ECONOMIC VIEW:

The 2004-05 Budget for Hong Kong

(10 March 2004)

By Mike Ng

The Financial Secretary, Mr. Henry Tang, will deliver the 2004-05 Budget speech at the Legislative Council today at 2:30 pm. Will there be any surprising good news to the general citizens of Hong Kong? I do not think so.

Since 1997, the Hong Kong economy has experienced several events such as the Asian Financial Crisis 1997-98, the dot.com crash of 2000, the slow-down of the United States economy, the event of September 11 in 2001 and the SARS event in 2003, which are serious enough to cause the economy into trouble. The economy was in recession twice; unemployment is at historically high level; deflation; serious government deficits; and 50-70% devaluation of property prices, etc. In fact, the economy has never experienced such bad time before. Perhaps this is why the government is not quite sure what to do sometimes.

When Mr. Tang became the new Financial Secretary last year, he was right to set a new target to balance the budget in the financial year 2008-09 rather than the original year 2006-07. Balancing the budget too quickly at this stage is self-defeating. Indeed, the current budget deficit problem of Hong Kong is mainly cyclical rather than structural. (When the economy grew at 10.2% in 2000 - the highest level within the period of 1997-2002, the deficit figure in 2000 was also the lowest within this period.) Therefore, the deficit problem will automatically be solved or disappear once the economy fully recovers. However, the following three conditions must be met before we are safe to say that the Hong Kong economy fully recovers.

(1). GDP Growth at 3.5% or above

(2). Full Employment, i.e. unemployment at 3-4%

(3). Stable Prices, i.e. inflation at 2-3% or above

Has Hong Kong met all these conditions? Certainly, not! When will this happen? I forecast that this will happen at the end of 2007 or in the first half of 2008 assuming no government interventions or other shocks. No doubt the labour market will be the slowest to adjust. Now, let us look at two main macroeconomic policies.

Monetary Policy: Due to the linked exchange-rate policy, Hong Kong has followed the US to cut interest rates to a historically low level since 2001. Low interest rates are beneficial to the economy as they stimulate consumption and investment. Many economists have expected that the Federal Reserve will start to raise interest rates in the second half of this year. This means that Hong Kong will follow the rate rises. However, Hong Kong and the US are in two different economic conditions. Raising interest rates will have a negative impact on economic growth, particularly that the Hong Kong economy has not fully recovered.

Fiscal Policy: No doubt the tax base of Hong Kong is narrow at international standards. Imposing new taxes (e.g. sales taxes) can give the government extra income to run the budget. But tax rises will have a negative impact on economic growth and employment unless the government uses the collected taxes to stimulate the economy. If the government really wants to impose new taxes, I would not suggest them to do so before 2009. On the other hand, the government has not done enough to help the economy back on track, i.e. not enough spending in job creations. As a matter of fact, the more people are employed, the higher consumption, investment and government revenue will be. (Leaving the problems for too long will cause more problems.)

In conclusion, the current budget deficit problem will automatically be solved or disappear once the economy fully recovers. Because of expected higher interest rates in the months ahead, the government should not raise or impose any (new) taxes until the economy fully recovers. Conversely, increasing government spending to create jobs should be the top priority in the years ahead.