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IMF Releases Conclusions Of Article IV Consultation With Hong Kong

by Mary Swire, for, Hong Kong

10 January 2007

The Executive Board of the International Monetary Fund (IMF) on Monday published details of its Article IV consultation discussions with the Hong Kong Special Administrative Region, which was concluded in mid-December.

The Board suggested that Hong Kong has recovered strongly from a series of shocks in recent years and, as expected, the pace of growth is now moderating.

Growth was 6.8% (year-on-year) in the first three quarters of 2006, somewhat slower than the 7.3% recorded in 2005. The continued brisk pace of growth, and its pick-up in the third quarter relative to the second quarter, was due to stronger Mainland-related exports of goods and financial services, and continued strong domestic demand.

Job creation has continued to improve across all sectors and skill levels, bringing the unemployment rate to its lowest level in more than five years, and inflation is modest.

It observed that:

"On the policy front, this fiscal year's budget continues to take advantage of the strong economy to strengthen the fiscal position. Last fiscal year, revenue growth and expenditure restraint helped achieve the first budget surplus (of around 1% of GDP) since the Asian crisis. On current economic and spending trends, this year's target surplus of 0.5% of GDP is likely to be modestly over performed. In addition, the refinements made by the authorities to the Linked Exchange Rate System in May 2005 have dampened renminbi-related speculative pressures by effectively limiting currency movements against the US dollar to a narrow band."

"Looking ahead, staff expects growth to moderate to around 5.5% in 2007. Inflation is expected to firm modestly with the tightening labor market and as rents adjust to previous increases in property prices. Although the external position should remain strong, the current account surplus is expected to narrow with maturing external demand. The main near-term risks to this outlook are a sharper slowdown in global demand (particularly in the United States) and a rise in protectionist sentiments against China."

"Over the medium term, much will depend on how well the evolving financial integration with the Mainland is managed and leveraged, and competitive pressures from other regional financial centers withstood. Although fundraising by Chinese entities reached new heights in 2006, the extent of financial integration with the Mainland is still small relative to its potential. Increasing Hong Kong SAR's role in the direct intermediation of the Mainland's domestic savings will be key for the continued success of its financial center. Consequently, continued cooperation and coordination with the Mainland's financial authorities, which have advanced well, remain crucial."

The Executive Directors welcomed the Hong Kong economy's sustained expansion, now in its fourteenth consecutive quarter, which they attributed to the authorities' skillful macroeconomic management, the flexibility of Hong Kong SAR's markets, and the economy's highly developed financial infrastructure.

Looking ahead, the Directors noted that, while growth is likely to moderate, it will remain strong over the medium term if financial integration with the Mainland is further deepened and managed well.

They commended the authorities for making use of the current strong economy to strengthen the fiscal position and address the longer-term fiscal challenges of revenue volatility and age-related spending pressures. They welcomed the growing public recognition of the need to broaden the tax base, and public discussion of ways to do it.

In this context, several Directors noted that a low-rated and broad-based goods and services tax would be an efficient way to broaden the tax base, if targeted compensation is provided to alleviate the resulting burden on low-income households. Directors also suggested that the authorities consider seeking other ways to stabilize investment income through arrangements with the Exchange Fund."

The IMF officials noted that financial integration with the Mainland would be a key driver of future economic prospects. They encouraged continued coordination between the authorities and their Mainland counterparts on ways to use Hong Kong SAR's advanced financial platform to improve financial intermediation in the Mainland, noting that such coordination would be of benefit to both economies.

In conclusion, the Directors concurred with the authorities that enhancing financial sector supervision is critical to safeguarding the competitiveness of the financial center. In this regard, they welcomed progress on cross-border regulatory supervision, preparations for Basel II adoption, and plans to broaden Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) enforcement.

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