Hong Kong with a population of 7.4 million is now part of China as of July 1, 1997 as a Special Administration Region (SAR) of mainland China under the principle of “one country - two systems” allowing Hong Kong to continue with free market principles and autonomy except in the areas of defense and foreign affairs where China overrides. This concept is alive and working well today. Hong Kong is a very prosperous economy highly dependent on international trade - considered to be one of the world’s freest economies supported by low taxes and minimal regulations. Hong Kong today is also a massive shipping port & transportation centre, tourism destination with a brand new Disney theme park to be opened by 2005, and Hong Kong also plays an important role as a leading international financial & banking haven for Asia .
The Hong Kong economy is also diversifying away from its reliance on property management, international trade for re-export and financial services more towards the development of high-tech & knowledge-based information industries and a capital market haven for many mainland Chinese corporations. The domestic government is committed to the success of this transformation towards the Internet and mainland Chinese companies as many of Hong Kong’s entrepreneurs, wealthy elite and real estate tycoons are targeting new business opportunities and industries for future Hong Kong. The low tax environment within Hong Kong is tailor-made for entrepreneurs as the business climate is very stable with established instititions and the rule of law.
POLITICS: Chief Executive Tung Chee-hwa holds the top political job in Hong Kong, Chief of State is the President of mainland China, Jintao Hu. Tung was re-appointed to a second term in March 2002. However, many view Tung as a puppet of Beijing perhaps accounting for his unpopularity by Hong Kong citizens. An election is scheduled for 2007 as set out in the consititution, at this time the people will then supposedly decide their Chief Executive. Critics have accused Chief Executive Tung of failing to implement greater liberties such as free speech and the rule of law. Political risk is a factor as there is a limited extent of electoral democracy within Hong Kong. On July 1, 2003, upwards of 500,000 citizens in Hong Kong marched in protest against the government participating in a democracy rally as the people do not support attempts by Tung to implement tough new national security laws. Pro-Beijing versus pro-democracy forces were at work again on January 1, 2004 with another pro-democracy rally with an estimated 100,000 protesting their dissatisfaction with the government and economy although it is recovering. The people are expressing their interest to elect their own officials, the proposed security bill that would have diminished their freedoms was dropped. The fallout from this security bill has created a level of skepticism and distrust with their political leadership and with Beijing as many believe that Beijing has too much power, is it really two systems the critics question?
ECONOMY: rebounding strongly particularly in real estate and tourism after the Severe Acute Respiratory Syndrome (SARS) scare during spring 2003. Improving over the last 6 months with GDP growth forecasted as high as 4 percent for the next 2 years including a projected strong IPO (Initial Public Offering) market on the horizon as many mainland Chinese companies seek Hong Kong listings. The latter part of the 1990’s was an era of recession and flat economic growth for Hong Kong after recording strong GDP growth that averaged 5 percent from 1990-97. Deflating asset values, particularly in real estate by upwards of 65 percent since the market peak during the Asian financial currency crisis in 1997-98 which sparked a regional recession at that time due to large capital outflows. Some estimates have 25 percent of Hong Kong homeowners having negative equity. Hong Kong’s currency peg to the US-dollar (‘USD’) has resulted in deflation for the territory unlike many other Asian countries which devalued its currency to counter deflation although lower cost China has aided in these deflation pressures as well as both Hong Kong and China integrate closer economically. The terrorist attacks within the United States have resulted in a drop-off in tourism and global recession during 2001 although 30 percent of the current visitors are from mainland China, a growing and important trend for Hong Kong. Hong Kong re-exports goods manufactured from mainland China to markets abroad including the United States. A large number of foreign companies are using Hong Kong as a base for there regional headquarters in the Asia Pacific region. The potential for a very deep phase two recession in the United States economy later in 2004-05 will impact exports from Hong Kong to this market, the U.S. is Hong Kong’s number two market after mainland China. However, tremendous growth in China in the years to come will be the market that will propel Hong Kong to greater wealth.
Many of Hong Kong’s macroeconomic fundamentals are sound including zero net external debt (May 2003), very high savings & investment rates and the fact that many of the world’s largest export companies are headquartered in Hong Kong. Conversely, area’s of weakness include the territory’s persistent fiscal deficit. Some analysts have suggested that Hong Kong introduce a Goods and Services Tax (GST) to narrow this fiscal shortfall. This is unlikely, the authorities have recently modestly raised some tax rates including income tax. BankINTRO.com projects a strong rebound in GDP growth for Hong Kong will provide for surplus revenues to the treasury due to a continuation of the USD decline and the fact that both Hong Kong & mainland China’s currency regime is pegged to the USD which will help to keep China’s exports competitive for the time being in the international market.
