COUNTRY REPORT

Hong Kong Macau Hong Kong at a glance: 2002-03

OVERVIEW The Hong Kong chief executive, Tung Chee-hwa, will probably be reappointed in March 2002. The September 11th terrorist attacks on the US will add to Hong Kong’s economic woes, but a gradual recovery is in prospect in 2002 and thereafter in line with a pick-up in US economic growth. Real GDP will shrink by 0.5% in 2001, recovering to grow by 2.8% in 2002 and by 6.3% in 2003 as Hong Kong benefits from its strategic location on the doorstep of China, which will open its economy by implementing World Trade Organisation (WTO) accession obligations. The current-account surplus will fall slightly in 2002 as the trade deficit widens. The current-account surplus will narrow further in 2003 as the economy recovers and import growth accelerates. Key changes from last month Political outlook • China has proposed actions to support Hong Kong‘s contracting economy in an attempt to shore up public support for the unpopular government of Mr Tung. Economic policy outlook • The chief executive‘s 2001 policy address will have a minor impact on the economy, but a widening budget deficit will increase calls for an investigation into whether or not the deficit is becoming cyclical. Economic forecast • Real GDP is estimated to have shrunk by 0.5% in 2001, revised down from the previous estimate of a 0.2% contraction, as the external sector will weaken further in the fourth quarter.

December 2001

The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The EIU delivers its information in four ways: through our digital portfolio, where our latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group.

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ISSN 0269-6762

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Contents

3 Summary

Hong Kong

5 Political structure 6 Economic structure 6 Annual indicators 7 Quarterly indicators 8 Outlook for 2002-03 8 Political outlook 9 Economic policy outlook 10 Economic forecast 14 The political scene 17 Economic policy 18 The domestic economy 18 Output and demand 20 Employment, wages and prices 21 Financial indicators 23 Sectoral trends 24 Foreign trade and payments

Macau

26 Political structure 27 Economic structure 27 Annual indicators 28 Quarterly indicators 29 Outlook for 2002-03 29 Political outlook 30 Economic forecast 31 The political scene 32 Economic policy and the economy

List of tables

10 Hong Kong: forecast summary 11 Hong Kong: international assumptions summary 12 Hong Kong: gross domestic product by expenditure 19 Hong Kong: gross domestic product 20 Hong Kong: employment by sector

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23 Hong Kong: customer deposits by currency and foreign-exchange reserves 25 Hong Kong: balance of payments

List of figures

14 Hong Kong: gross domestic product 14 Hong Kong: Hong Kong dollar real exchange rates 20 Hong Kong: retail sales 22 Hong Kong: money supply 30 Macau: gross domestic product 30 Macau: pataca real exchange rates 35 Macau: number of visitor arrivals

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Summary

December 2001

Hong Kong

Outlook for 2002-03 In the short term Hong Kong’s political scene will be dominated by concerns over the worsening economy, rising unemployment and the perceived failure of the government to respond decisively to these problems. The chief executive, Tung Chee-hwa, is likely to be reappointed for a second five-year term in March 2002. China is taking measures to support Hong Kong’s economy and thereby shore up support for Mr Tung’s government. Real GDP will contract in 2001 as the effects of the international economic slowdown affect Hong Kong’s highly open economy. Recovery will begin in 2002 and continue into 2003 in line with faster world economic growth. The current- account surplus will come under pressure but will remain in surplus during the forecast period.

The political scene Business security in Hong Kong has been ramped up following the terrorist attacks on the US. The Hong Kong government was criticised for its lack of sympathy towards the US. The chief executive’s 2001 policy address won little support from business or the public. A cross-party anti-Tung coalition has not put forward an alternative candidate for the post of chief executive.

Economic policy The chief executive has announced HK$15bn (US$1.9bn) of measures to support the economy. Trade unionists and smaller businesses have expressed their disappointment at these measures. The budget deficit for fiscal year 2001/02 (April-March) has widened.

The domestic economy Real GDP contracted in the third quarter of 2001 in year-on-year terms. Unemployment has increased, with prospects for new graduates poor. The government has rejected a Liberal Party call for a civil service pay cut. Income inequality has worsened. The stockmarket was volatile after September 11th. Property prices have dropped further.

Foreign trade and Merchandise imports and exports have fallen in value terms. The border with payments China will open for longer hours. The Airport Authority is planning to develop the logistics network.

Macau

Outlook for 2002-03 A pro-democracy group won the largest number of votes in the recent election for the Legislative Assembly, Macau’s legislature. The Legislative Assembly will not, however, constitute a major challenge to the appointed government of the chief executive, Edmund Ho. Managing an orderly liberalisation of the gambling sector by clamping down on potential organised crime will be a challenge for the government in 2002. The economy will contract or barely

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grow in 2001, reflecting poor export performance, but recovery will begin from mid-2002 in line with more rapid world economic growth.

