People’s Republic of China—Hong Kong Special Administrative Region: 2018 Article IV Consultation—Press Release and Staff Report

International Monetary Fund. Asia and Pacific Dept

doi:10.5089/9781484395707.002.A001

Author: International Monetary Fund. Asia and Pacific Dept

Publication Date:: 24 Jan 2019

eISBN:: 9781484395707

ISBN:: 9781484395707

Language:: English

Keywords:: ISCR; CR; SAR.; HK dollar; China; authority; housing market; U.S. dollar; exchange rate; banking sector; real GDP; Housing; Housing prices; Trade tensions; Global

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2018 Article IV Consultation-Press Release and Staff Report

Abstract

2018 Article IV Consultation-Press Release and Staff Report

Context: Strong Rebound AMID Growing Risks

1. The Hong Kong SAR economy benefited from a strong cyclical upswing and momentum continued through the first half of 2018… Growth rebounded strongly in 2017 and the first half of 2018 as a result of the global recovery, continued momentum in Mainland China, and increased consumer confidence. Inflation remained subdued and unemployment fell to a 20-year low. The booming economy and the buoyant property market boosted fiscal revenues, resulting in a large fiscal surplus.

2. …but challenges are increasingly clouding the horizon. Risks, including the escalating trade tensions, a disorderly tightening of global financial conditions, slower-than-expected growth in Mainland China, and a sharp property market correction, could have a significant negative impact on Hong Kong SAR’s economic prospects. At the same time, Hong Kong SAR should continue to benefit from its role as a global financial center, and growth opportunities could be generated from the development of the Guangdong-Hong Kong SAR-Macao SAR Bay Area (Greater Bay Area).

3. Going forward, Hong Kong SAR will need new drivers of growth. The property boom has left the city with one of the least affordable housing in the world and high commercial rents, amid elevated income inequality. Its services sectors face stiff competition from cities in Mainland China and elsewhere in Asia. That, together with the structural challenge of an aging population—likely to bring a decline in the labor force and productivity—may result in falling competitiveness, slower growth, and a deteriorating fiscal position. Fortunately, many years of prudent macro policies left Hong Kong SAR with ample buffers that should ease the transition and allow for policies to ensure continued stability and prosperity, and increased inclusion. The authorities’ have taken a number of steps to address these challenges including efforts to increase housing supply and provide public housing to a large part of the population, and boosted spending on health and social welfare to increase inclusion, as well as maintaining robust financial regulation and supervision including for fintech.

Developments: The Economy Operating at Full Employment

4. Strong growth continued amid increased consumer confidence and the global recovery, slowing modestly in Q3.

Domestic activity. Growth remained strong in 2017 and through 2018:Q1, and started to moderate since 2018:Q2. Private consumption was the main contributor, supported by a tight labor market (unemployment stood at 2.8 percent in the three months ending October, the lowest in over 20 years), continued growth in real wages, and tourism inflows from Mainland China (which account for 40 percent of retail sales). The output gap is estimated to be 0.5 percent and inflation remains subdued, although picked up slightly to 2.7 percent in October.
External sector. Despite rising trade tensions between Hong Kong SAR’s two major trading partners, exports expanded 8 percent y/y in 2018Q1-Q3 (compared to the average of 1.6 percent during 2015–2017), with 5 percent increase in volumes. Amid strong domestic demand, imports edged up even more: net exports continued to subtract from growth and the current account surplus moderated from 4.3 percent of GDP in 2017 to 2.4 in H1 2018. Capital outflows resumed in Q2, after large inflows in 2017, driven by portfolio investment.
Exchange rate. The Linked Exchange Rate System (LERS) has continued to anchor exchange rate developments. Ample liquidity in the domestic interbank market slowed the upward adjustment of the HIBOR despite interest rate increases by the U.S. Fed. The resulting HIBOR-LIBOR differential widened in April, leading to HK dollar depreciation to 7.85 per U.S. dollar, the floor of the convertibility undertaking. The Hong Kong Monetary Authority (HKMA) intervened as part of the currency board, selling US$13 billion between April and August. These operations drained liquidity from the banking system and raised the HIBOR closer to the LIBOR, which led to the recent strengthening of the HKD closer to midpoint of the band.
Property prices. Housing prices continued their upward trend, but softened recently. Trough-to-peak (March 2016 to July 2018), house prices grew 45 percent, and even more for the smallest, and thus most affordable, apartments. House prices declined 3.7 percent between July and October, and transactions declined from the robust figures seen in the first half of the year.
Financial conditions. Financial conditions remained accommodative in the first half of 2018 and then started to move towards neutral. Local interest rates rose modestly from historically low levels, equity prices fell 20 percent from the peak in January to end-November, capital outflows resumed and domestic lending moderated.
Credit. Credit growth slowed to 7.2 percent y/y in Q3 2018 vs. 16.1 percent in 2017, particularly among loans for use outside Hong Kong SAR, especially in Mainland China. The growth of domestic loans moderated as well, with growth in consumer lending easing to 9.9 percent, driven by 13 percent y/y growth in other household lending (including credit cards and other unsecured loans) and continued robust mortgage lending. The household debt-to-GDP ratio dropped slightly from 71.2 percent in Q2 to 70.7 percent in Q3 2018, while corporate debt also came down from 177 percent of GDP to 170 percent over the same period.¹ With a moderation in credit growth, the domestic credit-to-GDP ratio stabilized at 240 percent in Q3 and the credit gap, defined as the credit-to-GDP ratio relative to trend, fell to 16.1 percent in Q2 from 20.6 percent in Q4 2017, but remains elevated.
Fiscal. The FY2017/18 surplus came in at 5.6 percent of GDP, much stronger than budgeted (0.6 percent of GDP). Land premia and stamp duties were the main contributors, amid the booming property market. As a result, fiscal reserves rose to about 41 percent of GDP or 28 months of government spending by end-2017.

5. Baseline projections. Growth is projected to slow moderately in the second half of 2018 and through 2019. The annual growth rate is projected to be 3.5 percent in 2018, and 2.9 percent in 2019. The forecast relies on the following assumptions:

Tariffs announced until end-September 2018 come into effect, but trade tensions do not escalate further, and global trade grows at 4.4 percent in 2019–2020.
Mainland China’s economic growth slows slightly but remains robust at 6.2 percent over the next two years.
Rising global interest rates are transmitted to Hong Kong SAR, gradually reducing the credit gap and cooling the property market.
Private consumption remains robust, supported by tight labor market conditions.
Government spending rises significantly in 2018, delivering a positive fiscal impulse.

6. Medium-term growth. Over the medium-term, Hong Kong SAR is expected to grow close to its potential growth of around 3 percent and the positive output gap is expected to gradually close. Hong Kong SAR’s growth prospects are projected to be supported by sustainable (though gradually declining) growth in Mainland China, as rebalancing and financial sector reforms progress.

Authorities’ Views

7. The authorities broadly agreed with mission’s assessment. They noted that the short- term outlook for Hong Kong SAR remained strong until the third quarter of 2018 on the back of robust private consumption aided by tight labor market conditions and investment, as well as still- strong exports. Some of the negative effects of some external downside risks started to materialize at the end of Q3. Overall, the authorities believe that Hong Kong SAR’s strong buffers and robust policy frameworks will enable it to navigate through the challenges. Some softening in the property market should have only a limited impact on growth given the strong financial position of both households and banks. Hong Kong SAR is expected to benefit from further development of the Greater Bay Area, as well as its position as the gateway to Mainland China and a global financial center.

Many Risks Surround the Baseline

Risks have shifted to the downside. Hong Kong SAR remains vulnerable to further escalating U.S.China trade tensions, possible disorderly tightening of global financial conditions, slower-than-expected growth in Mainland China, and a sharp housing market correction. GDP could be knocked down by 2½ percent over two years and remain lower in the medium-term in a scenario in which multiple shocks, including escalating trade tensions and turmoil in emerging markets, materialize.

A. Rising Trade Tensions

8. Rising trade tensions would have a significant impact on Hong Kong SAR’s highly-open economy. China and the U.S. are its major trading partners, and the city’s economy and labor market are highly dependent on a range of trade-related industries, including logistics, wholesale and retail. While tariff actions thus far have not weighed on trade through Hong Kong SAR, the impact of further escalation could lower its GDP by 1 percent in 2019, with the effects likely larger once the full impact on consumer confidence and financial markets is factored in (see Box 1). The transmission would operate through real economy channels—chiefly trade, logistics and tourism—and financial channels, through re-pricing of risk in equity markets, higher corporate spreads and possible deterioration of the quality of the large Mainland-related loan portfolio.

B. Sharper-Than-Expected Tightening of Global Financial Conditions

9. After a decade of “easy money”, Hong Kong SAR remains vulnerable to faster-than- expected tightening of global financial conditions. Several factors are at play:

Monetary policy surprises by the Fed or the ECB. Robust growth in the U.S., aided by fiscal stimulus, raises the prospect of faster-than-anticipated interest rate hikes. Also, the ECB has announced that the bond purchase program will end in December 2018. Higher rates in the U.S. and the Euro-area, in turn, could lead to a rise in global rates, term premia, and U.S. dollar appreciation, which would feed directly into HK dollar appreciation and increase local funding rates.
“Bumpy” financial and local government reforms in China. If further reforms are not managed well, they could bring about increased volatility and disorderly repricing of credit risks, resulting in investor losses and a reduced risk appetite.

10. Tighter liquidity conditions would have a broad-based impact.

Households. HIBOR-based mortgages accounted for 50.8 percent of new mortgages in October. While most HIBOR-based mortgages are capped by the prime rate that prevents rates from rising too sharply, if banks decide to increase prime rates, mortgage payments would rise. Staff analysis suggests that for every 1 percentage point increase in interest rates, household debt service rises by about 5 percentage points. Moreover, analysis by the HKMA indicates that a 1 percentage point increase in the outstanding mortgage debt service ratio would reduce household consumption by around ¾ percent in the long-run.
Corporates. The leverage of nonfinancial corporates has also been rising, with corporate debt increasing from 125 percent of GDP in 2010 to 170 percent in Q3 2018. Higher interest rates would increase refinancing costs, reduce investment and potentially weigh on bank balance sheet growth. Staff analysis suggests that a 3 percentage point interest rate increase would reduce investment by ½ - 1 percent.
Global financial market volatility and capital flows. As a financial center, Hong Kong SAR is highly vulnerable to shifts in risk sentiment. Already, high-frequency data suggests that capital outflows have increased in recent months.