Economic Statistics
GDP as measured by purchasing power parity is at $198.5 billion USD (2002) with corresponding GDP/Capita at $27,200 USD. Real GDP growth for 1998 was negative at -5.1 percent, 2000 was a huge rebound year at 10.2 percent positive growth, 2001 during the global recession was flat at 0.6 percent, 2002 at 2.3 percent, year 2003 at 2.2 percent. BI.C estimates GDP growth at 4 to 5 percent for 2004. CPI is presently deflationary as this has been the case since 1998 where deflation has ranged from 4 percent in 1999 to 1.6 percent deflation in 2001. Year 2003 deflation at 2.3 percent and 2004 is estimated at 1.9 percent. The Hang Seng Index has rebounded smartly over the last 6 months now at the 13,000 level still off its March 2000 peak at the 17,500 point range. Although Hong Kong runs a trade deficit, the strong FDI & capital inflows have yielded a healthy current account surplus that is increasing again after year 1999 was at a robust 10.5 percent of GDP, 2000 at 5.5 percent, 2001 at 7.5 percent, 2002 at 10.7 percent and year 2003 at 11.6 percent. Hong Kong’s trade deficit more than doubled in 2001 from 2000 to $8.2 billion USD, exports for year 2002 at $200 billion USD with China and the United States the largest market. Looking at imports, they were measured at $208 billion USD for 2002 with China, Japan and Taiwan the largest suppliers. The fiscal deficit came in at 4.9 percent of GDP or approximately $70 billion HKD for 2002, year 2000 at 0.8 percent, 1999 at 1.3 percent. Unemployment was at 7.4 percent for 2003. There are currently higher levels of government spending in the economy. The service sector represents 85 percent of the economy.
POSITIVE: member of WTO, economic fundamentals are sound, Disney construction development, very low taxation for corporate & personal, large market potential within mainland China, Hong Kong is beginning to re-brand and market itself globally to attract business, average life expectancy at 80 years, 94 percent literacy rate, large merchant marine at 550 ships approximately. CONCERN: the Hang Seng stock market has a history of wild volatility, the budget deficit maybe structural, domestic credit demand is weak, deflation persists, domestic political risk within Hong Kong - opposition/volatility to Beijing’s policies, too few powerful tycoons control much of the Hong Kong economy, money laundering potential, rising synthetic drug use among the young, few natural resources - oil and much food to be imported.
BANKING SYSTEM: the banking system is sound with more than healthy capital adequacy ratios. The banks are well-run, capitalized and profitable. The Hong Kong Monetary Authority (HKMA), effectively Hong Kong’s central bank is responsible for maintaining monetary, exchange rate and banking system stability. Hong Kong has one of the world’s largest foreign exchange reserve position at an enormous level of $114 billion USD (November 2003) or equivalent to approximately 7 times the amount of money in circulation and/or 20 months of import coverage. This extraordinarly high official reserve asset coverage provides for the backbone of currency safeness for the Hong Kong dollar. Interest rates in Hong Kong follow the US Fed movements. Hong Kong’s banking system will remain an offshore money haven attracting monies particularly from wealthy mainland Chinese as they experience a wealth boom.
REGIONAL: China, Japan, Asia The risk for another regional currency crisis similar to 1997-98 is low to moderate. A continuing depreciating USD in year 2004 will make Hong Kong exports more attractive to markets in Europe and Japan where both the Euroland euro and Japanese yen currencies are appreciating. The city of Shanghai, China in the years to come will develop to be Hong Kong’s main competitor for banking, finance, exports, etc.. However, with a market of 1.3 billion people in mainland China, the immense size of this market will more than benefit both Hong Kong and Shanghai as mainland China today is Hong Kong’s largest trade partner. China today with over $1.3 trillion USD in savings will be the pillar of economic growth in the future for Hong Kong as many local Hong Kong companies are taking advantage by setting up manufacturing plants within mainland China. The opening up of China with WTO will see a change in Hong Kong towards the development of ‘human capital’ in management, knowledge industries and in the areas of banking, conglomerates, telecommunications, utilities, etc. Hong Kong will maintain its financial reputation as a safe haven within Asia. Amongst other regional economies, both South Korea and Taiwan are presently rebounding economically although South Korea is swamped in consumer debt.
CURRENCY: ISO Symbol: ‘HKD’, Hong Kong dollar. The currency exchange regime in use is that of currency board arrangement which was established in 1983 whereby the Hong Kong dollar monetary base is backed 100 percent or more with USD assets (HKD is thus fully convertible) such as US government securities under the supervision of the Hong Kong Monetary Authority (HKMA). At present, the official curency peg is set at 7.80 HKD to 1 USD. At time of review on January 5, 2004, the market currency exchange rate is at 7.7636 HKD to 1 USD. The currency peg forces Hong Kong to basically give up control over their domestic interest rates, allowing Hong Kong’s interest rates to move directly with the US Fed’s rate. Some analysts believe the currency peg to the USD has made Hong Kong less flexible and competitive. Since 1998, reforms have been implemented to strengthen the currency board system to help control any unexpected volatility or exchange pressure to the currency peg. As measured by purchasing power parity, some estimates have the HKD at about 20 percent undervalued to the USD. No currency exchange controls are in place for the HKD. The Hong Kong dollar is issued by one of three banks in Hong Kong under the supervision of the HKMA. Moreover, China’s renminbi (yuan) currency is already informally ciruclating within Hong Kong to facilitate transactions as it is estimated that upwards of 100 billion renminbi are in circulation.