The political scene A democratic group won the most votes in the Legislative Assembly election, winning two seats, and two pro-China parties also won two seats each. The main popular concerns in the campaign were unemployment and corruption.

Economic policy and the The chief executive announced tax cuts in the 2002 budget, but overall the economy budget is contractionary at a time of expected economic weakness. Unemployment has fallen. New gambling regulations have been set out. Air Macau has revealed expansion plans. Goods trade has been hit by the international economic downturn. The number of visitors has risen. The government is seeking to diversify the tourist sector away from gambling.

Editors: Duncan Wrigley (editor); Robert Ward (consulting editor) Editorial closing date: December 5th 2001 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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Hong Kong

Political structure

Official name The Hong Kong Special Administrative Region (SAR) of the People’s Republic of China

Form of state Special administrative region of China, with its own constitution (the Basic Law), guaranteeing a “high degree of autonomy” for the next 47 years. Presided over by a chief executive appointed by China

The executive Fourteen-member Executive Council (Exco), serving in an advisory role to the chief executive

Head of state Jiang Zemin, president of the People’s Republic of China

Legislature Unicameral Legislative Council (Legco), comprising 24 directly elected members, 30 members elected by functional constituencies and six elected by an election committee mostly consisting of delegates chosen by functional constituencies

Local government Local government municipal councils (urban and regional) were abolished in December 1999. District boards were renamed district councils after elections in November 1999. The powers of the municipal councils were retained by government departments, with only minor increases in the budgets of the advisory and partly (20%) appointed district councils

Legal system Based on English law and the Basic Law, a mini-constitution underpinned by an international treaty. Foreign affairs and defence fall within the ambit of the central government in China

Elections The Provisional Legislative Council (PLC), which replaced the dissolved Legco on July 1st 1997, was itself replaced when a new Legco was elected in May 1998. The most recent Legco election was in September 2000. The next election will be in 2004

Main political parties The pro-democracy Democratic Party (DP, or Democrats) narrowly retained its status as the largest party in Legco in the September 2000 election. The pro-government Democratic Alliance for the Betterment of Hong Kong (DAB) came in second, displacing the pro-business Liberal Party (LP)

Chief executive Tung Chee-hwa Chief secretary for administration Donald Tsang Financial secretary Antony Leung Secretary for justice Elsie Leung

Secretaries Constitutional affairs Michael Suen Economic services Sandra Lee Education & manpower Fanny Law Financial services Stephen Ip Treasury Denise Yue Commerce & industry Chau Tak-hay Head of central policy unit (acting) Patrick Lau

Chief executive of the Hong Kong Monetary Authority Joseph Yam

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Economic structure

Annual indicators

1996 1997 1998 1999 2000 GDP at market prices (HK$ bn) 1,191.9 1,323.9 1,259.3 1,231.4 1,271.7 GDP (US$ bn) 154.1 171.0 162.6 158.7 163.2 Real GDP growth (%) 4.5 5.0 –5.3 3.0 10.5 Consumer price inflation (av; %) 6.4 5.7 2.8 –4.0 –3.8 Population (m) 6.4 6.5 6.5 6.6 6.7 Exports of goods fob (US$ m) 180,743 192,188 175,833 174,719 202,673 Imports of goods fob (US$ m) 199,094 209,487 183,666 177,878 210,891 Current-account balance (US$ m) –2,157 –6,159 3,905 11,483 8,827 Foreign-exchange reserves excl gold (US$ m) 63,808 92,804 89,601 96,236 107,542 Total external debt (US$ bn) 38.1 40.4 48.3 54.3 57.2a Debt-service ratio, paid (%) 2.0 1.5 2.5a 2.9 a 2.8a Exchange rate (av) HK$:US$ 7.73 7.74 7.75 7.76 7.79

December 5th 2001 HK$7.80:US$1

Origins of gross domestic product 1999 % of total Components of gross domestic product 2000 % of total Primary industries 0.1 Private consumption 58.3 Manufacturing 5.8 Government consumption 9.6 Utilities 3.0 Gross fixed capital formation 25.8 Transport, storage & communications 9.6 Stockbuilding 1.7 Construction 5.8 Exports of goods & services 149.9 Wholesale & retail import & export trade 24.8 Imports of goods & services –145.2 Finance, insurance, real estate & business services 23.4 Total at current market prices 100.0 Total incl others at factor cost 100.0

Principal domestic exports fob 2000 US$ bn Principal imports cif 2000 US$ bn Clothing 9.9 Electrical machinery & appliances 37.1 Electrical machinery & apparatus 3.7 Telecommunications & sound equipment 20.7 Textiles yarn & fabric 1.2 Office machinery 18.3 Specialised scientific equipment 1.0 Clothing 16.5 Office machinery 0.9 Textiles yarn & fabric 13.7 Total incl others 23.2 Total incl others 213.1

Main destinations of exports 2000 % of total Main origins of imports 2000 % of total China 34.5 China 43.1 US 23.2 Japan 12.0 Japan 5.5 Taiwan 7.5 UK 4.0 US 6.8 a EIU estimate.

