4.4	3.0	2.4	1.6	1.8	2.0	2.2	2.4	2.6
	GDP deflator			3.5	1.8	2.9	3.6	1.8	3.0	1.0	1.1	1.1	1.3	1.5
GENERAL GOVERNMENT (percent of GDP)
Consolidated budget balance				3.2	1.0	3.6	0.6	4.5	2.6	1.6	1.4	1.3	1.2	1.2
	Revenue			21.7	21.3	21.2	18.8	23.0	21.0	20.4	20.4	20.5	20.6	20.6
	Expenditure			18.5	20.3	17.5	18.2	18.6	18.4	18.9	19.0	19.2	19.4	19.4
Fiscal reserves as of March 31				36.0	35.3	36.7	35.1	38.3	38.5	38.7	38.5	38.3	37.9	37.4
FINANCIAL
Interest rates (percent, period-average)
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	0.6	0.9	…	…	…	…	…
10-year Treasury bond yield ^1/				1.0	1.7	2.0	1.6	1.2	1.5	…	…	…	…	…
MACRO-FINANCIAL
Loans for use in Hong Kong SAR (not including trade financing)				7.0	10.6	13.5	6.3	8.0	13.3	4.8	1.0	3.0	4.5	5.1
House prices (end of period, percent change)				25.7	7.7	13.5	2.4	7.9	16.1	1.6	1.9	5.7	5.6	5.3
Mortgage payment to income ratio ^2/				43.6	45.7	44.7	49.1	45.1	50.3	52.1	53.2	53.6	51.1	48.5
Household debt (in percent of GDP)				61.3	62.7	65.5	67.1	67.7	73.6	72.0	70.6	71.7	72.6	73.1
Non-financial corporate debt (in percent of GDP)				173.1	195.2	213.4	227.7	233.9	224.9	219.4	219.5	219.4	218.8	218.2
Hang Seng stock index (percent change)				22.9	2.9	1.3	-7.2	0.4	28.0	…	…	…	…	…
EXTERNAL SECTOR
Merchandise trade (percent change)
	Export volume			-0.1	2.7	1.5	-1.7	1.4	5.5	3.0	2.8	3.1	3.4	3.5
		Domestic exports		-12.4	-9.3	2.8	-12.8	-7.1	5.5	3.0	2.8	3.1	3.4	3.5
		Reexports		0.1	2.9	1.5	-1.6	1.5	5.5	3.0	2.8	3.1	3.4	3.5
	Export value			2.9	3.6	3.2	-1.8	-0.5	7.0	4.8	3.9	3.9	4.4	3.8
	Import value			3.9	3.8	4.0	-4.1	-0.9	7.9	5.1	4.3	4.4	5.0	4.5
	Terms of trade			0.1	0.4	0.1	0.5	0.0	-0.2	0.5	-0.1	-0.2	-0.2	-0.4
Current account balance (percent of GDP) ^3/				1.6	1.5	1.4	3.3	4.6	3.0	3.1	3.2	3.3	3.4	3.5
Foreign exchange reserves ^3/
	In billions of U.S. dollars, end-of-period			317.4	311.2	328.5	358.8	386.1	392.3	405.2	421.4	433.7	445.1	456.9
	In percent of GDP			120.9	112.9	112.7	116.0	120.3	115.0	114.2	113.2	112.0	110.5	108.8
Net international investment position (percent of GDP)				274.5	274.8	298.6	324.2	367.5	347.3	337.4	327.8	318.3	308.4	298.3
Linked rate (fixed)
	Market rate (HK$/US$1, period average)			7.757	7.757	7.755	7.752	7.762	7.790	…	…	…	…	…
	Real effective rate (period average, 2010=100) ^1/			98.7	102.2	105.6	113.9	117.8	118.3	…	…	…	…	…

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

^{^1/}For 2017, average for first 11 months

^{^2/}CentaData, HIBOR-based for all households

^{^3/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 1.

