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Hong Kong F10/11 Budget - Addressing Property Supply While Offering More Concessions Hong Kong Continued Recovery in 4Q09; Forecasts Upgraded View GEF Archive

		The Global Economics Team

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Financial Secretary, Mr. John Tsang, presented the F2010/11 Budget speech on February 24, 2010, his third since he assumed the post in July 2007. The latest Budget provided answers to the public in the form of: i) extending fiscal concessions to further secure the ongoing economic recovery, and ii) committing to increasing the supply of residential property in response to public concerns over deteriorating affordability. Meanwhile, Tsang also outlined plans to further enhance the development of Hong Kong's key competitive areas in the years ahead, consolidating cooperation with the mainland and Taiwan, and infrastructure investment. For F2010/11, the government expects to run a deficit budget of HK$25.2 billion, or 1.6% of GDP. Stripping out investment income on reserves, there will be a fiscal injection into the economy of 2.3% of GDP.

Better-than-Expected F2009/10 Outturn

The government's updated estimates point to a better-than-expected fiscal outturn in F2009/10 (year ending March 2010). There is a respectable surplus of HK$13.8 billion, or 0.8% of GDP, against an original budget of a HK$39.9 billion deficit, plus a HK$16.8 billion package announced in May 2009. This is a significant upside surprise, attributable mainly to better-than-expected land premium (HK$37.3 billion versus HK$16.5 billion budgeted), stamp duty (HK$40.5 billion versus HK$25 billion), salaries tax (HK$39 billion versus HK$35.2 billion) and profits tax (HK$75.5 billion versus HK$71 billion) revenues. Meanwhile, the government booked HK$29.1 billion as return on fiscal reserves invested with the Exchange Fund (EF), also higher than the budgeted HK$27.5 billion. As a result, Hong Kong enjoyed a surplus in its operating fiscal account for the fifth straight year of an estimated HK$19 billion (versus HK$9.8 billion budgeted deficit originally), up from HK$4.3 billion in F2008/09. The operating deficit before investment income amounted to HK$10.1 billion (HK$33.3 billion deficit in F2008/09), much smaller than the budgeted HK$37.3 billion.

Another Deficit Budget for F10/11 - More ‘Stimulative' than Expected

Although the Hong Kong economy has shown convincing signs of recovery and reclaimed positive year-on-year growth in 4Q09 (real GDP +2.6%), and we saw much reduced necessity for further fiscal support, the government responded to public demand for extended ‘sweeteners', especially in light of the favorable outturn in F2009/10. The government projects a 4.3% decline in revenues in F2010/11, versus an 8.9% increase in expenditure. In all, the government expects to run a deficit budget of HK$25.2 billion in F2010/11, or 1.6% of GDP. Stripping out investment income on reserves, there will again be a fiscal injection into the economy of 2.3% of GDP. Note that this is larger than the budgeted 1.5% of GDP injection at last year's ‘recession' Budget, and the actual withdrawal of 2.4% of GDP in the revised estimates. The supportive fiscal stance, nevertheless, is projected to normalize from F2011/12 onwards.

What Are the F2010/11 Giveaways?

The giveaways in the coming fiscal year turned out to be more generous than expected, given the improved economic conditions. The concessions amount to HK$19.6 billion (1.2% of GDP), even larger than last February's HK$8.4 billion (0.5% of GDP) (although smaller than the combined HK$25.2 billion when the May 2009 additional relief package is included).

A 75% rebate (versus 50% expected) was granted on personal income taxes (salaries tax and personal assessment), with a cap of HK$6,000 (costs HK$4.5 billion), compared to the 100% rebate last year, with a cap of HK$8,000 (May 2009). The concession on property rates, which has been a key giveaway since 2007, was surprisingly extended for all four quarters, versus an expected two quarters, in the coming fiscal year, although with a cap of HK$1,500 per quarter, same as last year (costs HK$8.6 billion). The bonus social security (CSSA, elderly, disability) allowances were again offered for one month (costs HK$1.8 billion). And yet again, the government offered to waive public housing rents for two months, versus the expected one quarter (costs HK$1.8 billion). Moreover, tied with efforts on the education front, a HK$1,300/year subsidy will be offered to students from underprivileged families for internet service subscription, and the government will also allocate spending to subsidize the provision of internet services and computer hardware through the private sector (total HK$500 million earmarked).