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Quarterly indicators

1999 2000 2001 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr General government finance (HK$ bn) Revenue 45.21 77.53 27.03 22.02 56.63 73.05 27.87 n/a Expenditure 49.94 48.50 45.13 46.64 46.74 53.66 47.92 n/a Balance –4.73 29.03 –18.10 –24.62 9.89 19.39 –20.05 n/a Output GDP at constant 1990 prices (HK$ bn) 220.9 209.0 213.3 234.8 236.4 213.6 215.0 234.2 % change, year on year 9.2 14.1 10.7 10.8 7.0 2.2 0.8 –0.3 Manufacturing index (1986=100) 108 90 103 110 107 90 103 n/a % change, year on year –2.7 –1.1 –1.0 0.0 –0.9 0.0 0.0 n/a Employment and prices Employment (end-period; ’000) Internal tradea 1,002.3 1,027.9 1,036.4 1,053.3 1,009.1 1,017.1 1,034.9 n/a Financial servicesb 415.3 414.8 429.3 437.0 434.1 428.9 442.5 n/a Manufacturing 244.7 233.7 238.8 229.4 226.2 217.0 218.7 n/a Unemployment rate (% of the labour force; seasonally adjusted) 6.3 5.8 5.2 4.9 4.5 4.5 4.5 5.0 Consumer prices (1999/2000=100) CPI (A)c 101.2 100.1 99.5 99.2 99.0 98.1 98.4 98.4 % change, year on year –2.8 –4.1 –3.4 –2.0 –2.2 –2.0 –1.1 –0.8 Composite CPI 101.4 100.0 99.6 99.0 98.9 98.1 98.2 97.9 % change, year on year –4.2 –5.2 –4.5 –2.8 –2.5 –2.0 –1.3 –1.1 Financial indicators Exchange rate HK$:US$ (av) 7.77 7.78 7.79 7.80 7.80 7.80 7.80 7.80 HK$:US$ (end-period) 7.77 7.79 7.79 7.80 7.80 7.80 7.80 7.80 Interest rates (av; %) Prime lending 8.50 8.75 9.33 9.50 9.50 8.50 7.17 6.42 Money market 5.94 5.69 6.04 5.90 6.17 5.48 3.96 3.54 M2, HK$ (end-period; HK$ bn) 1,882.6 1,864.7 1,894.7 1,947.3 1,980.4 1,971.7 1,976.1 1,988.2 % change, year on year 5.5 4.1 4.2 6.5 5.2 5.7 4.3 2.1 Hang Seng stockmarket index (end-period; Jul 31st 1967=100) 16,962 17,407 16,156 15,649 15,096 12,761 13,043 9,951 % change, year on year 68.8 59.1 19.4 22.9 –11.0 –26.7 –19.3 –36.4 Sectoral trends Building work completed (private; usable floor area; ‘000 sq m) Total 822 355 408 234 479 275 351 n/a Passenger arrivals (‘000) 17,056 16,729 17,924 18,793 18,588 18,001 18,311 n/a Retail sales (1994/95=100) (Value; % change, year on year) –3.0 7.5 4.9 2.0 0.9 0.0 2.4 –2.0 (Volume; % change, year on year) 4.7 14.1 10.9 5.6 3.2 2.5 4.9 0.5 Foreign trade (HK$ bn) Exports fob 373.8 339.9 382.1 432.6 420.0 347.5 363.9 401.6 Re-exports fob 328.0 298.3 337.7 382.2 375.2 312.4 324.6 360.1 Imports cif –385.5 –363.6 –406.8 –449.4 –440.3 –376.8 –393.1 –420.0 Trade balance –11.7 –23.7 –24.7 –16.8 –20.3 –29.3 –29.2 –18.4 Foreign reserves (US$ bn) Reserves excl gold (end-period) 96.24 93.81 97.08 101.48 107.54 114.59 114.07 n/a a Wholesale, retail and import/export trades, restaurants and hotels. b Financing, insurance, real estate and business services. c Low income group.

Sources: Census and Statistics Department; IMF, International Financial Statistics.

