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Upside Risk to Inflation and Downside Risk to Growth

The Hong Kong economy slowed in the second quarter as export growth decelerated, but despite the increasing level of uncertainty in the global environment, concern about an imminent recession in Hong Kong might be overblown as domestic demand remains strong.

In fact, slowing growth might be a blessing in disguise as it would help ease escalating inflation pressures.

Inflation has been surging on the back of higher food prices and housing rentals. Easing demand would at least help alleviate domestically-generated price pressures, though imported inflation would keep consumer prices at relatively high levels. Overall inflation is expected to average 5.3% for the year as a whole, the highest since 1997.

With the local dollar pegged to the US dollar, Hong Kong has little monetary independence and therefore cannot tighten monetary policy especially when the US is pondering further stimulus to boost its growth. The Hong Kong government is expected to announce more one-off inflation relief measures at the October policy address to help the general populace cope with inflation.

GDP Contracted QoQ in Q2 as Export Growth Decelerated

The Hong Kong economy contracted by 0.5% in the second quarter on a quarter-on-quarter, seasonally-adjusted basis, raising fear that the local economy is headed back into recession. While this was the first quarterly decline in GDP since the recession years of 2008-09, it should be viewed against the exceptionally strong growth of 3.1% in the first quarter.

On a year-on-year comparison, GDP expanded 5.1% in the second quarter. Although the pace was much slower than the 7.5% rate recorded in the first quarter, it represented sixth consecutive quarter of above trend year-on-year growth.

The main reason for second quarter’s slower growth was a sharp deceleration in the exports of goods. Affected by weaker demand in the US and Europe, as well as Japan’s major earthquake in mid-March, which had a significant impact on the global supply chains, Hong Kong’s total exports only rose 0.5% in real terms, after increasing 25.7% in the first quarter. Exports to the US declined by 12.4% in the second quarter, and those to mainland China and Japan by 2.3% and 5.7% respectively, all in real terms. As these three markets accounted for close to 70% of Hong Kong’s total exports of goods in the first half of the year, their decline inevitably weighed on the overall performance of the export sector.

The outlook for external demand is likely to remain uncertain. The US economy is in danger of slipping back into recession as consumer sentiment is still affected by high levels of unemployment and falling house prices. The situation in Europe is no better due to lingering debt problems in the region. Fiscal policies might offer little help as governments on both sides of the Atlantic are trying to reduce budget deficits and debts in a bid to restore some kind of fiscal discipline. Similarly, monetary policies are already extremely loose after the US Federal Reserve, the European Central Bank and other central banks of the advanced countries have been maintaining near zero interest rates, or resorting to quantitative easing measures, with limited effects on consumer spending and investment.

Domestic Demand to Remain the Growth Driver

Despite a sharp slowdown in exports, overall GDP growth in Hong Kong was supported by resilient domestic demand. Private consumption expenditure (PCE) grew 9.2% in the second quarter, faster than the 8.0% in the first quarter. Overall investment, or gross domestic fixed capital formation (GDFCF), also rebounded, to a growth of 8.1% from a contraction of 0.3% during the same periods. As a result, the contributions from these two components to overall GDP growth rose from 4.8 percentage points in the first quarter to 7.6 percentage points in the second quarter.

Going forward, consumer spending is likely to continue growing at a solid pace in the second half of this year, supported by rising incomes. With Hong Kong’s unemployment rate staying at relatively low levels of around 3.5%, workers are enjoying the fastest nominal earnings growth in many years. Investment spending is also expected to remain strong on continued expansion in public building and construction works as well as faster growth in private machinery and equipment investment.

Against such a background, it seems that concern about an imminent recession in Hong Kong is overblown. While we expect overall GDP growth to decelerate to a sub-5% pace in the second half of the year, full-year growth is forecast to be 5.2%. If achieved, the pace would still exceed the average rate of about 4.5% over the past decade. Moreover, slowing growth at the current juncture might be a blessing in disguise as it would help ease escalating inflation pressures.

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Hong Kong Economic Monitor (Sep/Oct 2011). Hang Seng Bank Limited. All rights reserved. Reproduction of article(s) in whole or in part is permitted provided the source is quoted. Please direct any inquiry to Economic Research Department, G.P.O. Box 2985, Hong Kong.

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