Hong Kong SAR: Selected Economic and Financial Indicators, 2012-22

									Proj.
				2012	2013	2014	2015	2016	2017	2018	2019	2020	2021	2022
NATIONAL ACCOUNTS
Real GDP (percent change)				1.7	3.1	2.8	2.4	2.0	3.7	2.8	2.8	2.9	3.0	3.1
	Contribution
		Domestic demand		3.7	3.9	2.8	1.5	2.6	4.6	3.8	3.2	3.3	3.5	3.4
			Private consumption	2.5	2.9	2.2	3.1	1.2	3.7	3.1	2.1	2.2	2.4	2.3
			Government consumption	0.3	0.2	0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3
			Gross fixed capital formation	1.6	0.7	0.0	-0.8	-0.1	0.3	0.4	0.7	0.8	0.8	0.8
			Inventories	-0.8	0.1	0.4	-1.2	1.1	0.1	0.0	0.0	0.0	0.0	0.0
		Net exports		-1.9	-0.8	-0.1	0.8	-0.5	-0.9	-0.9	-0.4	-0.4	-0.5	-0.4
	Potential GDP growth			2.9	2.8	2.7	2.7	2.8	2.8	2.9	2.9	2.9	3.0	3.0
	Output gap (in percent of potential)			0.1	0.4	0.4	0.1	-0.6	0.2	0.1	0.0	0.0	0.0	0.0
Saving and investment (percent of GDP)
	Gross national saving			26.8	25.5	25.2	24.9	26.4	24.4	24.1	24.4	24.5	24.6	24.7
	Gross domestic investment			25.2	24.0	23.8	21.5	21.7	21.4	21.1	21.1	21.2	21.2	21.2
	Saving-investment balance			1.6	1.5	1.4	3.3	4.6	3.0	3.1	3.2	3.3	3.4	3.5
LABOR MARKET
Employment (percent change)				2.1	1.9	0.4	0.9	0.2	0.5	0.3	0.2	0.2	0.2	0.1
Unemployment rate (percent, period average)				3.3	3.4	3.3	3.3	3.4	3.2	3.2	3.2	3.2	3.2	3.2
Real wages (percent change)				1.6	0.2	-2.4	0.5	1.2	0.6	0.8	0.9	1.2	1.3	1.4
PRICES
Inflation (percent change)
	Consumer prices			4.1	4.3	4.4	3.0	2.4	1.6	1.8	2.0	2.2	2.4	2.6
	GDP deflator			3.5	1.8	2.9	3.6	1.8	3.0	1.0	1.1	1.1	1.3	1.5
GENERAL GOVERNMENT (percent of GDP)
Consolidated budget balance				3.2	1.0	3.6	0.6	4.5	2.6	1.6	1.4	1.3	1.2	1.2
	Revenue			21.7	21.3	21.2	18.8	23.0	21.0	20.4	20.4	20.5	20.6	20.6
	Expenditure			18.5	20.3	17.5	18.2	18.6	18.4	18.9	19.0	19.2	19.4	19.4
Fiscal reserves as of March 31				36.0	35.3	36.7	35.1	38.3	38.5	38.7	38.5	38.3	37.9	37.4
FINANCIAL
Interest rates (percent, period-average)
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	0.6	0.9	…	…	…	…	…
10-year Treasury bond yield ^1/				1.0	1.7	2.0	1.6	1.2	1.5	…	…	…	…	…
MACRO-FINANCIAL
Loans for use in Hong Kong SAR (not including trade financing)				7.0	10.6	13.5	6.3	8.0	13.3	4.8	1.0	3.0	4.5	5.1
House prices (end of period, percent change)				25.7	7.7	13.5	2.4	7.9	16.1	1.6	1.9	5.7	5.6	5.3
Mortgage payment to income ratio ^2/				43.6	45.7	44.7	49.1	45.1	50.3	52.1	53.2	53.6	51.1	48.5
Household debt (in percent of GDP)				61.3	62.7	65.5	67.1	67.7	73.6	72.0	70.6	71.7	72.6	73.1
Non-financial corporate debt (in percent of GDP)				173.1	195.2	213.4	227.7	233.9	224.9	219.4	219.5	219.4	218.8	218.2
Hang Seng stock index (percent change)				22.9	2.9	1.3	-7.2	0.4	28.0	…	…	…	…	…
EXTERNAL SECTOR
Merchandise trade (percent change)
	Export volume			-0.1	2.7	1.5	-1.7	1.4	5.5	3.0	2.8	3.1	3.4	3.5
		Domestic exports		-12.4	-9.3	2.8	-12.8	-7.1	5.5	3.0	2.8	3.1	3.4	3.5
		Reexports		0.1	2.9	1.5	-1.6	1.5	5.5	3.0	2.8	3.1	3.4	3.5
	Export value			2.9	3.6	3.2	-1.8	-0.5	7.0	4.8	3.9	3.9	4.4	3.8
	Import value			3.9	3.8	4.0	-4.1	-0.9	7.9	5.1	4.3	4.4	5.0	4.5
	Terms of trade			0.1	0.4	0.1	0.5	0.0	-0.2	0.5	-0.1	-0.2	-0.2	-0.4
Current account balance (percent of GDP) ^3/				1.6	1.5	1.4	3.3	4.6	3.0	3.1	3.2	3.3	3.4	3.5
Foreign exchange reserves ^3/
	In billions of U.S. dollars, end-of-period			317.4	311.2	328.5	358.8	386.1	392.3	405.2	421.4	433.7	445.1	456.9
	In percent of GDP			120.9	112.9	112.7	116.0	120.3	115.0	114.2	113.2	112.0	110.5	108.8
Net international investment position (percent of GDP)				274.5	274.8	298.6	324.2	367.5	347.3	337.4	327.8	318.3	308.4	298.3
Linked rate (fixed)
	Market rate (HK$/US$1, period average)			7.757	7.757	7.755	7.752	7.762	7.790	…	…	…	…	…
	Real effective rate (period average, 2010=100) ^1/			98.7	102.2	105.6	113.9	117.8	118.3	…	…	…	…	…