Focus on Longer-Term Development

As labor market conditions have already shown signs of improvement, with the unemployment rate dipping to 4.9% of late (from the peak of 5.4% in mid-2009), the latest Budget did not dedicate specific efforts to job creation. Nevertheless, Tsang did outline plans to further enhance the development of Hong Kong's key competitive areas in the years ahead, consolidating cooperation with the mainland and Taiwan, infrastructure investment, continuing as well as introducing new initiatives in the four traditional pillar industries (financial services, logistics, tourism, and business/professional services) and six industries with competitive advantage (medical services, education services, environmental industries, testing and certification, innovation and technology, cultural and creative industries). Specifically on the finance front, the government is making explicit efforts to promote asset management business (especially ETFs).

Addressing Property Supply - Answering the Middle Class...

As the economic recovery since 2Q09 has been powered by capital inflows and gains in asset markets, the benefits had fallen disproportionately on asset owners, further widening Hong Kong's rich-poor gap. Fiscal support measures had focused on the lowest income groups in the past. Meanwhile, the middle class, although able to support themselves with reasonable incomes, had been suffering from deteriorating affordability of private housing. Although not with high hopes, the community did seek answers from the Budget in terms of relief measures for the middle class and clearer policy direction with regard to the residential property market.

Given the liquidity- and asset market-driven nature of the Hong Kong economy, we had highlighted that policy changes in the property space would be a key risk factor in 2010.  Specifically, while we recognized measures already introduced on the demand side, we were wary of possible changes in policy with regard to the supply side (see A Fragile Recovery in 3Q09, November 15, 2009). Due to the sensitivity of the issue, especially amid increasing concerns over policy exits by major central banks around the world of late, we did not expect substantial and radical measures to be unveiled at the latest Budget. Nevertheless, to our surprise, the speech boldly addressed the property market issue head-on and provided more specific details than we had expected.

The Financial Secretary explicitly admitted the need to increase the supply of residential units. Specifically, while maintaining the Application List system as the principal mechanism for land sales, the government committed to put up several sites in the list for sale by auction/tender in the next two years if they have not been triggered. The government will also "explore means to revitalise the Home Ownership Scheme secondary market", so as to improve the availability of medium- and low-priced properties.

The government is also stepping up measures to contain excessive speculative activity from the demand side. As rumored, the rate of stamp duty on transactions of luxury properties (>HK$20 million) is hiked from 3.75% to 4.25%. The government is also stepping up surveillance on speculative activity through tax measures, as well as enhancing transparency and disclosure by property developers on residential projects. Mortgage lending also remains under close monitoring by the HKMA. 

As the above announcements related to the property market were more explicit and direct than expected, we believe that this will help cool speculative sentiment in the property market, and we would not be surprised if there is a mildly negative reaction in the residential property market in the short term, although we doubt this would result in a market ‘crash', or derail the longer-term asset appreciation trend.

...but Saying No to Large-Scale Redistribution of Wealth

Needless to say, income and wealth inequality cannot be rectified by one-off fiscal concessions alone, but rather require more comprehensive policy planning over the medium term. Also, to our surprise, the Budget speech made explicit reference to this area, in response to public demand. Another surprise to us was a frank and candid "No" to large-scale redistribution of wealth through fiscal measures. The Financial Secretary attributed Hong Kong's poverty problem (or wealth inequality) to the economy being "small and open" and "subject to external constraints", exacerbated by pressures from cross-border integration with the mainland, and that the long-term strategy for poverty alleviation is to promote overall economic growth rather than turning Hong Kong into a welfare state. In our view, it is considerably bold for the government to be so upfront about such a delicate social issue, although we undoubtedly commend the government's determination in adhering to ‘Big Market, Small Government' principles.

Overall a Budget That Provided Answers

In all, we see the latest Budget as one that provided answers to most contemporary economic issues and public demands, and one that communicated the government's policy stance clearly. While this does not mean satisfying all interest groups (which, theoretically, is not possible), it does demonstrate the government's efforts to strike a balance between immediate support and long-term development, as well as clearly defining its role in the economy.