11. The end of a prolonged period of easy financial conditions is expected to dampen growth over the medium term. Easy financial conditions in the recent past are tightening amid rising interest rates, equity market losses, capital outflows, and an increase in market volatility. With financial conditions moving to neutral, the near-term impact on growth is expected to be limited. However, a dramatic tightening in financial conditions could have a large negative impact on growth (see Box 2).²

C. Sharp Slowdown in the Property Market

12. The property market remains one of the least affordable in the world due in part to supply shortages, although it has recently started to show signs of cooling. Staff analysis suggests that as of Q2 2018, house prices exceeded those suggested by fundamentals by around 20–35 percent. Housing affordability deteriorated further: since 2009, house prices increased more than 260 percent and rents doubled, while average wages grew less than 50 percent. The average mortgage payment-to-income ratio for owners of small and medium-sized units stood at 74 percent in Q2 2018 (based on government estimates). As a result, Hong Kong SAR remains one of the least affordable housing market in the world. More recently, prices retreated from their July peak by 3.7 percent to October, indicating that the housing market may be starting to soften.

13. Gradual interest rate increases have the potential to cool the market in an orderly way, but sharper-than-expected increases would pose a risk. A sharper-than-expected increase in interest rates, particularly if accompanied by weaker growth in trading partners, could weigh on consumption. The direct impact on the banking sector would likely be limited given that the share of mortgages in bank portfolios has fallen to 20 percent, loan-to-value (LTV) ratios on new mortgages fell to 45 percent in October, and banks are well capitalized. Instead, adverse impacts on banks’ balance sheets would materialize through second-round effects of lower consumption and reduced business profitability and investment via the wealth effects channel.

D. Slowdown in Mainland China

14. The degree of interconnectedness between Hong Kong SAR and Mainland China is high and continues to rise. Hong Kong SAR benefits from close ties to Mainland China through trade, tourism, and financial sector linkages (Figure 6). Thus, a significant slowdown in Mainland China either due to insufficient/not-well-managed domestic reforms or further trade tensions could significantly impact Hong Kong SAR.

Real sector. Trade linkages between Mainland China and Hong Kong SAR remain strong and Mainlanders account for over ¾ of all tourism spending. Domestic consumption also likely captures some of their spending. A slowdown in Mainland China would impact the trade, logistics and tourism sectors.
Banking system. Financial exposure to Mainland China remains high, with around 39 percent of loans extended for Mainland-related purposes. Asset quality of that lending remained sound, with an NPL ratio at 0.64 percent in Q3 2018. Also, the average interest coverage ratio of A-share firms improved and the debt-at-risk ratio fell from 6.9 percent in Q2 2017 to 5.0 percent in Q3 2018, reflecting stronger earnings and moderation in leverage. Softer growth in Mainland China combined with a weaker global trade environment could lower growth of Mainland-related lending and dent the quality of existing loans.
Hong Kong SAR is a regional financial center and a gateway to Mainland China. Cross-border flows between the Mainland and Hong Kong SAR have increased in recent years, boosting the prospects of Hong Kong SAR’s financial sector. Its role as a fundraising platform for Chinese firms has expanded from equity fundraising through IPOs to bank borrowing and bond financing.
- Bank financing. A downturn in the investment and financing needs of Mainland corporates could negatively weigh on Hong Kong SAR banks’ balance sheet growth and profit outlook.
- Capital market financing. In 2017, total equity raised by Mainland firms listed in Hong Kong SAR amounted to US$47 billion, and offshore bonds issued by Mainland firms increased by almost 60 percent to US$66 billion. Much of this expansion is dependent on China’s growth prospects and is sensitive to RMB exchange rate expectations. Anticipating greater fund flows between the Mainland and Hong Kong SAR, the daily quota for Stock Connect Schemes was increased: the southbound daily quota into Hong Kong SAR increased from RMB 10.5 billion to RMB 42 billion for both the Shanghai-Hong Kong and Shenzhen-Hong Kong Schemes since May 2018. Usage remains limited, however, with net inflows averaging no more than 3 percent of the new quota in 2018.
- Asset management business. The asset management business has grown rapidly, with total asset under management reaching HK$31.6 trillion in mid-2018 from HK$18.3 in 2016. Overseas investors make up two-thirds of the funding. The industry’s growth reflects Hong Kong SAR’s highly-regarded regulatory framework and position as a preferred gateway to the Mainland, where the number of high-net-worth individuals has increased rapidly.
- RMB internationalization. RMB deposits edged higher relative to a year ago in 2018, reflecting stabilization of RMB expectations in 2017 and 2018:H1. However, the escalation of trade tensions and recent RMB depreciation could weigh on the demand for renminbi assets in the near term and have a negative impact on RMB deposits and trade settlement conducted through Hong Kong SAR.³ Over the medium to long term, this market is expected to continue growing with ongoing RMB internationalization and further opening-up of Mainland China’s capital account.

E. Amplification of Risks Scenario

15. GDP could fall by 2½ percent over two years under a scenario of rising trade tensions and turmoil in emerging markets. Rising trade tensions could come in conjunction with a generalized re-pricing of risks in emerging markets and tighter global financial conditions, leading to capital outflows and dollar appreciation. These external shocks could be amplified as sharp corrections in Hong Kong SAR’s asset markets dampen consumption and investment through sizable wealth effects (see Box 1).

Authorities’ Views

16. The authorities broadly agreed with the mission’s assessment of risks and are carefully monitoring risks and exposures. They agreed that near-term risks have increased, but underscored that Hong Kong SAR’s strong buffers and robust policy frameworks, including ample fiscal reserves, the smoothly operating Linked Exchange Rate System underpinned by sizeable Exchange Fund, strong regulatory and supervisory frameworks and a well-capitalized banking system, will enable Hong Kong SAR to navigate through these challenges. They underscored that the Government and the financial regulators will continue to closely monitor developments and financial markets, with a view to ensuring financial stability.

Trade tensions. The authorities generally share the mission’s view that a further escalation in trade tensions between the US and Mainland China, together with its repercussions on global economic sentiment, trade and investment activities, and financial markets, could be a major source of downside risk to the Hong Kong SAR’s economic outlook. The direct impact of tariffs through the trade channel is not expected to be large, however indirect impacts through confidence effects and financial markets and those affecting the Asian value chain could be much larger, but are highly uncertain.
Faster-than-expected U.S. monetary policy normalization could potentially trigger sizeable outflows from Hong Kong SAR after years of easy monetary policy globally. Fed rate hikes, combined with the uncertainties associated with the economic and financial market impacts of the trade disputes, have already affected investor sentiment and contributed to some capital outflows. That said, contagion to Hong Kong SAR from emerging markets’ outflows has been limited.
Disruptive correction in the property market. Eight rounds of macroprudential measures left banks well prepared for the first-round impact of a correction in house prices. Even accounting for second-round effects, stress tests indicate that banks’ solvency positions would not breach safe regulatory thresholds.
Mainland exposures. Tight underwriting standards have been maintained, and the NPL ratio for this lending remained below 1 percent during the 2015–16 episode of market stress in Mainland China. The HKMA also pays close attention to credit mitigation actions, like guarantees or collateral, to make sure they are enforceable. While the share of exposures to POEs has risen, these remain to less risky sectors.

Significant Buffers in Place

17. Many years of prudent macroeconomic policies left Hong Kong SAR with significant buffers to weather these shocks.

External. Despite the recent interventions as part of the operation of the currency board, FX reserves currently stand at around 126 percent of GDP, or twice the monetary base. The current account is in surplus and the net international investment position is equivalent to 409 percent of GDP, one of the largest in the world, and a strong buffer against external shocks.
Fiscal. Prudent fiscal management and the strong real estate market allowed Hong Kong SAR to accumulate fiscal reserves of 41.4 percent of GDP. Budgetary debt remains negligible at 0.1 percent of GDP, 4.6 percent if considering the wider General Government, and are more than offset by the official assets. Staff and the authorities project fiscal surpluses in the coming 5 years, and staff estimates that fiscal reserves will increase to HK$1.5 trillion (41 percent GDP) by 2023.
Banks. Banks’ capital buffers and liquidity positions remain strong. The Common Equity Tier 1 capital ratio stood at 15.3 percent in Q2 2018, significantly above Basel III standards. Banks’ significant holdings of high-quality liquid assets—a cushion against funding pressures—kept the liquidity coverage ratio at 158 percent in Q3, well above the international requirement of 90 percent. Asset quality remained high, and net interest margin widened to 1.6 percent, boosting profitability. However, systemic risks arise from banks’ high and increasing exposure to Mainland China and to the overvalued property market, amid rising household leverage.

Policy Challenges

The authorities’ macroeconomic policies continue to be guided by the principles of a lean and efficient government and a reliance on market forces with flexible and efficient markets for goods, labor and capital, all of which have served Hong Kong SAR well. The main policy lever is fiscal policy, with monetary and exchange rate policies constrained by the Linked Exchange Rate System, which has served as an anchor of stability. The main fiscal policy challenge is to guard the economy against near-term shocks while preparing for longer-term challenges. Going forward, preserving financial stability, increasing housing supply to contain the housing price boom, increasing spending to combat elevated inequality and impending aging pressures will be key to securing growth.

A. Ensuring Continued Financial Stability

18. Robust financial regulation and supervision should help weather domestic and foreign shocks.

Banking, securities and insurance sectors. The authorities have implemented all the main recommendations from the 2014 FSAP (See Appendix IV). The next FSAP is scheduled for 2019.
- The implementation of Basel III requirements remains on track. Given the large credit gap and the overvalued housing market, the countercyclical capital buffer has been appropriately set at 1.875 percent and is planned to increase to 2.5 percent in 2019. To ensure stability of banks’ liquidity positions, the authorities have introduced the net stable funding ratio.
- Detailed implementation of the resolution framework has progressed with new loss-absorbing capacity requirements for authorized institutions becoming operational by year-end. These ensure that systemic institutions hold sufficient financial resources to absorb losses and can be re-capitalized in case of failure.
- Supervision of bank loans to property developers has been appropriately strengthened through higher capital charges for those exposed to developers offering high-LTV mortgages. Mainland China-related exposures are also closely monitored.
- The development of a risk-based capital regime for insurance companies is in the Phase-2, with a focus on detailed rules for quantitative requirements.
- Stock exchange listing rules have been eased to allow dual class stocks with the aim to attract more IPOs.
Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT). The enactment of the Anti-Money Laundering and Counter-Terrorist Financing (Amendment) Ordinance and the Companies (Amendment) Ordinance in 2018 is an important step to better align Hong Kong SAR’s AML/CFT legal framework with Recommendations of the Financial Action Task Force (FATF) including with respect to the risk-based approach. Their effective implementation is crucial to preserve Hong Kong SAR’s reputation as a leading global financial center, in particular in light of the ongoing FATF evaluation. Some progress has been made⁴ and these efforts should be advanced to enhance effectiveness of AML/CFT measures.