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

^{^1/}For 2017, average for first 11 months

^{^2/}CentaData, HIBOR-based for all households

^{^3/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 2.

Hong Kong SAR: Balance of Payments, 2012-18 ^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, 2012-18 ^1/

									Proj.
				2012	2013	2014	2015	2016	2017	2018
				(In billions of U.S. dollars)
Current account				4.1	4.2	4.1	10.3	14.9	10.2	10.8
	Goods balance			-18.9	-27.9	-32.4	-22.9	-17.6	-23.5	-26.6
	Services balance			21.9	29.6	33.0	30.3	24.4	29.5	33.2
	Income balance			1.2	2.5	3.5	2.9	8.0	4.1	4.2
		Primary income balance		3.8	5.2	6.0	5.7	10.8	7.0	7.3
		Secondary income balance		-2.6	-2.7	-2.6	-2.9	-2.8	-2.9	-3.1
Capital and financial account				-8.7	-11.1	-9.5	-16.6	-15.8	-10.2	-10.8
	Capital account			-0.2	-0.2	-0.1	0.0	0.0	0.0	0.0
	Financial account			-8.5	-10.9	-9.4	-16.6	-15.8	-10.1	-10.8
		Net direct investment		-13.2	-6.5	-11.1	102.5	45.7	61.3	67.6
			Assets	-88.1	-83.3	-140.9	-78.5	-71.4	-63.2	-61.9
			Liabilities	74.9	76.8	129.8	181.0	117.1	124.5	129.5
		Portfolio investment		-4.1	-49.8	-8.3	-125.2	-41.9	-44.6	-46.4
			Assets	-40.1	-66.3	-35.6	-85.3	-46.5	-49.5	-51.5
			Liabilities	36.0	16.6	27.3	-39.9	4.6	3.5	2.4
		Financial derivatives		2.0	7.0	15.3	12.8	3.7	4.1	4.4
			Assets	39.7	54.8	57.9	72.8	91.4	101.0	110.0
			Liabilities	-37.8	-47.7	-42.6	-60.0	-87.7	-89.2	-90.7
		Other investment		31.2	45.7	12.6	29.7	-22.0	-23.0	-24.0
			Assets	-17.1	-82.4	-119.3	36.8	-34.4	-35.8	-37.5
			Liabilities	48.2	128.2	131.9	-7.0	12.3	12.8	13.5
		Reserve assets (net change)		-24.3	-7.5	-17.9	-36.4	-1.1	-8.0	-12.4
Net errors and omissions				4.6	6.9	5.5	6.3	0.9	0.0	0.0
Memorandum item:
Nominal GDP				262.6	275.7	291.4	309.4	320.9	341.2	354.9
				(In percent of GDP)
Current account				1.6	1.5	1.4	3.3	4.6	3.0	3.1
	Goods balance			-7.2	-10.1	-11.1	-7.4	-5.5	-6.9	-7.5
	Services balance			8.3	10.7	11.3	9.8	7.6	8.7	9.3
	Income balance			0.4	0.9	1.2	0.9	2.5	1.2	1.2
Capital and financial account				-3.3	-4.0	-3.3	-5.4	-4.9	-3.0	-3.0
	Capital account			-0.1	-0.1	0.0	0.0	0.0	0.0	0.0
	Financial account			-3.3	-4.0	-3.2	-5.4	-4.9	-3.0	-3.0
		Net direct investment		-5.0	-2.3	-3.8	33.1	14.2	18.0	19.0
		Portfolio investment		-1.6	-18.1	-2.8	-40.5	-13.1	-13.1	-13.1
		Financial derivatives		0.7	2.6	5.2	4.1	1.1	1.2	1.3
		Other investment		11.9	16.6	4.3	9.6	-6.9	-6.7	-6.8
		Reserve assets (net change)		-9.3	-2.7	-6.2	-11.8	-0.4	-2.3	-3.5
Net errors and omissions				1.7	2.5	1.9	2.0	0.3	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, 2012-18 ^1/