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Outlook for 2002-03

Political outlook

Domestic politics In the short term Hong Kong’s political scene will be dominated by concerns over the worsening economy, rising unemployment and the perceived failure of the government to respond decisively to these problems. However, the government’s major failing has not been its selection of policies; there is little that it could do to offset the economic downturn given Hong Kong’s high dependence on foreign trade and the deteriorating world economy. Rather, Hong Kong’s executive-led government has failed to demonstrate decisive leadership or show that it is in tune with popular concerns, and has displayed an excessive tendency to be influenced by mainland interests at the expense of the autonomy and interests of the Hong Kong Special Administrative Region (SAR). The chief executive of the SAR, Tung Chee-hwa, whose reappointment for another five years in March 2002 is almost certain, is talking about making senior officials more accountable, but only to himself, rather than to the public; this move will not counter his unpopularity.

In advance of Mr Tung’s likely reappointment in March 2002, China has been trying to demonstrate the economic advantages of being part of China and of having a pro-China government in the SAR. Long Yongtu, China’s lead trade negotiator, said in late November that China would look favourably upon a hitherto unpublicised proposal by Mr Tung for a free-trade area embracing China, Hong Kong and Macau, with special consideration for Hong Kong companies entering China’s banking and insurance sectors. Yet no one has addressed the basic difficulty: Hong Kong is a free port, while China, even after formal accession to the World Trade Organisation (WTO) on December 11th 2001, will have tariffs and other barriers to trade. A free-trade area would mean a removal of barriers to trade between China and its SARs. Therefore, either China would need to remove all external barriers to trade, or Hong Kong would have to erect trade barriers in common with China, ending its status as an entrepôt and creating a single customs area as exists in the EU.

Both alternatives are unlikely. At most the proposal is likely to amount to a selective freeing of sectors, predominantly service sectors, from which Hong Kong has the most to gain, using legal requirements to minimise the loopholes through which overseas companies might benefit. The announcement seems to be rather a declaration of Chinese support as Hong Kong’s economy contracts on the brink of China’s accession to the WTO, which Hong Kong businesses fear will bring heightened competition from companies outside Greater China. The pro-business Liberal Party has disparaged Mr Tung’s hope that China’s WTO entry will assist Hong Kong’s economic recovery.

Other recent proposals for Chinese economic support include eased restrictions on Chinese tourists visiting Hong Kong; preferential treatment for Hong Kong investors in Beijing; permitting Hong Kong financial institutions to manage more of China’s foreign-exchange reserves; issuing the next tranche of China’s sovereign debt in Hong Kong; allowing China’s investors to buy equity on the

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Hong Kong stock exchange; allowing Hong Kong companies to be the first from outside China to buy stakes in Chinese banks and ports; and easing visa restrictions for visits to China by foreign residents in Hong Kong. All of this seems to be aimed first at shoring up support among the 800 local corporate representatives who are likely to reselect Mr Tung as chief executive for appointment by the Chinese government. The second goal is to counter Mr Tung’s unpopularity; although he is not democratically accountable, he will be concerned about the growing possibility of social unrest in Hong Kong as unemployment rises.

Economic policy outlook

Policy trends Hong Kong’s fiscal position has deteriorated sharply in 2001, and there will be a significant budget deficit in 2002-03, although the deficit will narrow as economic growth brings higher tax revenue and reduced government spending on welfare benefits. In the medium term the government will seek to exploit the opportunities and minimise the dangers arising from China’s membership of the WTO, which became effective on December 11th. Owing to the economic slowdown, the financial secretary, Antony Leung, has ruled out in the medium term any major new taxes or increases in existing taxes, which his predecessor had thought might be necessary.

Fiscal policy Hong Kong’s budget deficit for fiscal year 2001/02 (April-March) will be much higher than originally forecast by the government. The budget deficit for the first seven months of 2001/02 was HK$63bn (US$8.1bn), an increase of 64% year on year. Particularly worrisome was the 17.7% year-on-year fall in revenue to HK$72.1bn, reflecting the economic slowdown. Government expenditure rose by 7.2%.

The Economist Intelligence Unit now estimates that the fiscal deficit in 2001/02 will approach HK$50bn, or 3.8% of GDP. The deceleration in economic growth will depress corporate and personal income tax receipts for the rest of the fiscal year. Revenue from land sales and investment returns will not hit the original government target and the HK$15bn sale of a second tranche of Mass Transit Railway Corporation shares seems unlikely to proceed soon. This deficit is not, however, a major short-term threat. Hong Kong has in the past run fiscal surpluses and accumulated a large fiscal reserve, HK$367.3bn at end-October. It will therefore have no trouble financing this shortfall. The government will be concerned that Hong Kong’s deficits are becoming structural rather than cyclical, which is eschewed under the Basic Law, Hong Kong’s mini-constitution.