CURRENCY HISTORY: during the 1997-98 Asian currency crisis, the HKD came under pressure as speculators believed the HKD would have to be devalued in order to stay competitive with other Asian producers as other regional currencies depreciated. A series of speculative currency attacks during the 1997 Asian financial crisis and in August 1998 as this is nothing new to the HKD. The currency peg has been tested several times over the last 20 years successfully holding its value while several other regional currencies have been depreciating for years. In 1998 alone, the HKMA alone spent $15 billion USD from its foreign reserves position to defend the peg. Historical exchange valuations for the Hong Kong dollar include January 1990 at 7.8116 HKD to 1 USD, September 1992 at 7.282, January 1995 at 7.442, January 2000 at 7.78, January 2001 at 7.7996, January 2002 at 7.7989, January 2003 at 7.7992, October 2003 at 7.7421, December 2003 at 7.7641.
KNOWLEDGE: Hong Kong’s currency board does not allow for the HKD to weaken away from its peg at 7.80 HKD to 1 USD, that is, the HKD cannot fall below 7.80 ie. 7.85, 7.90, etc. However, there is no restriction on allowing the HKD to strengthen ie. 7.78, 7.76, etc. At times, the HKMA at its authority and discretion may sell HKD in attempt to weaken the HKD if it strengthens. From September 2003 to January 2004, the HKMA sold $33 billion HKD in attempt to weaken the HKD by buying US-dollars. The bottom line is that the HKMA is committed to the exchange peg. Several times over the last two decades, speculators have been defeated and the peg has won as it has maintained its exchange value. During the 1997-98 Asian currency crisis when many Asian countries currencies collapsed in value, the HKD held its value as the currency peg survived although Hong Kong’s economy consequently experienced deflation. Conversely today, many Asian currencies are now undervalued in relation to the USD as they are facing appreciation pressures. As the HKD is pegged to the USD, the spectacular decline in the USD will help Hong Kong to alleviate continued deflation with higher projected GDP growth rates and lower unemployement as the HKD is now more competitive particularly against currencies like the Japanese yen, Euroland euro. Potential currency risks to HKD include domestic political risk and Hong Kong’s persistent and growing fiscal deficit as reserves may get depleted although this short to medium term outlook is favorable with stronger GDP growth rates and higher revenues forcasted for the government. Some analysts believe that this fiscal deficit is more political as the authorities in Beijing are focused on strengthening Hong Kong’s economy as a top priority to maintain the stability. In an absolute worst case scenario, officials have the room and option to implement a consumption tax if required, but unlikely in the short to medium term.
CURRENCY FORECAST: currency devaluation is NOT likely for the Hong Kong dollar in the near term, and the current peg at 7.8 HKD to 1 USD is to stay until at least year 2005. BI.C has a 12-month exchange forecast for the HKD at 7.71 HKD to 1 USD. The HKMA has strongly defended the current currency peg to the USD as it has yielded great stability to Hong Kong, this is projected to continue with its arsenal of huge foreign exchange reserves. A devaluation of the Hong Kong dollar would be a disaster if implemented and is not forecasted, it would erode great loss of confidence, particularly for Hong Kong’s reputation as an international tax haven and global banking centre. More likely scenario is an appreciation for the HKD as it is experiencing strong capital inflows, growing reserves, rebounding economy, low tax environment and no external debt. Some speculators are trying to take advantage of a revaluation of the China’s yuan by looking at investing in the Hong Kong stock and real estate market as a possible way to play a yuan appreciation. There has been a noticeable up trend in capital inflows since September 2003 into Hong Kong. Some analysts have conflicting views on China, some say deflation may pesist while others are concerned about the level of money growth in China as printing presses are rampant with an inflation threat on the horizon coupled with their vulnerable banking system.
In the medium term, a strong potential and realistic scenario is for the Hong Kong dollar to be re-pegged or revalued to a higher valuation (ie. 6.5 HKD to 1 USD) to perhaps to the same exchange as the Chinese renminbi once it is forced to revalue. In the long term by year 2010, with a successful transition and modernization of the mainland Chinese economy with WTO, it is highly likely the renminbi will be a major world currency bloc with a free floating convertible exchange rate perhaps at a revaluation or a free float in the range of 5 CNY to 1 USD. Under this scenario, it is quite possible the USD peg will be replaced by the Chinese renminbi or the HKD itself will be replaced by a new currency union with the renminbi as ease of conversion and integration of economies makes business more efficient. One other possible scenario is a hybrid currency peg including both the USD/CNY for the HKD. However, the overall current situation in Hong Kong is quite favorable even with domestic political risk which is manageable. The Hong Kong dollar warrants a high safety ranking in relation to many other currencies in the world today in a time of global economic uncertainty particularly with Hong Kong’s huge war chest of USD foreign exchange reserves.
UPDATED: January 5, 2004