19. …but continued efforts are necessary to counter potential risks.

The rapid growth of household bank loans deserves continued intensified scrutiny. To strengthen risk management of this type of lending, the HKMA required banks to adhere to prudent underwriting standards such as setting maximum loan tenor and debt-servicing ratio limits in extending personal loans; longer tenor loans are usually subjected to lower debt-servicing ratio limits. In general, banks have maintained prudent credit limits, conservative collateral valuation and prompt margin call mechanisms for personal lending.
Margin lending by brokers has also risen rapidly and the Securities and Futures Commission’s proposal to impose quantitative limits to their leverage and concentrated exposures is warranted. The HKMA and the Securities and Futures Commission should continue to cooperate closely to monitor brokers’ leverage through the banking system.
Lending by property developers should continue to be monitored closely. The authorities should consider measures to extend the regulatory perimeter to reduce regulatory arbitrage.

20. Continued efforts to support healthy development of the fintech sector will be key to bolster Hong Kong SAR’s standing as a regional financial center. A number of initiatives are currently underway:

The HKMA launched an Open Application Programming Interface Framework for the banking sector in July 2018 to encourage greater banking sector competition and innovation⁵; all retail banks will be required to have open API at the end of the implementation, which will take place over four phases.
The revised Guidelines on Authorization of Virtual Banks was issued in May 2018.
The Faster Payment System, allowing the use of emails and mobile phones for payments in Hong Kong dollars and RMB across 21 banks and ten e-wallets, was launched in September 2018 and supports instant, multi-currency payments on a 24/7 basis.
The HKMA is strengthening collaboration with authorities in other jurisdictions to support innovation and information sharing. A distributed ledger technology-based trade finance platform – eTradeConnect – was launched in October 2018. Meanwhile, the Enhanced Fintech Supervisory Sandbox, in operation since September 2017, helps to enhance communications between regulators and financial institutions on ongoing Fintech projects.

Authorities’ Views

21. The authorities welcomed the favorable assessment of the regulatory framework. Hong Kong SAR’s financial system is still largely bank-centric and thus bank buffers and robust bank regulation guard against financial stability risks. Lending by nonbanks, including mortgage lending by money lenders and developers, is monitored closely and remains limited. Were it to become systemic, new regulations could be considered. The SFC and the HKMA will continue to coordinate closely, including on margin lending by brokers. The Insurance Authority is proceeding with the implementation of the new risk-based capital regime and is soon launching new initiatives concerning policyholders protection schemes and group-wide supervision. Tech risks and cybersecurity continue to be a focus, with the aim to achieve a balance between innovation and regulation.

B. Containing the Housing Market Boom

22. The authorities’ strategy to contain the housing boom using tight macroprudential measures and stamp duties remains appropriate, but more needs to be done to raise housing supply. The authorities’ three-pronged approach relies on a mix of macroprudential policies, stamp duties to contain excessive demand, and measures to increase housing supply. While macroprudential measures have allowed for building buffers in the financial system against a correction, housing prices rose until recently, and affordability deteriorated. A significant increase in housing supply remains the most needed course of action. Given affordability concerns, the authorities could also consider increasing spending on public housing and allocating a larger share of new housing stock for public housing.

23. Tight macroprudential regulations have helped contain systemic risks and should remain in place. These include: LTV and debt service-to-income (DSR) ratios that vary with the residence type (primary vs. other) and the source of borrower’s income (originating in vs. outside of Hong Kong SAR); stress tests on the DSR to ensure affordability if interest rates increase; and floors on risk weights on property loans.⁶ These measures, together with stringent regulation and supervision, allowed banks to build significant buffers that should help cushion the impact of house price declines. While the mix should be reassessed on a regular basis, the authorities should cautiously await more signs of a sustained decline before considering loosening macroprudential and demand-side measures. At the same time, if prices rebound, further tightening of macroprudential measures would likely result in leakages to unregulated non-bank financial institutions as borrowers secure mortgage financing outside regular bank channels (e.g., property developers offering financing to potential buyers).

24. Stamp duties on real estate have helped contain systemic risks and should be retained for now but phased out when these risks dissipate.

The government maintains three types of stamp duties on purchase of residential properties: Ad Valorem Stamp Duty on all purchases except of primary residences of permanent residents who do not have any other local residential property at the time of purchase (called previously Doubled Ad Valorem Stamp Duty/currently New Residential Stamp Duty), Special Stamp Duty (SSD) on resale of residential properties within 36 months, and Buyer’s Stamp Duty (BSD) on purchases by non-residents.⁷ Staff analysis indicates that stamp duties have been effective in curbing house price increases by as much as 9 percent, and, consequently, helped limit household indebtedness and the buildup of systemic risks in the banking sector.⁸
The DSD/NRSD is levied at a higher rate on non-residents and is assessed to be a capital flow management measure and macroprudential measure under the IMF’s Institutional View of Capital Flows. It continues to be assessed as appropriate given that it: i) was imposed to stem the inflow of capital into the property market; ii) was not used to substitute for the appropriate macroeconomic adjustment; and iii) was imposed because macroprudential measures did not apply to cash buyers, and their further tightening could have resulted in leakages to less-regulated non-bank financial institutions. Moreover, the systemic financial risk remains elevated. Stamp duties should be phased out once systemic risks dissipate.

25. Efforts to further increase supply will be key to resolving the demand-supply imbalance and moderating further price increases.

After a significant increase in the number of housing units in the early 2000s, the average annual housing production between 2006–2013 fell below 25,000 units. In 2014 the authorities adopted the Long-Term Housing Strategy, which aimed to provide 460,000 housing units over ten years. This was complemented by the Hong Kong 2030+ Strategy—a guide to long-term planning and development of land and infrastructure. While housing production has increased to around 30,000 units on average over 2015–17, it has been falling short of target by around 40 percent on average.
The authorities are implementing new measures to boost housing supply. In April 2018, the Task Force on Land Supply presented options to increase the availability of land for residential housing, including reclaiming land in Victoria Harbor, and potential development of two strategic areas in East Lantau Metropolis and New Territories North. The “Lantau Tomorrow” reclamation project, as well as further development of brownfield sites, land sharing, and revitalization of existing buildings have been proposed in the 2018 Policy Address. Furthermore, the authorities announced plans to reform the pricing of subsidized housing, initiate a starter homes project, and set up a task force to assist with provision of transitional housing. In addition, a vacant property tax (“Special Rates” tax) of 200 percent of a flat’s “ratable” value (rental value estimated by the Rating and Valuation Revenue Department, roughly 5 percent of the property value) was proposed for unsold new residential units, and a requirement on developers to offer no less than 20 percent of flats during each sale to prevent the accumulation of unsold flats.
The authorities should also review and—where possible—expedite the procedures guiding the process of identifying land and building sites, zoning, and conducting the necessary environmental, design, transportation, and other assessments to streamline the process.

26. Frequent reviews of eligibility for social housing could potentially help alleviate social pressures. Around 30 percent of households currently live in public rental housing, with eligibility based on income and wealth, and additional 15 percent of households live in subsidized sale flats. Wait time for public rental housing have increased significantly, from 1.8 years for general applicants and 1.1 years for the elderly in 2008, to 5.1 years and 2.8 years, respectively, in 2017 to ensure proper allocation of benefits, frequent reviews of eligibility should be conducted: in 2016, around 5½ percent of households in the highest income quantile lived in public rental housing.

Authorities’ Views

27. The authorities agreed that increasing land and housing supply was fundamental to resolving the housing problem facing the community. Challenges in achieving the ten-year housing supply targets under the Long-Term Housing Strategy remain, tied to insufficient land for development and the necessary time to carry out due procedures. The authorities re-iterated that no efforts are being spared, as evidenced by the Government’s vision for the development of Lantau as outlined in the 2018 Policy Address, which should greatly increase land supply in the long-term. Macro-prudential and demand-side measures in the form of stamp duties have been conducive to a healthy development of the property market and will be maintained at this juncture. The authorities added that they could revisit measures as needed if warranted by changes in conditions. They underscored that the current state of the housing market is very different from that pre-Asian Financial Crisis: LTVs are much lower as are debt service burdens, supply is tighter, and banks, developers and households are much less leveraged now.

C. Preserving the Exchange Rate Arrangement

28. The Linked Exchange Rate System remains the appropriate exchange rate arrangement for Hong Kong SAR.

Since its introduction in 1983, the LERS has served as an anchor of stability for the Hong Kong SAR’s economy, helping to ensure smooth functioning of the extensive financial services industry. The functioning of LERS is aided by Hong Kong SAR’s flexible economy, ample fiscal and foreign reserve buffers, and strong financial regulation and supervision. The peg to the US dollar remains appropriate given that Hong Kong SAR’s business cycle, and trade and financial linkages, remain closely synchronized with those of the U.S. and other advanced economies, not that just of Mainland China.
FX intervention by the HKMA in 2018 was in line with the regular functioning of the currency board. Under the Convertibility Undertaking, the HK dollar moves against the U.S. dollar within a range of 7.75–7.85, and the authorities intervene if the exchange rate touches these bands. Such interventions are rare: prior to 2018, the HKMA intervened last in 2015 to prevent the currency from breaching the strong side of the band, while operations in 2018 aimed to keep the currency from breaching the weak side. The credibility of the arrangement is further underscored by ample FX reserves, which, at 126 percent of GDP, fully cover the monetary base—another requirement for a successful currency board. Enhanced and frequent public communications were key to educate the public on such infrequent operations and helped maintain orderly market conditions.
The external position remains broadly in line with medium-term fundamentals and desirable policy settings. The current account surplus is projected to stabilize at 3.4 percent of GDP in 2018, roughly unchanged in cyclically-adjusted terms from 2017. Staff assesses that the cyclically-adjusted current account is roughly in the mid-point of the norm range of 2.1 to 5.1 percent of GDP. The real effective exchange rate—largely determined by the HKD/USD movement—was essentially unchanged in 2017 and remained broadly consistent with medium-term fundamentals and desirable policies.