Monetary policy The benchmark Hong Kong Monetary Authority (HKMA) base rate will continue to shadow its counterpart in the US, the Federal Funds Target Rate, owing to the fixed link between the Hong Kong and US dollars. Commercial banks, however, will resist following the HKMA because their interest-rate margins are already tight, and this will reduce the effectiveness of loosening monetary policy. Barring a deep, prolonged contraction in the US economy— which we are not forecasting—we expect US monetary policy to be neutral

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throughout much of 2002, with rates not beginning to rise markedly again until the US recovery is well under way in 2003. We expect the US three-month commercial paper rate to average 4.5% in 2003, compared with 1.4% in 2002.

Economic forecast

Hong Kong: forecast summary (% unless otherwise indicated) 2000a 2001b 2002c 2003c Real GDP growth 10.5 –0.5 2.8 6.3 Industrial production growth –0.6 –9.0 –3.7 –2.5 Gross fixed investment growth 9.8 2.1 2.8 8.2 Unemployment rate (av) 5.1 5.2 6.0 5.5 Consumer price inflation Average –3.8 –1.4 –1.0 2.5 Year-end –2.1 –1.5 0.9 3.3 Short-term interbank rate 9.5 6.8 7.0 7.4 Government balance (% of GDP) –0.3 –3.8 –3.0 –2.1 Exports of goods fob (US$ bn) 202.7 191.7 192.7 211.3 Imports of goods fob (US$ bn) 210.9 204.6 206.4 228.5 Current-account balance (US$ bn) 8.8 4.2 3.3 1.8 % of GDP 5.4 2.7 2.0 1.0 External debt (year-end; US$ bn) 57.2b 58.5 60.5 67.4 Exchange rates HK$:US$ (av) 7.79 7.80 7.80 7.80 HK$:¥100 (av) 7.23 6.44 6.29 6.42 HK$:¤ (year-end) 7.32 7.18 7.88 7.88 HK$:SDR (year-end) 10.16 10.02 10.37 10.40

a Actual. b EIU estimates. c EIU forecasts.

International assumptions The short-term prospects for the global economy are poor: world economic growth in 2001 is undergoing the largest percentage-point slowdown since the 1974 oil crisis. Real economic growth in the US—Hong Kong’s second largest export market—will be just 1% in 2001 and 1.2% in 2002, but will rebound to 3.6% in 2003. The aftermath of the September 11th terrorist attacks on the US will slow US growth in late 2001 and early 2002: private consumption, in particular, will be affected in the fourth quarter of 2001. We expect a US recovery to begin around mid-2002 and to be under way by 2003. We are forecasting annual real GDP growth in China in 2002-03 of 7.2%, but most of this growth will be domestic demand-driven and will thus be of less benefit to Hong Kong than externally led growth, because much of China’s exports pass through Hong Kong. Growth in world merchandise trade will drop from 12.8% in 2000 to just 0.8% in 2001, before rebounding to 7.2% in 2003.

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Hong Kong: international assumptions summary (% unless otherwise indicated) 2000 2001 2002 2003 Real GDP growth World 4.7 2.2 2.7 4.2 OECD 3.7 0.8 1.1 2.9 EU 3.3 1.5 1.4 2.6 Exchange rates (av) ¥:US$ 107.8 121.1 124.0 121.5 US$:¤ 0.924 0.898 0.963 1.015 SDR:US$ 0.758 0.784 0.766 0.749 Financial indicators ¥ 2-month private bill rate 0.24 0.18 0.10 0.10 US$ 3-month commercial paper rate 6.32 3.59 1.43 4.50 Commodity prices Oil (Brent; US$/b) 28.5 24.3 18.3 20.2 Gold (US$/troy oz) 279.3 268.8 255.0 250.0 Food, feedstuffs & beverages (% change in US$ terms) –6.1 –1.0 11.9 13.4 Industrial raw materials (% change in US$ terms) 13.4 –9.2 0.3 14.5

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

Economic growth We now expect real GDP in Hong Kong to contract by 0.5% in 2001, with growth of just 2.8% in 2002. The economic downturn will begin to abate by the second half of 2002, however, which, coupled with the positive effects of low real interest rates, will set the stage for a strong recovery in 2003, when we forecast real GDP growth will reach 6.3%.

Real GDP contracted by 0.3% year on year in the third quarter of 2001, after growing by 0.8% in the second quarter. The slowdown has been led by the external sector. In year-on-year terms merchandise exports on a national accounts basis fell by 4% in the third quarter of 2001, continuing a year-long trend of deterioration. Hong Kong has been less affected by the global economic slowdown than other regional economies such as Taiwan and Singapore because of its lesser dependence on information-technology exports and owing to its integration with the strong mainland economy, which grew by 7.6% year on year in the first nine months of 2001. Although China’s domestic economy has performed strongly, Chinese exports have also been hit by the global trade slowdown.