									Proj.
				2012	2013	2014	2015	2016	2017	2018
				(In billions of U.S. dollars)
Current account				4.1	4.2	4.1	10.3	14.9	10.2	10.8
	Goods balance			-18.9	-27.9	-32.4	-22.9	-17.6	-23.5	-26.6
	Services balance			21.9	29.6	33.0	30.3	24.4	29.5	33.2
	Income balance			1.2	2.5	3.5	2.9	8.0	4.1	4.2
		Primary income balance		3.8	5.2	6.0	5.7	10.8	7.0	7.3
		Secondary income balance		-2.6	-2.7	-2.6	-2.9	-2.8	-2.9	-3.1
Capital and financial account				-8.7	-11.1	-9.5	-16.6	-15.8	-10.2	-10.8
	Capital account			-0.2	-0.2	-0.1	0.0	0.0	0.0	0.0
	Financial account			-8.5	-10.9	-9.4	-16.6	-15.8	-10.1	-10.8
		Net direct investment		-13.2	-6.5	-11.1	102.5	45.7	61.3	67.6
			Assets	-88.1	-83.3	-140.9	-78.5	-71.4	-63.2	-61.9
			Liabilities	74.9	76.8	129.8	181.0	117.1	124.5	129.5
		Portfolio investment		-4.1	-49.8	-8.3	-125.2	-41.9	-44.6	-46.4
			Assets	-40.1	-66.3	-35.6	-85.3	-46.5	-49.5	-51.5
			Liabilities	36.0	16.6	27.3	-39.9	4.6	3.5	2.4
		Financial derivatives		2.0	7.0	15.3	12.8	3.7	4.1	4.4
			Assets	39.7	54.8	57.9	72.8	91.4	101.0	110.0
			Liabilities	-37.8	-47.7	-42.6	-60.0	-87.7	-89.2	-90.7
		Other investment		31.2	45.7	12.6	29.7	-22.0	-23.0	-24.0
			Assets	-17.1	-82.4	-119.3	36.8	-34.4	-35.8	-37.5
			Liabilities	48.2	128.2	131.9	-7.0	12.3	12.8	13.5
		Reserve assets (net change)		-24.3	-7.5	-17.9	-36.4	-1.1	-8.0	-12.4
Net errors and omissions				4.6	6.9	5.5	6.3	0.9	0.0	0.0
Memorandum item:
Nominal GDP				262.6	275.7	291.4	309.4	320.9	341.2	354.9
				(In percent of GDP)
Current account				1.6	1.5	1.4	3.3	4.6	3.0	3.1
	Goods balance			-7.2	-10.1	-11.1	-7.4	-5.5	-6.9	-7.5
	Services balance			8.3	10.7	11.3	9.8	7.6	8.7	9.3
	Income balance			0.4	0.9	1.2	0.9	2.5	1.2	1.2
Capital and financial account				-3.3	-4.0	-3.3	-5.4	-4.9	-3.0	-3.0
	Capital account			-0.1	-0.1	0.0	0.0	0.0	0.0	0.0
	Financial account			-3.3	-4.0	-3.2	-5.4	-4.9	-3.0	-3.0
		Net direct investment		-5.0	-2.3	-3.8	33.1	14.2	18.0	19.0
		Portfolio investment		-1.6	-18.1	-2.8	-40.5	-13.1	-13.1	-13.1
		Financial derivatives		0.7	2.6	5.2	4.1	1.1	1.2	1.3
		Other investment		11.9	16.6	4.3	9.6	-6.9	-6.7	-6.8
		Reserve assets (net change)		-9.3	-2.7	-6.2	-11.8	-0.4	-2.3	-3.5
Net errors and omissions				1.7	2.5	1.9	2.0	0.3	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.