Authorities’ Views

29. The authorities underscored that the Linked Exchange Rate System (LERS) has continued to provide an anchor to the Hong Kong dollar and remains appropriate for Hong Kong SAR. The LERS has performed as designed this year, as widened negative Hibor-Libor interest rate spreads earlier in the year encouraged outflows from HKD and moved the HKD to the weak- side of the Convertibility Undertaking—which eventually triggered an increase in domestic interest rates.

D. Ensuring Fiscal Sustainability

30. The booming economy, coupled with conservative fiscal management, helped deliver another large fiscal surplus in FY2017/18, which the authorities partially redistributed through a mix of retroactive tax cuts and additional spending.

The preliminary FY2017/18 surplus was much higher than expected, at 5.6 percent of GDP vs. the 0.6 percent of GDP budgeted. As in previous years, very strong revenues, especially land premia and stamp duties, accounted for most of the overperformance. Public expenditure underperformed by around 4.2 percent (or 0.8 percentage points of GDP), with spending in most areas except for health and education lower than planned.
Part of the surplus has been redistributed through retroactive tax cuts and cash transfers. Similar to the previous year, the authorities reduced salaries and profit taxes, and provided additional grants to social security recipients and students. They also intend to distribute one-off cash transfers to eligible residents. These measures are expected to lower revenues by 1.6 percent of GDP, with extra spending of 0.5 percent of GDP.

31. The FY2018/19 budget is expected to deliver a fiscal stimulus through a combination of modest revenue cuts and significant spending increases. Revenues are expected to fall by around 1.1 percent of GDP, as a result of lower personal income tax rates, increased child and parent allowances, a new disability allowance, a one-off reduction in the recurrent property tax, and property-related revenues coming down from a historically high level. At the same time, the authorities intend to significantly increase spending (staff estimate puts it at 14 percent). The primary fiscal balance is projected to fall by 1.2 percentage points of GDP. Nonetheless, even with higher spending, Hong Kong SAR will continue to operate a very lean government.

32. The fiscal stimulus is not necessary given the economy’s cyclical position but higher spending in some areas is consistent with past staff advice in view of structural headwinds. Going forward, authorities should strive for greater countercyclicality in the face of both positive and negative shocks.

Expenditure on social welfare and healthcare will increase by 0.6 and 0.1 p.p. of GDP respectively.
Higher education spending—while still contained—should help preserve competitiveness, though the authorities should study spending efficiency.
Spending on public housing is expected to remain constant as a share of GDP (despite being below historical levels and amid a significant unmet demand for public housing) and should be raised in future.
On other expenditure, the authorities should carefully consider spending plans on technology and other industries to ensure that there is adequate demand for planned facilities and services that could not be met by private sector initiatives. More broadly, other increases in recurrent spending should also be carefully analyzed as they may be difficult to reverse in the future, thus complicating long-term fiscal management when aging pressures arise.

33. …but tax relief measures could have been more progressive, and the authorities should consider reversing the tax cuts.

Tax relief measures could have better targeted to the most vulnerable. With a relatively flat tax scale and high tax deductions, taxes are paid mostly by the wealthy (91 percent of income and property taxes are paid by the citizens in the two highest income deciles). When similar measures were implemented in 2016, over 50 percent of relief accrued to the two highest income deciles. Higher allowances to help the vulnerable should have been better targeted. The Old Age Allowance is not means-tested above the age of 70 and its benefits are relatively low. Merging it with the means-tested Old Age Living Allowance and increasing its level would be more beneficial to the elderly poor.
Personal and corporate income tax cuts will further reduce non-property revenues and increase reliance on a narrow and volatile tax base. Hong Kong SAR’s tax revenue as a share of GDP is relatively low, even when compared to other financial centers. Over 30 percent comes from real estate-related transactions, and another 30 percent from corporate income taxes, both subject to volatile property and business cycles. Such a revenue structure, combined with a low contribution of personal income taxes and no sales tax, may lead to a significant revenue underperformance if the property market turns or the economy slows. Further tax cuts in response to tax cuts elsewhere should also be avoided as they would likely result in significant revenue losses.

34. In the long term, measures will be needed to ensure fiscal sustainability. Aging will lead to higher pension and healthcare spending, leading to structural fiscal deficits. Therefore, measures will be needed to ensure fiscal sustainability, unless the social safety net is scaled back (which would have undesirable social and economic costs).

Increase revenues. Amid impending aging pressures and the likely normalization of the housing market, options should be considered to raise revenues while maintaining competitiveness. Options identified through international benchmarking include introducing/raising indirect taxes like sales tax or VAT and raising excise taxes to avoid overreliance on direct taxes. The authorities should also consider reversing the PIT tax cuts and raising the top personal income tax rate. Relief on the recurrent property taxes should also be avoided, and its administration and collection strengthened, given that it that property tax is considered to be an efficient revenue measure. The Tax Policy Unit should study possible tax-broadening measures and their impact on competitiveness and growth.
Ensure continued high quality of fiscal spending. In the medium-term, aging will likely result in structural deficits—expected within about a decade—due to higher spending on healthcare, pensions, and social welfare. Periodic expenditure reviews should continue to ensure adequate prioritization of fiscal spending.

Authorities’ Views

35. The authorities noted that the 2018/19 budget was based on a new fiscal philosophy of the administration of Hong Kong SAR.

Expenditures. Higher expenditures on social welfare, health, and housing are to ensure high level of services to the Hong Kong SAR’s population to fulfill the “caring and sharing” pledge of the government. The authorities also highlighted that they viewed increased spending on education and innovation and technology as investment to secure future growth in Hong Kong SAR. They also noted that they stand ready to support the Housing Authority, which presently still has not fully utilized the HKD $78.8 billion (balance as of end-2017) set aside a few years ago as the Housing Reserve. The Housing Authority will continue to monitor its funding position and discuss with the Government if injections are required.
Revenues. The authorities noted that one-off tax concessions instituted in the 2018/19 budget aimed to return part of the significant revenue overperformance to the population. Reduced marginal tax rates for salaries tax, as well as the two-tier profits tax aim to reduce the tax burden on the middle class and SMEs. No tax increases have been planned for the immediate future given the strong fiscal position of the government and its sizable fiscal reserves.

E. Bolstering Long-Term Growth Prospects

Preserving growth in the medium- to long-term will require addressing the issues of expected shrinking of the labor force, high inequality, as well as ensuring competitiveness of financial and other industries.

Labor Market

36. Hong Kong SAR is facing a structural challenge of an aging population that may soon impinge on growth prospects. UN projections indicate that over a quarter of the city’s population will be aged 65 years or above by 2030. The dependency ratio (the number of adults aged 65 and over supported by 100 working-age adults) is expected to rise from 21 in 2015 to 41 by 2030, while the labor force will shrink by over 10 percent. While the “open door” policy and willingness to integrate foreign workers helps, these demographic shifts are expected to lower potential GDP growth by ¾ percent between 2020–2050 on average, while higher healthcare and pension spending, combined with lower revenues, is projected to generate structural deficits by around 2025–30, and deplete fiscal reserves by 2035–40.

37. Raising female labor force participation (LFP) could help alleviate labor market pressures.

Participation rates. While the male LFP rate stands at over 80 percent (broadly in line with the OECD average), the ratio for women is almost 15 percentage points lower. Women are increasingly participating in the work force: higher female employment accounted for over 80 percent of the overall increase in employment since 2000. However, while young women enter the labor force in significant numbers, they start dropping out in their mid-thirties. Insufficient government childcare facilities and the very high cost of private childcare—exceeding half of the monthly average wage for children under 2—are hurdles for working mothers. Moreover, women (including foreign domestic helpers) tend to hold lower-paying jobs (their median wage is only 2/3 of a man), and rarely work part-time. These factors (plus caring for the elderly) make it much more probable that women drop out of the labor force.
Policies. Additional expenditure in the FY2018/19 budget aimed at improving child care is a step in the right direction. The authorities could study whether more affordable child care is needed, with possibly extended hours to accommodate working parents, as well as after-school care. Promoting flexible work arrangements and part-time employment would also help, as well as improving care for the elderly.

38. Retaining older workers could be another avenue to stop labor force depletion.

Participation rates. While LFP of elderly workers increased from 6 percent in 2006 to 10 percent in 2016, it remains below the OECD average. The participation rate is especially low for women: in 2016, only around 5 percent of women over 65 remained in the labor force, compared with about 16 percent of men. Retaining older workers longer should help them stay longer in the labor force and alleviate elderly poverty by providing additional income and boosting retirement savings.
Policies. The authorities have enhanced their Employment Program for the Middle Aged by providing higher incentives for employers hiring jobseekers or retirees over-60. The Research Office of the Legislative Council identified numerous policies currently in place in Japan and Singapore—economies with rapidly aging populations—that could be usefully considered in Hong Kong SAR. These include legislating mandating re-employment of older workers up to a certain age, employer subsidies, support for short-term and flexible job creation, and statutory protection against age discrimination. The authorities’ plans to abolish the arrangement for “offsetting” severance payments and long-service payments in the Mandatory Provident Fund are welcome and should also proceed as planned.

Inequality

39. Inequality remains high despite government’s efforts to alleviate it. Since 2010, the authorities introduced several policies aimed at increasing inclusion, including introducing and enhancing the Statutory Minimum Wage, the Working Family-, the Old Age Living-, and the Personal Disability Allowances, transport subsidies, and subsidized housing. Introduction of the Annuity Scheme with a guaranteed internal rate of return, as well as reverse mortgages that could help “income-poor but asset-rich” households could also help ensure adequate retirement income. Tax deductions for contributions to the Mandatory Provident Fund and for medical insurance layouts are also steps in the right direction. However, despite significant redistributive policies, inequality remains high.

40. A number of policies could increase inclusion.

Increasing progressivity of personal income taxation, as discussed above.
Ensuring adequate levels of spending on housing, health, education and social welfare.

Health and pension spending are currently below levels of other advanced economies, in part due to the current demographic structure, but required expenditure will increase given impending aging.⁹

Better targeting existing benefits. While benefits and transfers are designed to foster progressivity, the share of housing and education benefits allocated to Hong Kong SAR’s low-income citizens has also been declining, and, for education, has not been progressive (though differences in household composition may explain some of these results).