Hong Kong
Continued Recovery in 4Q09; Forecasts Upgraded
February 26, 2010

By Denise Yam & Katheirne Tai | Hong Kong

4Q09 GDP Beat Expectations

The Hong Kong economy continued on its recovery path in 4Q09.  As expected, the economy reclaimed positive YoY growth in real terms, at 2.6%, after contracting for four straight quarters, but the pace beat our (+1.4%) as well as market (+1.5%) expectations by a wide margin.  On a QoQ seasonally adjusted basis, the economy grew 2.3% (+9.5% annualized), also much stronger than we expected (+1.7%).  For full-year 2009, the economy shrank by 2.7% in real terms, milder than our forecast of 3.1%, although part of the upside could be attributed to backward revisions in the 2008 (downward) and 1Q-3Q09 (upward) data.

Upside Surprise across Most Expenditure Components

The key expenditure components all posted stronger growth than expected.  Private consumption jumped 4.9%Y (+2.1%Q SA) in 4Q, up from 0.5% in 3Q, while private investment surged 15%Y (+0.6% in 3Q).  These helped drive domestic demand up 10.9%Y (+5.8% in 3Q) (contributing 9.3pp to overall GDP growth), offsetting the further narrowing in the external surplus (contributing -6.7pp).

Although the net exports position continued to contribute negatively to growth, similar to the situation in 3Q09, it is worth noting that both exports and imports of services recovered more strongly than expected.  Service exports grew 6%Y in nominal terms (-7.5% in 3Q), while imports jumped 8% (-6.3% in 3Q), reviving Hong Kong's role as the region's service center as the macro environment improves.

Lifting Our Growth Forecast for 2010...

Taking stock of the rebound already realized in 2009, we lift our 2010 GDP growth forecast to 4.5% from 3.8%.  The upward revision stems from upgrades in most expenditure components, including private consumption (+4.4% versus +3.6% previously), private investment (+8% versus +6%) and public investment (+4% versus +2%), as well as trade activity (goods exports +9.9% versus +7.8% previously, goods imports +10.5% versus +8%, service exports +8% versus +6%, service imports +10% versus +8%).

...but Remaining More Conservative than Consensus

While we are structurally positive on the Hong Kong economy, we are only cautiously optimistic in 2010.  Our revised forecasts remain more conservative than consensus, as we recognize the risks and uncertainties around the asset market-driven recovery so far.  We refrain from extrapolating a similar bounce in domestic demand similar to that in 2009, which was driven primarily by the surge in asset prices. Instead, we factor in downside risk from monetary conditions becoming less loose than last year upon gradual policy exits by global central banks.  In other words, while the rebound in 2009 was driven primarily by asset-market-buoyed domestic demand, the recovery in the external sector should be the main driver in 2010.

Meanwhile, this revision also factors in our team's growth forecast upgrade for China earlier this month (see Upgrade 2010 Forecasts on Improved External Outlook, February 4, 2010).  While Hong Kong stands to benefit from stronger Chinese growth through the external sector, we now see the possibility of earlier monetary tightening in China.  We are expecting multiple RRR hikes, and have brought forward the first rate hike from 2H10 to 2Q10.  In other words, the negative implication (on Hong Kong asset prices) from earlier monetary tightening in China could offset the boost from stronger trade growth.  In addition, with a clearer indication that the Hong Kong government is committed to curbing a further sharp ascent in residential property prices (from the latest Budget speech), we find comfort with growth forecasts that are consistent with much more subdued gains in asset markets this year, hence our relative conservative growth outlook even post-revision.

Revised Inflation Outlook, Factoring in Latest Fiscal Concessions

On the inflation front, we have been highlighting upside risks to our forecast for 2010 amid the notable turnaround in the property market as well as consumer demand.  Continued recovery in the economy and the catch-up in residential rents will likely lift underlying inflation noticeably this year.  Nevertheless, the fiscal concessions announced at the latest budget have lessened the further upward bias in headline inflation from the expiry of the ongoing concessions (because they have been extended to F10/11).  Balancing the counteracting effects, we are lifting our 2010 CPI inflation forecast to 2.8% from 2% previously.

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