Consolidated Government Account, 2012/13-2022/23 ^1/

(In percent of Fiscal Year GDP, unless otherwise stated)

Sources: CEIC; and IMF staff estimates.

^{^1/}Using medium-range forecast as a starting point to make staff adjustments. Fiscal year begins April 1.

^{^2/}Operating balance, as defined by the authorities, is akin to the current balance.

^{^3/}Balance excluding investment income and interest expenditure.

^{^4/}Change in structural primary balance adjusted for one-off factors, non-inflationary output and house price gaps. A positive corresponds to an expansionary fiscal stance.

Table 3.

Consolidated Government Account, 2012/13-2022/23 ^1/

(In percent of Fiscal Year GDP, unless otherwise stated)

								Prov.	Proj.
				2012/13	2013/14	2014/15	2015/16	2016/17	2017/18	2018/19	2019/20	2020/21	2021/22	2022/23
Consolidated revenue				21.4	21.0	20.8	18.6	22.7	20.7	20.1	20.1	20.2	20.3	20.3
	Operating revenue			16.7	16.4	17.2	15.8	16.3	15.2	16.2	16.3	16.4	16.4	16.4
	Capital revenue			4.7	4.7	3.7	2.9	6.5	5.6	4.0	3.9	3.8	4.0	4.0
	Taxes			13.6	13.3	15.4	14.3	13.7	14.4	14.1	14.2	14.3	14.4	14.4
		Of which:
			Salaries tax	2.4	2.6	2.6	2.4	2.3	…	…	…	…	…	…
			Profits tax	6.1	5.6	6.0	5.8	5.5	…	…	…	…	…	…
			Stamp duties	2.1	1.9	3.3	2.6	2.4	…	…	…	…	…	…
	Nontax			7.9	7.7	5.4	4.4	8.9	6.3	6.0	5.9	5.9	5.9	5.9
		Of which:
		Land premium		3.4	3.9	3.4	2.5	5.1	4.9	3.5	3.4	3.4	3.4	3.4
		Investment income		1.8	1.7	0.0	0.0	0.8	0.7	0.8	0.6	0.6	0.6	0.6
Consolidated expenditure				18.3	20.0	17.3	18.0	18.3	18.1	18.6	18.7	18.9	19.1	19.1
	Operating expenditure			14.7	15.6	13.8	14.4	14.0	14.2	14.4	14.6	14.5	14.8	14.8
		Of which:
			Personnel related (including pensions)	4.1	4.1	4.2	4.3	4.4	4.4	4.4	4.4	4.5	4.5	4.5
			Capital expenditure	3.6	4.4	3.5	3.7	4.3	4.0	4.1	4.1	4.4	4.4	4.4
		Of which:
			Interest expenditure	0.0	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	3.2	0.6	4.4	2.6	1.5	1.4	1.3	1.2	1.2
Memorandum items:
	Operating balance ^2/			2.0	0.8	3.4	1.4	2.3	1.1	1.8	1.7	1.9	1.6	1.6
	Primary balance ^3/			1.3	-0.7	3.2	0.6	3.6	1.9	0.7	0.7	0.7	0.6	0.6
	Fiscal impulse ^4/			-0.6	3.0	-4.7	2.2	-1.3	1.4	0.4	-0.3	0.0	0.2	-0.1
	Fiscal reserves			35.6	34.9	36.1	34.9	37.7	37.9	38.1	38.0	37.8	37.3	36.8
		(Months of spending)		23.3	20.9	25.1	23.2	24.8	25.1	24.6	24.3	24.0	23.4	23.1

Sources: CEIC; and IMF staff estimates.