Competitiveness

41. While one of the most competitive economies in the world, Hong Kong SAR faces increased competition from other financial centers in Asia.

For many years Hong Kong SAR has been considered one of the most competitive economies in the world. It continues to be recognized for the high-quality regulatory framework based on the common law tradition and adapted to reflect international standards, transparent and efficient institutions, high-quality infrastructure, stable macro environment, and highly efficient and flexible markets for goods, labor, and financial markets.
Going forward, Hong Kong SAR faces growing competition from cities in Mainland China and other financial centers. With support from Mainland’s State Council, the development of the Guangdong-Hong Kong SAR-Macao SAR Bay Area, initiated in March 2017, could help increase the flow of people, capital, goods and services between Mainland China’s Guangdong province and Hong Kong SAR and Macao SAR. Given the development of Shenzhen and other cities in Southern China into a new technology cluster, with leading firms and significant human resources located there, greater integration could bring significant economic opportunities. At the same time, new risks will likely emerge, including greater exposure to the economic cycles in Mainland China.
Increased spending on education and R&D in the 2018–19 budget is a step in the right direction. Additional steps could include continued evaluation of university programs to ensure that the education system responds to industry needs, ensuring sufficient research funding, and promoting university-industry collaboration. R&D tax concessions could also help, though their effectiveness should be re-evaluated in future given upcoming fiscal pressures.

42. The authorities remain committed to further expanding Hong Kong SAR’s role as a leading financial center. Taking advantage of rising demand for bond financing in Asia, in part from the Belt and Road Initiative, in May 2018 the authorities launched a Pilot Bond Grant Scheme that will cover half of the issuance expenses of first time bond issuers (subject to a cap). The green bond program is also being actively developed by the HKMA and the Hong Kong Quality Assurance Agency, with the latter launching a Green Finance Certification Scheme to provide third-party certification for potential issuers. Given the relatively limited fixed income trading in Hong Kong SAR thus far, policies to help raise bond issuance appear warranted. The authorities have also further amended tax laws to improve the city’s attractiveness as a hub for treasury centers of multinational companies. Over the medium-term, the development of the Greater Bay Area will provide new economic impetus to Hong Kong SAR, including improved connectivity, industrial development, financial services, and freer flows of capital and talent (see Box 3).

Authorities’ Views

43. The authorities agreed that boosting labor force participation and helping the most vulnerable are key to ensuring strong and inclusive growth in the medium-term.

Long-term growth. The authorities underscored their commitment to increasing labor force participation of women and older workers and intend to further study policies that could help. In a separate context, they noted that immigration requirements for skilled workers have been relaxed, allowing companies to bring in three foreign employees if they hire one local person and provide internships to two local students. They are also studying options to increase supply of local labor in the construction and elderly care sectors.
Inequality. The authorities noted that their policies focus on the most vulnerable through a combination of tax allowances, social welfare payments, and public housing. High-quality education, including high school, is also free, and post-secondary education is subsidized, providing quality education to students regardless of parents’ wealth and promoting upward mobility. At the same time, a low and simple tax regime has long underpinned Hong Kong SAR’s growth model, and there are no plans to change that.

Staff Appraisal

44. Outlook. Growth is projected to remain robust in 2018 a result of the global recovery, continued solid growth in Mainland China, and increased consumer confidence, while a modest slowdown is expected in 2019 including as a result of ongoing trade tensions. Over the medium-term, Hong Kong SAR is expected to grow close to its potential growth of around 3 percent supported by sustainable (though gradually slowing) growth in Mainland China as rebalancing and financial sector reforms progress.

45. Risks. The balance of risks for Hong Kong SAR has shifted to the downside. Risks arise from further escalating U.S.-China trade tensions, possible disorderly tightening of global financial conditions, slower-than-expected growth in Mainland China, and a sharp housing market correction. These shocks are likely correlated and could materialize together, which would amplify their effects. At the same time, the development of the Greater Bay Area creates opportunities for Hong Kong SAR over the medium term, given its unique position as the gateway to Mainland China and as a global financial center with renowned professional services.

46. Buffers. Many years of sound macroeconomic and prudential policies have endowed Hong Kong SAR with significant buffers to weather these shocks. These include ample FX reserves, one of the strongest net International Investment Positions in the world, and fiscal reserves covering more than two years of government spending. Banks’ capital buffers and liquidity positions remain strong, due to stringent regulatory standards.

47. Financial sector policies. Robust financial regulation and supervision should help weather domestic and external shocks. The implementation of Basel III requirements remains on track, and the countercyclical capital buffer has appropriately been increased further. The authorities have also introduced the net stable funding ratio, and rules on loss-absorbing capacity requirements for authorized institutions will be operationalized by year-end, ensuring that institutions have sufficient financial resources to absorb losses and be re-capitalized in case of failure. Supervision of bank loans to property developers has been appropriately strengthened through higher capital charges. Mainland China-related exposures are also closely monitored. The authorities should also consider measures to extend the regulatory perimeter to reduce regulatory arbitrage from lending by property developers. The Securities and Futures Commission intends to impose quantitative limits on margin lending by brokers. The development of a risk-based capital regime for insurance companies is in the Phase-2, with a focus on detailed rules for quantitative requirements.

48. Housing policy. The combination of macroprudential measures and stamp duties currently in place remains appropriate, but more needs to be done to raise housing supply. While macroprudential measures have allowed for building buffers in the financial system against a correction, housing prices remain overvalued, and affordability has deteriorated. A significant increase in housing supply remains the most needed course of action. The DSD/NRSD is assessed to be a capital flow management measure and macroprudential measure under the IMF’s Institutional View of Capital Flows and should be phased out once systemic risks dissipate.

49. Exchange rate regime and external position. The LERS remains the appropriate exchange rate arrangement for Hong Kong SAR. Since its introduction, the LERS has served as an anchor of stability, helping to ensure sustained growth, competitiveness, and the smooth functioning of the extensive financial services industry. The functioning of LERS is aided by Hong Kong SAR’s flexible economy, ample fiscal buffers, and strong financial regulation and supervision. The credibility of the arrangement is further underscored by ample FX reserves. Hong Kong SAR’s external position and the HK dollar remain broadly in line with medium-term fundamentals and desirable policy settings.

50. Fiscal policy. The FY2018/19 budget is expected to deliver a fiscal stimulus that is not needed given the economy’s strong cyclical position. At the same time, increased expenditure on social welfare, health, and education is welcome, though some allowances could be better targeted, and spending on public housing should be raised. Other expenditure increases should be carefully analyzed as they may be difficult to reverse in the future, thus complicating long-term fiscal management when aging pressures arise. The authorities should also consider reversing the recent tax cuts. Furthermore, the authorities should strive for greater countercyclicality in the face of both positive and negative shocks.

51. Long-term fiscal challenges. Aging will lead to higher pension and healthcare spending and the housing market will likely normalize, which may lead to structural fiscal deficits. Therefore, the authorities will need to consider measures to ensure fiscal sustainability, unless the social safety net is scaled back. The Tax Policy Unit should study possible tax-broadening measures and their impact on long-term fiscal sustainability, competitiveness and growth. Options identified through international benchmarking include introducing/raising indirect taxes like sales tax or VAT and raising excise taxes to avoid overreliance on direct taxes. On the expenditure side, periodic expenditure reviews should continue to ensure adequate quality of fiscal spending. Hong Kong SAR’s strong fiscal buffers afford it time to plan for meeting future needs.

52. Inequality. The authorities’ efforts to reduce inequality and poverty through a combination of subsidies, allowances, social welfare payments, and public housing should continue. Introduction of the Annuity Scheme and the reverse mortgage can help ensure adequate retirement income. Going forward, additional steps would be welcome including: increasing progressivity of personal income taxation, ensuring adequate levels of spending on housing, health, education and social welfare, and better targeting existing benefits.

53. Competitiveness and long-term growth. Efforts to raise labor force participation of women and older workers should continue. The authorities’ plan to abolish the arrangement for “offsetting” severance payment and long service payment with Mandatory Provident Fund benefits is welcome, and should proceed as planned. Plans to develop the bond market and further promote innovation and technology are steps in the right direction. Further expansion of the Hong Kong SAR’s role as a leading financial center and as the gateway to Mainland China should also help.

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

Box 1.

Amplification of Risks Scenario for Hong Kong SAR¹

Tariff actions could significantly impact the global economy, with sizable spillovers to Emerging Markets (EMs). IMF (2018) assesses the impact of tariff actions by the U.S. and several of its trading partners on the G20 using the Global Integrated Monetary and Fiscal (GIMF) model. It finds that tariffs not in the baseline but under consideration² could result in lower global GDP by about 0.7 percent in 2019–20 when also factoring-in impacts on confidence and financial markets. Mainland China, the U.S. and NAFTA partners would be particularly affected. Not featured in IMF (2018) are impacts on other EMs, which presumably are even more sensitive to changes in global risk sentiment and in some cases are heavily exposed to the trade relationship between the U.S. and China. Thus, shocks to confidence and corporate risk premia could be expected to be significantly larger for EMs not in the G-20.

The IMF’s Flexible System of Global Models (FSGM) is used to assess the combined impact on HKSAR of trade tensions and turmoil in EMs. The simulation considers three layers: (i) trade tensions, modeled as an exogenous demand shock to match IMF (2018); (ii) a shock to confidence in EMs and higher corporate spreads, calibrated to be double that on G20 EMs in IMF (2018); and (iii) financial amplification in HKSAR, to match stock market responses to “mid-sized” shocks.³ This combination of shocks is highly relevant for Hong Kong SAR, given its exposure to the U.S. and the Mainland (Figure 6), and its role as a global financial center that is highly sensitive to shifts in the global capital flow cycle.

Under this scenario where risks materialize together, Hong Kong SAR’s GDP could decline by close to 2½ percent in 2019 and remain lower in the long-term. An escalation of trade tensions would depress both external and domestic demand. The HK dollar would appreciate versus trading partners following the US dollar because of the LERS. Interest rates would thus be relatively tight, and further depress domestic demand. If EM tensions flare up, investment would slump further on the back of a sharp reversal of flows and decreased confidence. In addition, Hong Kong SAR’s domestic asset markets could fall significantly, further depressing investment and consumption through wealth effects. Taking all of these together, the level of real GDP could be around 2½ percent below the baseline in 2019 and 2020 and recover only slowly, being roughly 1 percent below baseline in 2023. These estimates though are subject to a great degree of uncertainty. The results also abstract from discretionary policy responses, both in HKSAR and elsewhere, with only automatic fiscal and monetary responses operating when relevant.