According to data from China’s National Bureau of Statistics, 70% of Chinese exports to the US pass through Hong Kong and therefore show up in Hong Kong’s import and re-export data. China’s merchandise exports have been surprisingly robust given the weak international economy, growing by 7.9% year on year in the first ten months of 2001. Merchandise exports from China’s Guangdong province, the prime source of Hong Kong re-exports originating in China, grew by only 2.2% year on year during the period. Hong Kong’s re-exports fared even worse, shrinking by 3.4% year on year. Part of the difference in reported performance may be attributable to discrepancies in customs data collection by the respective statistical bureaux. Mr Leung acknowledged at the end of November that the data also point to

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the inevitable shrinkage of the share of China’s exports that will pass through Hong Kong as competitive Chinese ports increase their handling of direct shipments.

Hong Kong: gross domestic product by expenditure (HK$ m at constant 1990 prices; % change year on year in brackets unless otherwise indicated) 2000a 2001b 2002c 2003c Private consumption 492,265.0 503,094.8 509,132.0 532,552.0 (5.4) (2.2) (1.2) (4.6) Public consumption 65,527 68,803 71,555 72,987 (2.1) (5.0) (4.0) (2.0) Gross fixed investment 255,190 260,549 267,844 289,808 (9.8) (2.1) (2.8) (8.2) Final domestic demand 812,982 832,447 848,532 895,346 (6.5) (2.4) (1.9) (5.5) Stockbuilding 14,865 5,000 2,000 2,500 (3.2)d (–1.1)d (–0.3)d (0.1)d Total domestic demand 827,847 837,447 850,532 897,846 (10.0) (1.2) (1.6) (5.6) Exports of goods & services 1,889,068 1,843,730 1,887,980 2,033,354 (16.7) (–2.4) (2.4) (7.7) Imports of goods & services –1,823,513 –1,792,513 –1,824,779 –1,959,812 (16.7) (–1.7) (1.8) (7.4) Foreign balance 65,555 51,217 63,201 73,542 (1.2)d (–1.6)d (1.3)d (1.1)d GDP 893,402 888,664 913,733 971,388 (10.5) (–0.5) (2.8) (6.3)

a Actual. b EIU estimates. c EIU forecasts. d Contribution to real GDP growth.

Almost all consumption indicators for Hong Kong suggest further economic deterioration. The seasonally adjusted unemployment rate rose to 5.5% in the three-month period from August to October 2001 from 4.5% in January- March. Retail sales, which held up earlier in 2001, fell in the three consecutive months to September, when they were down by 4.4% year on year in value terms. Retail sales are likely to decline at a faster rate in the fourth quarter as indicated by import figures for October and will not recover markedly until 2003. With the economic outlook at home and abroad unlikely to improve until well into 2002, investment will stagnate in the short term.

The cyclical downturn should ease later in 2002 as external demand rises and a mild fiscal stimulus begins to feed through. Growth should then gather momentum in 2003; an upturn in the US, rising exports from a more trade- competitive Chinese economy and stronger growth in Japan will all contribute to the recovery. Hong Kong’s advantageous position vis-à-vis China, whose WTO entry was finalised on December 11th 2001, will facilitate a resurgence of investment growth in Hong Kong in 2003 and beyond.

Inflation Deflationary forces in Hong Kong have continued in recent months. The composite consumer price index (CPI) fell by 1.2% year on year in October, the same rate of decline as in September. This reflects falling prices of clothes and durable goods, such as audio-visual equipment; Hong Kong is importing

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deflation from China. The prices of China’s exports, particularly non- machinery and non-electronic goods, have been under severe pressure; Chinese factory gate prices fell by 3.1% year on year in October, having dropped in every month since April. Combined with weak domestic demand, imported deflation will prolong consumer price deflation through 2002, although prices will fall at a slower rate. An export-led recovery in domestic demand starting in late 2002, together with accelerating price rises on the mainland, will lead to positive consumer price inflation in 2003. We expect consumer prices to fall by 1% in 2002 before rising by 2.5% in 2003.

Exchange rates In early September Mr Leung called Hong Kong’s US dollar-linked currency an obstacle to an efficient economy. Despite his comment, he reaffirmed that the authorities had no intention of breaking the link. Whatever benefit the SAR might gain from a different exchange-rate regime would almost certainly be outweighed, at least in the medium term, by the likelihood of capital outflows from alarmed investors. There is therefore unlikely to be any serious discussion of this subject during the forecast period. The more pressing concern is the risk of a steep fall of the yen against the US dollar, which could trigger a round of depreciations of regional currencies. This is unlikely, but cannot be ruled out given the weak Japanese economy. We do not expect any troubles with Argentina’s currency board to have an impact on Hong Kong because the economic fundamentals are different and the currency markets have already priced in risk from Argentina. The Hong Kong dollar is forecast to remain linked to the US dollar at a rate of HK$7.8:US$1 in 2002-03.