^{^1/}Using medium-range forecast as a starting point to make staff adjustments. Fiscal year begins April 1.

^{^2/}Operating balance, as defined by the authorities, is akin to the current balance.

^{^3/}Balance excluding investment income and interest expenditure.

^{^4/}Change in structural primary balance adjusted for one-off factors, non-inflationary output and house price gaps. A positive corresponds to an expansionary fiscal stance.

Table 3.

Consolidated Government Account, 2012/13-2022/23 ^1/

(In percent of Fiscal Year GDP, unless otherwise stated)

								Prov.	Proj.
				2012/13	2013/14	2014/15	2015/16	2016/17	2017/18	2018/19	2019/20	2020/21	2021/22	2022/23
Consolidated revenue				21.4	21.0	20.8	18.6	22.7	20.7	20.1	20.1	20.2	20.3	20.3
	Operating revenue			16.7	16.4	17.2	15.8	16.3	15.2	16.2	16.3	16.4	16.4	16.4
	Capital revenue			4.7	4.7	3.7	2.9	6.5	5.6	4.0	3.9	3.8	4.0	4.0
	Taxes			13.6	13.3	15.4	14.3	13.7	14.4	14.1	14.2	14.3	14.4	14.4
		Of which:
			Salaries tax	2.4	2.6	2.6	2.4	2.3	…	…	…	…	…	…
			Profits tax	6.1	5.6	6.0	5.8	5.5	…	…	…	…	…	…
			Stamp duties	2.1	1.9	3.3	2.6	2.4	…	…	…	…	…	…
	Nontax			7.9	7.7	5.4	4.4	8.9	6.3	6.0	5.9	5.9	5.9	5.9
		Of which:
		Land premium		3.4	3.9	3.4	2.5	5.1	4.9	3.5	3.4	3.4	3.4	3.4
		Investment income		1.8	1.7	0.0	0.0	0.8	0.7	0.8	0.6	0.6	0.6	0.6
Consolidated expenditure				18.3	20.0	17.3	18.0	18.3	18.1	18.6	18.7	18.9	19.1	19.1
	Operating expenditure			14.7	15.6	13.8	14.4	14.0	14.2	14.4	14.6	14.5	14.8	14.8
		Of which:
			Personnel related (including pensions)	4.1	4.1	4.2	4.3	4.4	4.4	4.4	4.4	4.5	4.5	4.5
			Capital expenditure	3.6	4.4	3.5	3.7	4.3	4.0	4.1	4.1	4.4	4.4	4.4
		Of which:
			Interest expenditure	0.0	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	3.2	0.6	4.4	2.6	1.5	1.4	1.3	1.2	1.2
Memorandum items:
	Operating balance ^2/			2.0	0.8	3.4	1.4	2.3	1.1	1.8	1.7	1.9	1.6	1.6
	Primary balance ^3/			1.3	-0.7	3.2	0.6	3.6	1.9	0.7	0.7	0.7	0.6	0.6
	Fiscal impulse ^4/			-0.6	3.0	-4.7	2.2	-1.3	1.4	0.4	-0.3	0.0	0.2	-0.1
	Fiscal reserves			35.6	34.9	36.1	34.9	37.7	37.9	38.1	38.0	37.8	37.3	36.8
		(Months of spending)		23.3	20.9	25.1	23.2	24.8	25.1	24.6	24.3	24.0	23.4	23.1

Sources: CEIC; and IMF staff estimates.

^{^1/}Using medium-range forecast as a starting point to make staff adjustments. Fiscal year begins April 1.

^{^2/}Operating balance, as defined by the authorities, is akin to the current balance.