¹ Prepared by Rui C. Mano (APD) and Keiko Honjo (RES).² These include the U.S. imposing a further 25 percent tariff on (i) all imports from China and (ii) on all imported cars and car parts, with major trading partners retaliating proportionately.³ This shock is roughly calibrated to responses of equity prices following “mid-sized” crisis episodes, like the mid- 90s tequila crisis or the uncertainty shock surrounding China following the summer of 2015, and is thus smaller than the Global Financial Crisis or Asian Financial Crisis. Therefore, there is still potential for larger disruptions.

Box 2.

Financial Conditions and Growth at Risk¹

Financial conditions in Hong Kong SAR remain accommodative but are moving towards neutral. Financial condition indices (FCIs) measure the ease of funding, incorporating information on prices, lending terms as well as other costs of credit for households and corporates. Since the end of 2017, easy conditions have begun to move towards neutral amid rising interest rates, sizable equity market losses and capital outflows.

The FCI for Hong Kong SAR underscores its sensitivity to external developments. Reflecting Hong Kong SAR’s highly-open economy and role as a global financial center, financial conditions have been mostly accommodative since the Global Financial Crisis and tightened during the European sovereign debt crisis in late 2011 and the Taper Tantrum in 2013 as well as the during the increased volatility following the change to the RMB fixing mechanism in 2015.

The growth-at-risk analysis suggests a low probability of recession in the near term but risks could rise.² Tighter financial conditions have been historically associated with declines in output growth. Higher funding costs, lower credit supplied and wealth effects from reduced asset prices could weigh on consumption and investment, introducing a negative feedback loop between investment and spending, profit growth, asset prices and investor confidence. A return to neutral FCI is not expected to have sizable impact on near-term growth. The probability of a recession in 2019 is about 11 percent, not much different from 2018. However, a prolonged period of easy conditions raises risks to growth. Over the medium term, should conditions remain at the current accommodative level, the probability of recession rises to around 15 percent. And, if financial conditions were to tighten sharply, growth could fall sizably.

¹ Prepared by Sally Chen (MCM).² GaR model forecasts the conditional distribution of future growth – using the quarterly growth rate – for different forecast horizons based on current financial conditions. “Near term” refers to the one-year horizon; “medium term” refers to the three-year horizon out to 2021.

Box 3.

Greater Bay Area: Opportunities and Challenges¹

The combined GDP of the Greater Bay Area (GBA) rivals the 17^th largest global economy. The area comprises Hong Kong SAR, Macau SAR and nine major cities in Guangdong; in total, it has 70 million people with a nominal GDP of US$1.5 trillion in 2017.

Unique and complementary advantages each region brings to the GBA can boost its overall productivity. Tertiary industry accounts for more than 90 percent of Hong Kong SAR’s GDP. Through closer integration, Hong Kong SAR can leverage its expertise in financial services to meet the funding needs of Mainland companies in the GBA. Meanwhile, Hong Kong SAR companies can utilize the research capacity in Shenzhen, which is Mainland China’s technology hub, to upgrade its fintech industry and other innovation capabilities.

The GBA development offers a rich array of opportunities for Hong Kong SAR. Hong Kong SAR residents will have greater opportunities to tap into the dynamic economies of the Area. Specifically, Hong Kong SAR could strengthen its roles as an international financial center and high-end professional services hub by tapping into increased fund flows and to meet the demand for financial and business services in the area.

Significant progress achieved in GBA development is already reducing trade barriers. Residents of Hong Kong and Macau SARs can apply for resident cards in Mainland China with greater ease, thus facilitating their access to online services in the GBA and other parts of Mainland China. Pilot use of Hong Kong e-wallets in Mainland started in October, facilitating cross-border mobile payments in the Area. The high-speed railway link between Hong Kong SAR and Mainland China, in operation since September 2018, has dramatically reduced travel time. The bridge that links Hong Kong SAR, Zhuhai and Macau SAR, opened in October 2018, will facilitate flows of goods and peoples among these three cities.

Still, challenges remain. Near-term challenges to GBA development revolve primarily around overcoming hurdles to movements of capital, people and goods. Some of the key challenges include:

Harmonizing customs policy by simplifying clearance procedures for transporting goods within the GBA;
Streamlining the working visa arrangement to promote talent exchange;
Simplifying procedures for opening bank accounts and further expanding the use of e-wallet by Hong Kong SAR residents.

¹ Prepared by Sally Chen (MCM).

Table 1.

Hong Kong SAR: Selected Economic and Financial Indicators, 2015–23

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

^{^1/}Based on loans for use in Hong Kong SAR

^{^2/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 1.

Hong Kong SAR: Selected Economic and Financial Indicators, 2015–23

							Proj.
				2015	2016	2017	2018	2019	2020	2021	2022	2023
NATIONAL ACCOUNTS
Real GDP (percent change)				2.4	2.2	3.8	3.5	2.9	3.0	3.1	3.1	3.1
	Contribution
		Domestic demand		1.4	2.5	5.2	5.4	3.3	3.5	3.5	3.6	3.5
			Private consumption	3.1	1.3	3.7	4.0	2.2	2.3	2.3	2.5	2.5
			Government consumption	0.3	0.3	0.3	0.4	0.3	0.3	0.3	0.3	0.3
			Gross fixed capital formation	-0.7	0.0	0.7	0.9	0.8	0.9	0.8	0.7	0.8
			Inventories	-1.2	0.9	0.5	0.1	0.0	0.0	0.0	0.0	0.0
		Net exports		0.8	-0.3	-1.4	-1.9	-0.4	-0.5	-0.3	-0.5	-0.4
	Output gap (in percent of potential)			-0.2	-0.8	0.0	0.5	0.3	0.2	0.2	0.1	0.1
Saving and investment (percent of GDP)
	Gross national saving			24.9	25.5	26.6	25.6	25.7	25.7	25.7	25.5	25.5
	Gross domestic investment			21.5	21.5	22.3	22.3	22.2	22.3	22.3	22.2	22.1
	Saving-investment balance			3.3	4.0	4.3	3.4	3.5	3.4	3.4	3.4	3.5
LABOR MARKET
Employment (percent change)				0.9	0.2	0.9	1.0	0.4	0.4	0.3	0.3	0.3
Unemployment rate (percent, period average)				3.3	3.4	3.1	2.6	2.6	2.6	2.6	2.6	2.6
Real wages (percent change)				0.5	1.2	2.3	1.6	1.0	1.2	1.3	1.3	1.3
PRICES
Inflation (percent change)
	Consumer prices			3.0	2.4	1.5	2.4	2.1	2.2	2.4	2.5	2.5
	GDP deflator			3.6	1.7	2.9	3.1	2.0	2.0	1.7	1.9	1.9
GENERAL GOVERNMENT (percent of GDP)
Consolidated budget balance				0.6	4.5	5.6	3.3	2.0	1.8	1.7	1.7	1.7
	Revenue			18.8	23.0	23.3	22.2	21.0	20.9	21.2	21.2	21.2
	Expenditure			18.2	18.6	17.7	18.9	19.0	19.1	19.5	19.5	19.5
Fiscal reserves as of March 31				35.1	38.3	41.4	42.2	42.1	41.9	41.6	41.3	41.0
FINANCIAL
Interest rates (percent, period-average)
Best lending rate				5.0	5.0	5.0	…	…	…	…	…	…
Three-month HIBOR				0.4	0.6	0.9	…	…	…	…	…	…
10-year Treasury bond yield				1.6	1.2	1.6	…	…	…	…	…	…
MACRO-FINANCIAL
Loans for use in Hong Kong SAR (ex. trade financing				6.3	8.0	16.1	14.6	8.4	7.4	9.1	8.1	9.3
House prices (end of period, percent change)				2.4	7.9	14.7	14.8	3.3	3.1	4.5	5.9	6.6
Credit Gap ^1/				11.0	10.9	19.6	19.3	10.2	7.2	5.6	2.6	2.0
Hang Seng stock index (percent change)				-7.2	0.4	36.0	…	…	…	…	…	…
EXTERNAL SECTOR
Merchandise trade (percent change)
	Export value			-1.8	-0.5	8.0	8.0	5.3	3.6	4.0	3.6	3.5
	Import value			-4.1	-1.0	8.7	8.6	5.3	3.9	4.3	4.1	3.8
	Terms of trade			0.5	0.0	-0.1	0.8	0.0	-0.1	-0.2	-0.2	-0.1
Current account balance (percent of GDP) ^2/				3.3	4.0	4.3	3.4	3.5	3.4	3.4	3.4	3.5
Foreign exchange reserves ^2/
	In billions of U.S. dollars, end-of-period			358.8	386.2	431.6	447.7	470.0	492.8	510.7	528.1	540.9
	In percent of GDP			116.0	120.3	126.4	123.6	122.2	119.9	117.2	113.9	109.4
Net international investment position (percent of GD				324.2	359.2	409.4	387.0	372.1	357.6	344.4	331.3	318.7
Linked rate (fixed)
	Market rate (HK$/US$1, period average)			7.752	7.762	7.793	…	…	…	…	…	…
	Real effective rate (period average, 2010=100)			113.9	118.3	118.2	…	…	…	…	…	…

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

^{^1/}Based on loans for use in Hong Kong SAR

^{^2/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 1.

