The main conclusion drawn by the IMF is that after growing at 7.5% annually over the past three years, the pace of Hong Kong's activity has remained fairly robust.

Domestic demand has resumed as the major driver of activity, supported by growing incomes and rising asset prices. Importantly, job creation has continued to improve across all sectors, bringing the unemployment rate to its lowest level in more than nine years.

Inflation, even after accounting for one-off budgetary measures, is modest, according to the IMF.

It went on to observe that the overall robust economic environment owes a lot to skillful macroeconomic management, the underlying flexibility of Hong Kong's markets, and the continued integration with the Mainland.

Looking ahead, the IMF expects a growth of 5.5-6% this year, slowing to below 5% next year.

This slowdown reflects a weaker external outlook, although domestic demand should remain supportive. Major near-term risks are a more-than-expected deterioration in US and European demand, a sudden reversal in equity market sentiment, and further international financial turbulence if the impact of the subprime turmoil spreads.

It was found that the fiscal stance in Hong Kong appears appropriate given the moderation in growth. This year's budget targets a smaller surplus, reflecting a number of one-off factors, but given economic and financial market developments so far, the outturn is likely to be much stronger.

The Chief Executive's Policy Address proposed a number of new initiatives, including a refocusing on infrastructure spending, which is important to enhance competitiveness and support medium term growth. Looking ahead, the IMF predicted that next year's budget may need to respond if growth slows significantly more than expected.

Lastly, the IMF found that over the medium term, Hong Kong SAR continues to face the twin challenges of high revenue volatility and rising aging-related spending pressures.

In this regard, the mission welcomed the new arrangement to smooth income earned on fiscal reserves, and the use of a reserves target to anchor medium-term fiscal policy.

However, it observed that:

"Nonetheless, broadening the tax base remains important to further limit revenue volatility. Last year's public consultation helped to focus attention on this issue and the government could explore alternatives—such as broadening the base of the salaries tax—in the coming years."

Concluding its report, the IMF commented that measures (including tax-related) should be considered to encourage a move to broad-based medical insurance and savings plan for old-age coverage. Given such considerations, the Fund suggested that it might be appropriate to reconsider the scope and timing of the proposed cuts in salaries and profits tax in the context of the new health-care financing mechanisms.