^{^3/}Balance excluding investment income and interest expenditure.

^{^4/}Change in structural primary balance adjusted for one-off factors, non-inflationary output and house price gaps. A positive corresponds to an expansionary fiscal stance.

Table 4.

Hong Kong SAR: Monetary Survey, 2012-18

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

Table 4.

Hong Kong SAR: Monetary Survey, 2012-18

							Proj.
		2012	2013	2014	2015	2016	2017	2018
		(In billions of Hong Kong dollars)
Net foreign assets		4447	4866	5064	4991	5293	5853	6388
	Monetary authorities	2431	2582	2792	3051	3114	3553	3988
	Banks	2016	2285	2272	1940	2179	2300	2400
Domestic credit		4097	4760	5333	5081	5246	5936	6227
	Claims on private sector	4044	4665	5271	4986	5076	5751	6027
	Claims on government	52	95	63	95	170	185	200
Other items (net)		406	431	614	1546	1969	1969	1969
M2		8950	10056	11011	11618	12508	13759	14584
	Of which:
	Deposits in HKD ^1/	4256	4481	4896	5416	5890	…	…
	Deposits in foreign currencies ^1/	4413	5261	5786	5853	6228	…	…
	Notes and coins in circulation	282	314	330	349	390	…	…
		(Annual percentage change)
Domestic credit		2.2	16.2	12.1	-4.7	3.2	13.2	4.9
	Claims on private sector	3.3	15.3	13.0	-5.4	1.8	13.3	4.8
M2		11.1	12.4	9.5	5.5	7.7	10.0	6.0
		(Contribution to M2 growth, in percent)
Net foreign assets		5.9	4.7	2.0	-0.7	2.6	4.5	3.9
Domestic credit		1.1	7.4	5.7	-2.3	1.4	5.5	2.1
	Claims on private sector	1.6	6.9	6.0	-2.6	0.8	5.4	2.0
	Claims on government	-0.5	0.5	-0.3	0.3	0.6	0.1	0.1
Other items (net)		4.1	0.3	1.8	8.5	3.6	0.0	0.0
		(In percent of GDP)
Net foreign assets		218.3	227.6	224.1	208.1	212.5	220.1	231.3
Domestic credit		201.1	222.6	236.0	211.9	210.6	223.2	225.5
Other items (net)		19.9	20.1	27.2	64.5	79.0	74.1	71.3
M2		439.4	470.3	487.2	484.4	502.1	517.4	528.1

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

Table 4.

Hong Kong SAR: Monetary Survey, 2012-18

							Proj.
		2012	2013	2014	2015	2016	2017	2018
		(In billions of Hong Kong dollars)
Net foreign assets		4447	4866	5064	4991	5293	5853	6388
	Monetary authorities	2431	2582	2792	3051	3114	3553	3988
	Banks	2016	2285	2272	1940	2179	2300	2400
Domestic credit		4097	4760	5333	5081	5246	5936	6227
	Claims on private sector	4044	4665	5271	4986	5076	5751	6027
	Claims on government	52	95	63	95	170	185	200
Other items (net)		406	431	614	1546	1969	1969	1969
M2		8950	10056	11011	11618	12508	13759	14584
	Of which:
	Deposits in HKD ^1/	4256	4481	4896	5416	5890	…	…
	Deposits in foreign currencies ^1/	4413	5261

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About

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Abstract

Context: Opportunities and Challenges

Recent Developments and Outlook: Solid Recovery on Track

Authorities’ View

Risks: Clouds on the Horizon

A. Sharp Property Price Correction

B. Global Financial Conditions

C. Mainland China’s Transition

D. Retreat from Cross-Border Integration

Authorities’ View

Strong Buffers in Place

Policies: Navigating Challenges and Securing Sustained and Inclusive Growth

A. Fiscal Policy: Ensuring Long-Term Sustainability and Short-Term Flexibility

Authorities’ View

B. Deflating the Housing Boom Safely

Authorities’ View

C. Preserving an Anchor of Stability

Authorities’ View

D. Maintaining Financial Stability

Authorities’ View

E. Ensuring Sustained and Inclusive Growth

Authorities’ View

Staff Appraisal