Hong Kong SAR: Selected Economic and Financial Indicators, 2015–23

							Proj.
				2015	2016	2017	2018	2019	2020	2021	2022	2023
NATIONAL ACCOUNTS
Real GDP (percent change)				2.4	2.2	3.8	3.5	2.9	3.0	3.1	3.1	3.1
	Contribution
		Domestic demand		1.4	2.5	5.2	5.4	3.3	3.5	3.5	3.6	3.5
			Private consumption	3.1	1.3	3.7	4.0	2.2	2.3	2.3	2.5	2.5
			Government consumption	0.3	0.3	0.3	0.4	0.3	0.3	0.3	0.3	0.3
			Gross fixed capital formation	-0.7	0.0	0.7	0.9	0.8	0.9	0.8	0.7	0.8
			Inventories	-1.2	0.9	0.5	0.1	0.0	0.0	0.0	0.0	0.0
		Net exports		0.8	-0.3	-1.4	-1.9	-0.4	-0.5	-0.3	-0.5	-0.4
	Output gap (in percent of potential)			-0.2	-0.8	0.0	0.5	0.3	0.2	0.2	0.1	0.1
Saving and investment (percent of GDP)
	Gross national saving			24.9	25.5	26.6	25.6	25.7	25.7	25.7	25.5	25.5
	Gross domestic investment			21.5	21.5	22.3	22.3	22.2	22.3	22.3	22.2	22.1
	Saving-investment balance			3.3	4.0	4.3	3.4	3.5	3.4	3.4	3.4	3.5
LABOR MARKET
Employment (percent change)				0.9	0.2	0.9	1.0	0.4	0.4	0.3	0.3	0.3
Unemployment rate (percent, period average)				3.3	3.4	3.1	2.6	2.6	2.6	2.6	2.6	2.6
Real wages (percent change)				0.5	1.2	2.3	1.6	1.0	1.2	1.3	1.3	1.3
PRICES
Inflation (percent change)
	Consumer prices			3.0	2.4	1.5	2.4	2.1	2.2	2.4	2.5	2.5
	GDP deflator			3.6	1.7	2.9	3.1	2.0	2.0	1.7	1.9	1.9
GENERAL GOVERNMENT (percent of GDP)
Consolidated budget balance				0.6	4.5	5.6	3.3	2.0	1.8	1.7	1.7	1.7
	Revenue			18.8	23.0	23.3	22.2	21.0	20.9	21.2	21.2	21.2
	Expenditure			18.2	18.6	17.7	18.9	19.0	19.1	19.5	19.5	19.5
Fiscal reserves as of March 31				35.1	38.3	41.4	42.2	42.1	41.9	41.6	41.3	41.0
FINANCIAL
Interest rates (percent, period-average)
Best lending rate				5.0	5.0	5.0	…	…	…	…	…	…
Three-month HIBOR				0.4	0.6	0.9	…	…	…	…	…	…
10-year Treasury bond yield				1.6	1.2	1.6	…	…	…	…	…	…
MACRO-FINANCIAL
Loans for use in Hong Kong SAR (ex. trade financing				6.3	8.0	16.1	14.6	8.4	7.4	9.1	8.1	9.3
House prices (end of period, percent change)				2.4	7.9	14.7	14.8	3.3	3.1	4.5	5.9	6.6
Credit Gap ^1/				11.0	10.9	19.6	19.3	10.2	7.2	5.6	2.6	2.0
Hang Seng stock index (percent change)				-7.2	0.4	36.0	…	…	…	…	…	…
EXTERNAL SECTOR
Merchandise trade (percent change)
	Export value			-1.8	-0.5	8.0	8.0	5.3	3.6	4.0	3.6	3.5
	Import value			-4.1	-1.0	8.7	8.6	5.3	3.9	4.3	4.1	3.8
	Terms of trade			0.5	0.0	-0.1	0.8	0.0	-0.1	-0.2	-0.2	-0.1
Current account balance (percent of GDP) ^2/				3.3	4.0	4.3	3.4	3.5	3.4	3.4	3.4	3.5
Foreign exchange reserves ^2/
	In billions of U.S. dollars, end-of-period			358.8	386.2	431.6	447.7	470.0	492.8	510.7	528.1	540.9
	In percent of GDP			116.0	120.3	126.4	123.6	122.2	119.9	117.2	113.9	109.4
Net international investment position (percent of GD				324.2	359.2	409.4	387.0	372.1	357.6	344.4	331.3	318.7
Linked rate (fixed)
	Market rate (HK$/US$1, period average)			7.752	7.762	7.793	…	…	…	…	…	…
	Real effective rate (period average, 2010=100)			113.9	118.3	118.2	…	…	…	…	…	…

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

^{^1/}Based on loans for use in Hong Kong SAR

^{^2/}Data published using the Balance of Payments Statistics Manual 6 (BPM6) format

Table 2.

Hong Kong SAR: Balance of Payments, 2015–23

Sources: CEIC and HKSAR Census and Statistics Department.

^{^1/}Sign convention as per BPM5: Negative = net lending (net outflow); Positive = net borrowing (net inflow).

Table 2.

Hong Kong SAR: Balance of Payments, 2015–23

								Proj.
					2015	2016	2017	2018	2019	2020	2021	2022	2023
					(In billions of U.S. dollars)
Current account					10.3	12.7	14.8	12.2	13.3	13.9	14.7	15.7	17.1
		Goods balance			-22.9	-16.7	-24.0	-29.2	-31.5	-35.3	-39.2	-44.6	-48.9
		Services balance			30.3	24.1	27.1	30.5	34.0	38.8	44.1	50.9	56.4
		Income balance			2.9	5.4	11.6	10.9	10.8	10.5	9.8	9.4	9.5
			Primary income balance		5.7	8.1	14.2	13.6	13.8	13.7	13.3	13.3	13.9
			Secondary income balance		-2.9	-2.7	-2.6	-2.7	-3.0	-3.2	-3.5	-3.9	-4.3
	Transfer balance
Capital and financial account ^1/					-16.6	-13.0	-19.9	-12.1	-13.2	-13.9	-14.7	-15.6	-17.0
		Capital account			0.0	0.0	-0.1	0.0	0.0	0.0	0.0	0.0	0.0
		Financial account			-16.6	-13.0	-19.8	-12.1	-13.2	-13.8	-14.7	-15.6	-17.0
			Net direct investment		102.5	57.7	21.5	23.1	23.1	23.5	23.6	24.1	21.9
				Assets	-78.5	-75.5	-100.9	-109.1	-120.0	-132.4	-144.7	-158.5	-176.5
				Liabilities	181.0	133.2	122.4	132.2	143.1	155.9	168.3	182.6	198.3
			Portfolio investment		-125.2	-60.5	39.1	13.8	12.9	11.9	10.5	8.8	6.7
				Assets	-85.3	-68.3	3.0	-16.7	-19.4	-22.6	-26.1	-30.2	-34.8
				Liabilities	-39.9	7.8	36.2	35.1	34.0	32.9	31.8	30.7	29.6
			Financial derivatives		12.8	4.7	5.1	5.5	6.1	6.7	7.3	8.0	8.9
				Assets	72.8	95.1	81.6	88.3	97.1	107.1	117.1	128.2	142.7
				Liabilities	-60.0	-90.4	-76.5	-78.0	-79.5	-81.0	-82.5	-84.0	-85.5
			Other investment		29.7	-13.7	-53.4	-37.0	-38.3	-41.0	-43.4	-46.2	-49.1
				Assets	36.8	-41.5	-187.7	-178.3	-184.6	-197.4	-209.0	-222.4	-236.5
				Liabilities	-7.0	27.8	134.4	141.2	146.2	156.4	165.6	176.2	187.4
			Reserve assets (net change)		-36.4	-1.1	-32.1	-17.5	-17.0	-14.9	-12.6	-10.3	-5.3
Net errors and omissions					6.3	0.3	5.1	0.0	0.0	0.0	0.0	0.0	0.0
Memorandum item:
Nominal GDP					309.4	320.9	341.5	362.3	384.8	411.1	435.6	463.8	494.3
					(In percent of GDP)
Current account					3.3	4.0	4.3	3.4	3.5	3.4	3.4	3.4	3.5
		Goods balance			-7.4	-5.2	-7.0	-8.1	-8.2	-8.6	-9.0	-9.6	-9.9
		Services balance			9.8	7.5	7.9	8.4	8.8	9.4	10.1	11.0	11.4
		Income balance			0.9	1.7	3.4	3.0	2.8	2.5	2.3	2.0	1.9
Capital and financial account					-5.4	-4.1	-5.8	-3.3	-3.4	-3.4	-3.4	-3.4	-3.4
		Capital account			0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
		Financial account			-5.4	-4.0	-5.8	-3.3	-3.4	-3.4	-3.4	-3.4	-3.4
			Net direct investment		33.1	18.0	6.3	6.4	6.0	5.7	5.4	5.2	4.4
			Portfolio investment		-40.5	-18.9	11.5	3.8	3.4	2.9	2.4	1.9	1.4
			Financial derivatives		4.1	1.5	1.5	1.5	1.6	1.6	1.7	1.7	1.8
			Other investment		9.6	-4.3	-15.6	-10.2	-10.0	-10.0	-10.0	-10.0	-9.9
			Reserve assets (net change)		-11.8	-0.4	-9.4	-4.8	-4.4	-3.6	-2.9	-2.2	-1.1
Net errors and omissions					2.0	0.1	1.5	0.0	0.0	0.0	0.0	0.0	0.0

Sources: CEIC and HKSAR Census and Statistics Department.

^{^1/}Sign convention as per BPM5: Negative = net lending (net outflow); Positive = net borrowing (net inflow).

Table 2.