External sector The value of goods exports (on a customs basis) fell by 4.8% year on year in the first ten months of 2001, after rising by 16.1% in 2000 as a whole. The reason for the slowdown is plain: re-exports of goods to the US fell by 7.2% year on year in January-September, declining at a double-digit rate in every month since May (except for July). US imports from all sources (goods and services on a seasonally adjusted, national accounts basis) declined by 15.2% year on year in the third quarter, and the trend throughout 2001 has been an increasing rate of decline. We are forecasting further declines in quarter-on- quarter terms with sluggish recovery at best in 2002. As growth is slowing in the EU and US-dependent Asian markets, external demand will be subdued.

The slowdown in exports will hit the current-account surplus, which will shrink to 2% of GDP in 2002 and then 1% in 2003, from an estimated 2.7% of GDP in 2001. Income flows from Hong Kong’s overseas assets will be hit by lower international interest rates and corporate profits. Exports of services may be hit after China enters the WTO because more mainland trade will be conducted directly with the rest of the world. In 2003 as the economic recovery deepens, imports will rise somewhat more quickly than exports, widening the trade deficit. This will be partly offset by receipts from the provision of trade-related services to mainland Chinese companies, but not enough to prevent a further erosion in the current-account surplus, to 1% of GDP in 2003.

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 14 Hong Kong

The political scene

Business security is ramped Reactions in the Hong Kong Special Administrative Region (SAR) to the up in Hong Kong September 11th terrorist attacks on the US were swift. The US consulate closed for a day for a “comprehensive security assessment” and then for another day when Macau officials arrested five Middle Eastern men on the mistaken suspicion that they were terrorists preparing for a attack on US interests in Hong Kong. Both actions prompted international businesses to reassess Hong Kong’s vulnerability to terrorism. A panel on international terrorism at the Foreign Correspondents’ Club and a presentation arranged by the American Chamber of Commerce in Hong Kong (AmCham) drew large turnouts. Many businesses implemented new security arrangements requiring identity checks, lobby-level sign-ins or escorted party access to upper floors.

Meetings of the World Economic Forum in October and the Pacific Economic Co-operation Council in late November also saw enhanced security measures. The police-imposed limits to demonstrations, which had sparked criticism during international forums in May, are now even more strictly enforced without much complaint, except from protestors. Protestors, who have held on average two demonstrations each day since the SAR was formed on July 1st 1997, objected in vain to police rules limiting vehicle access and restricting protestors to areas further away from meeting venues. Police also took new measures against the Falun Gong spiritual movement, outlawed in China but lawful in Hong Kong. Police officers visited buildings close to several mainland offices outside which daily Falun Gong protests take place, asking people to sign petitions declaring the protests an inconvenience or damaging to business. The police said that their action was not a petition but a survey of public sentiment toward the protesters to determine whether they were disrupting the peace.

Hong Kong’s response to the The chief executive, Tung Chee-hwa, and the financial secretary, Antony attacks on the US is criticised Leung, were strongly criticised in Hong Kong’s English-language press for not showing enough sympathy in the week after the attacks on the US, even

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though a dozen Hong Kong citizens had died in the New York attacks. The government did not hold a minute of silence or organise a memorial service, as happened in Europe and elsewhere, although the chief executive did address a heavily attended memorial service organised by AmCham and broadcast by RTHK, the government-funded public broadcaster. On September 10th 2001 the government had begun a new advertising campaign, proclaiming Hong Kong to be the “New York of Asia” on a par with the World Trade Center in New York. The government scrapped this element of the campaign after the terrorist attacks.

Several incidents apparently sparked by the terrorist example occurred in September and October in Hong Kong. In late September one note, signed by “Hong Kong bin Laden”, threatened the poisoning of food in stores unless Mr Tung and other government officials stepped down. In response police arrested and charged a couple in financial difficulties. Government officials also in October received a hoax anthrax letter, again demanding that Mr Tung resign. The Hong Kong post office has issued rubber gloves to mail handlers, but as in the US, the perpetrator has not been caught. Government officials downplayed the terrorist threat but sensitivities have become such that a RTHK satirical skit in October comparing the Taliban to Mr Tung (not the other way around as reported in the press) sparked heated demands for censorship of RTHK. A recently hired RTHK radio producer from New Zealand quit, alleging official interference in the scheduling of a radio broadcast. The government and RTHK senior staff vigorously denied the charge.

