city is in budget deficit, predicted to reach 6% of GDP for the current financial year, with many fearful this is symptomatic of a relative decline
Hong Kong is a master of re-invention but, with its government increasingly perceived as inefficient, it is slowly losing ground to China.
Dr Enzio von Pfeil, chief executive of Commercial Economics Asia and an independent analyst for Insight Investments, said the implications of China's growth for Hong Kong will see the city's role diminished, becoming the gateway from China, rather than to China.
Angus Tulloch, Far East manager at First State Investments, said the key to Hong Kong has always been its ability to reinvent itself. In the past, it has gone from being a manufacturing centre to a financial one, to the window of China to the world, to a regional centre.
However, at the moment, with a fiscal deficit for the first time and the strong growth seen in China, criticism of Hong Kong's government is casting a shadow over whether it will be able to re-invent itself this time.
The government is viewed as inefficient, weak, backward looking and reactionary, Tulloch noted. He said he would not be surprised to see the government implement tax increases on both personal and corporates to minimise its deficit problem but he did not expect it to implement a sales tax.
Flavia Cheong, China fund manager at Aberdeen Asset Management, said while Hong Kong is suffering from bad macro conditions, its companies remain in good shape, with the area's role as China's middleman intact.
Hong Kong is lagging the current economic cycle, with structural problems stunting recovery and falling property prices underscoring deflation, she said.
Roger Ellis of Jardine Fleming Asset Management believes Hong Kong has so far been disappointing but he still believes in the region's ability to bounce back, adding that it is a mistake to underestimate the ability of the Hong Kong business community to adapt to change in the region.
Jake Van der Kemp, a journalist with the South China Morning Post is more bullish on the region. He said the historically high unemployment in Hong Kong is deceiving as the area allows in 55,000 people each year, meaning it is a job creation issue.
He also minimised the issue of the deficit, pointing out that the government has some HK$700bn in reserves, so the problem is not an urgent one.
The peg to the US dollar is also not one of great concern, Van der Kemp said.
Problems experienced by the region, along with the rest of the global economy, have not impacted much on wages and productivity remains high leading Van der Kemp to conclude the peg has served the region well.
One of the real concerns in Hong Kong has been the falling property prices, down 70% from their peak. Prices, he said, are now rebounding after the government moved to eliminate its subsidised housing project early this autumn.
Sir Gordon Wu, chairman of Hopewell Holdings, said property prices are now at their lowest in years, falling from their peak in 1997 before the handover, when it cost in the neighbourhood of $2,000 a square foot. The boom in property in the region over the past 40 years was dictated by four main factors that were all working together effectively, supply/demand, high per capita incomes, the availability of credit and location.
Hong Kong utilises less than 17% of its land mass in an area, where the population is increasing by 10 million every decade. Before 1997 there was also a clause that limited new land developments to 50 hectares a year, thereby artificially pushing up the supply/demand curve, he said.
He added: 'All four factors were at work back then. Today, earnings are not as high and, although we still have location and credit availability, prices of property have come down.'
Tulloch, at First State, noted the rebound in property prices is likely to be limited to just a 10% bounce, adding he does not believe even that is sustainable.
Tony Latter, deputy director of the Hong Kong Monetary Authority, said, there has been much talk recently in the region about the possible threat to exchange rate stability from the burgeoning budget deficit, which is predicted by many to reach about 6% of GDP for the current financial year as a whole.
'Evidence of this concern is apparent when any media report suggesting a deterioration in the fiscal position is invariably accompanied by a weakening, even if shortlived, in the forward exchange rate of the Hong Kong dollar,' he said.
However, the situation in Hong Kong is different to most government deficit problems, Latter said, as the area has no specific central bank law and has no mainstream government debt. Instead, it operates a currency board rather than a discretionary monetary policy and it has only recently become familiar with the idea of a budget deficit persisting for longer than a year or two.
In order to fund its deficit, the government has a choice tapping into its fiscal reserves and borrowing, from banks or the markets.
Latter said: 'It has chosen for the time being the former route. The monetary impact would in either case be neutral. The mechanics of financing the deficit should not therefore raise any concerns in Hong Kong in the context of monetary stability.'
The infrastructure of monetary discipline is firmly in place, and peer pressure ensures it remains that way, he noted.
Latter believes the negative reaction to Hong Kong's budget deficit is down to a number of reasons, some as basic as people are not accustomed to the region being in debt.
It is also regarded as imprudent and there is the fear that the deficit may be a symptom of more fundamental problems.
However, Wu believes Hong Kong's deficit is not a problem, arguing that the government needs to tighten its belt much in the same way companies have been forced to do in the aftermath of the bubble.
Wu, an engineer by trade, said Hong is in danger of falling behind China as an attractive investment area. The Hong Kong government has one of the highest expenditure plans in the region's history, Wu said.
He pointed to the high wages civil servants, university professors and state musicians get as an example of some of what he sees as wastage by the government. 'Until structural changes take place, there is no way Hong Kong can get out of this easily,' he noted.
The government forecasts by 2007/08 it will be able to balance the budget, Wu said, but he added he did not share that view unless immediate changes were made.
Unlike many others who have shrugged off the fiscal debt as insignificant when Hong Kong's reserves are taken into account, Wu believes the government will easily spend through the reserves in a few years if it keeps operating as it does today. China is becoming more capitalistic than Hong Kong, Wu noted, adding that if Hong Kong fails it will be the only one to blame as interference from Beijing has been minimal.
Compare this with China, he said, where rapid reforms in government and upgrades in infrastructure are boosting its economy and attracting companies to set up their base there. Hong Kong used to the leader in the production of certain products, such as watches, toys and blue jeans, now that has moved across the border, Wu said.
The region, however, can still count on areas of its economy, which are reliant to a degree on mainland China, to pull it out of this difficult period, Wu claimed.
Retail trade provides an underpin to Hong Kong and if it keeps pace with what Chinese demand it will continue to do well, he said.
Tourism is another area forecast to prosper, benefiting from the increase in Chinese earnings and the population's increased travel. More Chinese visiting Hong Kong can also help with the unemployment situation, which now sits above 7%, said Wu.
Financial services has and continues to be a growth area and until China undergoes further reforms, it is likely to dominate the region for some time yet.
The legal system in Hong Kong supports this service and China is in some ways behind being able to offer a comparable service, Wu noted.
The long-term key to Hong Kong has been its deep harbour and logistics business, which should continue to provide for the region, but the government will need to take steps to ensure it continues to grow, Wu said.
With the harbour and the newly built airport, Hong Kong continues to thrive on its cargo businesses. Air cargo has become a vital business with the airport, one of the region's largest, with numerous connections, now shipping some 2.5 tonnes of cargo a year.
However, to continue this, Hong Kong needs to observe China and cater to its needs.
The region also needs to improve its connections with the mainland, restructure its harbour system and build up the area around the airport to better facilitate fast shipping. Wu said: 'Our position as a logistic centre is unbeatable but we need to kick the bureaucrats into doing something.
'Hong Kong is the number one cargo harbour in the world ' handling 18 million tonnes each year. The consultants say we do not need new terminals for another 10 years but I do not agree.
'We have left the terminal operators to charge whatever they want, so now they are the highest charges in the world and as a result goods will eventually stop coming here. It is a bit of the hare and the turtle, between Hong Kong and China, we are now sleeping and the turtle has turned into a hare. We need to increase our port capability, have better connectivity and lower prices.'
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