Hong Kong SAR: Balance of Payments, 2015–23

								Proj.
					2015	2016	2017	2018	2019	2020	2021	2022	2023
					(In billions of U.S. dollars)
Current account					10.3	12.7	14.8	12.2	13.3	13.9	14.7	15.7	17.1
		Goods balance			-22.9	-16.7	-24.0	-29.2	-31.5	-35.3	-39.2	-44.6	-48.9
		Services balance			30.3	24.1	27.1	30.5	34.0	38.8	44.1	50.9	56.4
		Income balance			2.9	5.4	11.6	10.9	10.8	10.5	9.8	9.4	9.5
			Primary income balance		5.7	8.1	14.2	13.6	13.8	13.7	13.3	13.3	13.9
			Secondary income balance		-2.9	-2.7	-2.6	-2.7	-3.0	-3.2	-3.5	-3.9	-4.3
	Transfer balance
Capital and financial account ^1/					-16.6	-13.0	-19.9	-12.1	-13.2	-13.9	-14.7	-15.6	-17.0
		Capital account			0.0	0.0	-0.1	0.0	0.0	0.0	0.0	0.0	0.0
		Financial account			-16.6	-13.0	-19.8	-12.1	-13.2	-13.8	-14.7	-15.6	-17.0
			Net direct investment		102.5	57.7	21.5	23.1	23.1	23.5	23.6	24.1	21.9
				Assets	-78.5	-75.5	-100.9	-109.1	-120.0	-132.4	-144.7	-158.5	-176.5
				Liabilities	181.0	133.2	122.4	132.2	143.1	155.9	168.3	182.6	198.3
			Portfolio investment		-125.2	-60.5	39.1	13.8	12.9	11.9	10.5	8.8	6.7
				Assets	-85.3	-68.3	3.0	-16.7	-19.4	-22.6	-26.1	-30.2	-34.8
				Liabilities	-39.9	7.8	36.2	35.1	34.0	32.9	31.8	30.7	29.6
			Financial derivatives		12.8	4.7	5.1	5.5	6.1	6.7	7.3	8.0	8.9
				Assets	72.8	95.1	81.6	88.3	97.1	107.1	117.1	128.2	142.7
				Liabilities	-60.0	-90.4	-76.5	-78.0	-79.5	-81.0	-82.5	-84.0	-85.5
			Other investment		29.7	-13.7	-53.4	-37.0	-38.3	-41.0	-43.4	-46.2	-49.1
				Assets	36.8	-41.5	-187.7	-178.3	-184.6	-197.4	-209.0	-222.4	-236.5
				Liabilities	-7.0	27.8	134.4	141.2	146.2	156.4	165.6	176.2	187.4
			Reserve assets (net change)		-36.4	-1.1	-32.1	-17.5	-17.0	-14.9	-12.6	-10.3	-5.3
Net errors and omissions					6.3	0.3	5.1	0.0	0.0	0.0	0.0	0.0	0.0
Memorandum item:
Nominal GDP					309.4	320.9	341.5	362.3	384.8	411.1	435.6	463.8	494.3
					(In percent of GDP)
Current account					3.3	4.0	4.3	3.4	3.5	3.4	3.4	3.4	3.5
		Goods balance			-7.4	-5.2	-7.0	-8.1	-8.2	-8.6	-9.0	-9.6	-9.9
		Services balance			9.8	7.5	7.9	8.4	8.8	9.4	10.1	11.0	11.4
		Income balance			0.9	1.7	3.4	3.0	2.8	2.5	2.3	2.0	1.9
Capital and financial account					-5.4	-4.1	-5.8	-3.3	-3.4	-3.4	-3.4	-3.4	-3.4
		Capital account			0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
		Financial account			-5.4	-4.0	-5.8	-3.3	-3.4	-3.4	-3.4	-3.4	-3.4
			Net direct investment		33.1	18.0	6.3	6.4	6.0	5.7	5.4	5.2	4.4
			Portfolio investment		-40.5	-18.9	11.5	3.8	3.4	2.9	2.4	1.9	1.4
			Financial derivatives		4.1	1.5	1.5	1.5	1.6	1.6	1.7	1.7	1.8
			Other investment		9.6	-4.3	-15.6	-10.2	-10.0	-10.0	-10.0	-10.0	-9.9
			Reserve assets (net change)		-11.8	-0.4	-9.4	-4.8	-4.4	-3.6	-2.9	-2.2	-1.1
Net errors and omissions					2.0	0.1	1.5	0.0	0.0	0.0	0.0	0.0	0.0

Sources: CEIC and HKSAR Census and Statistics Department.

^{^1/}Sign convention as per BPM5: Negative = net lending (net outflow); Positive = net borrowing (net inflow).

Table 3.

Hong Kong SAR: Consolidated Government Account, 2015–2023 ^1/

(In percent of GDP, unless stated otherwise)

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.

^{^5/}Negative sign indicates net assets.

Table 3.

Hong Kong SAR: Consolidated Government Account, 2015–2023 ^1/

(In percent of GDP, unless stated otherwise)

								Proj.
					2015	2016	2017	2018	2019	2020	2021	2022	2023
Consolidated revenue					18.8	23.0	23.3	22.2	21.0	20.9	21.2	21.2	21.2
	Operating revenue				15.9	16.5	16.6	17.0	16.5	16.5	16.7	16.7	16.7
	Capital revenue				2.9	6.5	6.7	5.2	4.5	4.4	4.5	4.5	4.5
	Taxes				14.4	14.0	14.3	13.7	12.9	12.9	13.0	13.0	13.0
			Of which:
				Salaries tax	2.4	2.4	2.3	…	…	…	…	…	…
				Profits tax	5.8	5.6	5.2	…	…	…	…	…	…
				Stamp duties	2.6	2.5	3.6	…	…	…	…	…	…
	Nontax				4.4	9.0	9.0	8.5	8.1	8.1	8.1	8.1	8.1
			Of which:
			Land premium		2.5	5.1	6.2	4.3	3.7	3.7	3.7	3.7	3.7
			Investment income		0.0	0.8	0.8	1.4	1.2	1.1	1.1	1.3	1.6
Consolidated expenditure					18.2	18.6	17.7	18.9	19.0	19.1	19.5	19.5	19.5
	Operating expenditure				14.5	14.2	13.9	15.0	15.2	15.4	15.5	15.5	15.5
			Of which:
				Personnel related (including pensions)	4.3	4.4	4.4	4.4	4.4	4.4	4.4	4.4	4.5
				Capital expenditure	3.7	4.4	3.8	3.9	3.8	3.7	4.0	4.0	4.0
			Of which:
				Interest expenditure	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Overall balance					0.6	4.5	5.6	3.3	2.0	1.8	1.7	1.7	1.7
Memorandum items:
	Operating balance ^2/				1.4	2.3	2.7	2.0	1.3	1.1	1.2	1.2	1.2
	Primary balance ^3/				0.6	3.6	4.8	1.9	0.8	0.7	0.5	0.3	0.1
	Fiscal impulse ^4/				2.1	-1.2	0.9	1.2	0.3	-0.1	0.3	-0.1	0.0
	Fiscal reserves				35.1	38.3	41.4	42.2	42.1	41.9	41.6	41.3	41.0
		(Months of spending)			23.2	24.8	28.1	26.8	26.6	26.3	25.6	25.4	25.2
	Government debt				0.1	0.1	0.1	0.1	0.0	0.0	0.0	0.0	0.0
	Government debt including Bond Fund				4.9	5.1	4.6	4.8	4.8	4.8	4.8	4.8	4.8
	Bond Fund assets				5.4	5.7	5.2	5.2	5.2	5.2	5.2	5.2	5.2
	Net general government debt ^5/				-35.6	-38.8	-42.0	-42.6	-42.6	-42.3	-42.1	-41.8	-41.5

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.

^{^5/}Negative sign indicates net assets.

Table 3.

Hong Kong SAR: Consolidated Government Account, 2015–2023 ^1/

(In percent of GDP, unless stated otherwise)

								Proj.
					2015	2016	2017	2018	2019	2020	2021	2022	2023
Consolidated revenue					18.8	23.0	23.3	22.2	21.0	20.9	21.2	21.2	21.2
	Operating revenue				15.9	16.5	16.6	17.0	16.5	16.5	16.7	16.7	16.7
	Capital revenue				2.9	6.5	6.7	5.2	4.5	4.4	4.5	4.5	4.5
	Taxes				14.4	14.0	14.3	13.7	12.9	12.9	13.0	13.0	13.0
			Of which:
				Salaries tax	2.4	2.4	2.3	…	…	…	…	…	…
				Profits tax	5.8	5.6	5.2	…	…	…	…	…	…
				Stamp duties	2.6	2.5	3.6	…	…	…	…	…	…
	Nontax				4.4	9.0	9.0	8.5	8.1	8.1	8.1	8.1	8.1
			Of which:
			Land premium		2.5	5.1	6.2	4.3	3.7	3.7	3.7	3.7	3.7
			Investment income		0.0	0.8	0.8	1.4	1.2	1.1	1.1	1.3	1.6
Consolidated expenditure					18.2	18.6	17.7	18.9	19.0	19.1	19.5	19.5	19.5
	Operating expenditure				14.5	14.2	13.9	15.0	15.2	15.4	15.5	15.5	15.5
			Of which:
				Personnel related (including pensions)	4.3	4.4	4.4	4.4	4.4	4.4	4.4	4.4	4.5
				Capital expenditure	3.7	4.4	3.8	3.9	3.8	3.7	4.0	4.0	4.0
			Of which:
				Interest expenditure	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0	0.0
Overall balance					0.6	4.5	5.6	3.3	2.0	1.8	1.7	1.7	1.7
Memorandum items:
	Operating balance ^2/				1.4	2.3	2.7	2.0	1.3	1.1	1.2	1.2	1.2
	Primary balance ^3/				0.6	3.6	4.8	1.9	0.8	0.7	0.5	0.3	0.1
	Fiscal impulse ^4/				2.1	-1.2	0.9	1.2	0.3	-0.1	0.3	-0.1	0.0
	Fiscal reserves				35.1	38.3	41.4	42.2	42.1	41.9	41.6	41.3	41.0
		(Months of spending)			23.2	24.8	28.1	26.8	26.6	26.3	25.6	25.4	25.2
	Government debt				0.1	0.1	0.1	0.1	0.0	0.0	0.0	0.0	0.0
	Government debt including Bond Fund				4.9	5.1	4.6	4.8	4.8	4.8	4.8	4.8	4.8
	Bond Fund assets				5.4	5.7	5.2	5.2	5.2	5.2	5.2	5.2	5.2
	Net general government debt ^5/				-35.6	-38.8	-42.0	-42.6	-42.6	-42.3	-42.1	-41.8	-41.5

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.

^{^5/}Negative sign indicates net assets.

Table 4.

Hong Kong SAR: Mon etary Su rvey, 2013–19

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

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

^{^2/}Domestic Credit measures loans for use in Hong Kong SAR.

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About

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Abstract

Context: Strong Rebound AMID Growing Risks

Developments: The Economy Operating at Full Employment

Authorities’ Views

Many Risks Surround the Baseline

A. Rising Trade Tensions

B. Sharper-Than-Expected Tightening of Global Financial Conditions

C. Sharp Slowdown in the Property Market

D. Slowdown in Mainland China

E. Amplification of Risks Scenario

Authorities’ Views

Significant Buffers in Place

Policy Challenges

A. Ensuring Continued Financial Stability

Authorities’ Views

B. Containing the Housing Market Boom

Authorities’ Views

C. Preserving the Exchange Rate Arrangement

Authorities’ Views

D. Ensuring Fiscal Sustainability

Authorities’ Views

E. Bolstering Long-Term Growth Prospects

Labor Market

Inequality

Competitiveness

Authorities’ Views

Staff Appraisal