Worries about treason and The international drive to crack down on terrorism has engendered fears that sedition laws resurface legislation on treason, subversion, secession and sedition will now be drafted with new urgency and broad scope. Article 23 of the Basic Law, Hong Kong’s mini-constitution, requires the SAR to enact such laws, but this has not yet been done. The timing for the replacement of the unpopular secretary for justice, Elsie Leung, due by end-June 2002, has raised fears that her successor will be chosen to take the brunt of criticism over the introduction of the new laws, just as Ms Leung had done when China in effect overruled a January 1999 ruling by Hong Kong’s highest court, the Court of Final Appeal, on immigration law in the most serious breach of Hong Kong’s autonomy since the reversion to Chinese sovereignty in 1997.

Racial tensions rise with Race relations have worsened after the September 11th attacks. Requests by the terrorist threat Muslims to build a mosque in the New Territories have encountered increased opposition and racial and religious intolerance. Chinese travel agents adopted discriminatory practices in visa and travel arrangements during the Asia-Pacific Economic Co-operation (APEC) forum summit held in Shanghai in October and may have tightened racial profile-based vetting. People who are not ethnically Chinese account for over 5% of Hong Kong’s population according to the March 2001 census. This does not include tourists and business visitors, who would bring the percentage up to 6-7% of the total population (400,000- 500,000 people), providing ample opportunities for incidents of racism to occur. Hong Kong government has no laws against racial discrimination, despite widespread reports of racial profiling and discrimination in hiring, flat

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sales and rental, and in charging by entertainment venues and traders. The UN has criticised Hong Kong for not passing a law prohibiting racial and other forms of discrimination.

Public fears of civil upheaval as a consequence of a renewed and deepened economic downturn increased markedly between April and November. Increasing income inequality is also undermining social cohesion (see The domestic economy: Employment, wages and prices).

The 2001 policy address The chief executive’s 2001 policy address made on October 10th won little fails to win approval support from business or the public. An Asian Wall Street Journal editorial the following morning accused the Hong Kong government of abandoning its quasi-laisser faire policy known as “positive non-interventionism” for a raft of pump-priming measures, the creation of artificial jobs and stepped up government initiatives. The criticism in the Legislative Council (Legco, Hong Kong’s legislature) came from the opposite direction. James Tien, the chairman of the pro-business Liberal Party, moved an amendment demanding that the government to adopt a series of relief measures worth HK$25bn (US$3.2bn). The amendment received the support of eight political groups. Mr Leung rejected the plan on November 13th, thus underlining the impotence of Legco.

A survey commissioned by the Home Affairs Bureau found that only about half of the respondents supported the measures and proposals contained in the 2001 policy address, while 90% said that further measures were required to deal with the unemployment situation. The terrorist attacks on the US and the US response had caused an extensive revision of the original draft of the policy address. The final draft was more cautious in tone and admitted that the terrorist attacks had contributed to greater uncertainty in the global economy with an adverse effect on Hong Kong’s trade-dependent economy.

A quasi-ministerial system In the 2001 policy address, Mr Tung offered more details on an “accountability is proposed system” for top civil servants that he had promised to create in the 2000 policy address. Senior government officials—the chief secretaries and most bureau directors—would be appointed and could be removed by China’s government on the chief executive’s recommendation. Senior civil servants, who head all but two of the major departments and cannot be removed from office except under civil service procedures that exclude political considerations, would remain as deputies to the political appointees. Making officials more accountable to a chief executive who himself is not accountable to the public— he is appointed by the Chinese government after being selected by a committee of corporate representatives—fails to address the basic structural problems that underlie much of the rising public discontent.

An anti-Tung coalition fails The formation of a cross-party coalition to oppose Mr Tung’s expected to convince re-election on March 24th 2002 was announced at the beginning of December, but it proposed no alternative candidates. Some members of the coalition with a vote in the chief executive election have pledged to abstain even if Mr Tung chooses not to run. Mr Tung’s lack of popular support leaves the Chinese government with a dilemma. A reappointed Mr Tung may, because of his weakness, be more inclined to give way to pressure for democratisation. One

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possible scenario is that he would serve two or three years of a second term, then step down owing to “illness”. Someone else would be selected by the current procedure, or by a similar procedure. He would then serve a five-year term, thus postponing until 2009 or 2010 the possibility of a directly elected chief executive. This would also avoid having an election for the post of chief executive in 2007, just months before a Legco election in 2008 that could be wholly democratically elected, according to the Basic Law; candidates for the post in 2007 would come under pressure to promise a fully democratic election for Legco sooner rather than later.

Economic policy

The policy address contains The 2001 policy address of the chief executive, Tung Chee-hwa, contained HK$15bn of measures HK$15bn (US$1.9bn) of measures to create jobs, upgrade education, provide tax relief and enhance the business environment. He announced a HK$3bn scheme to create 32,000 low-end temporary jobs. To assist homeowners, the government will cut property rates by up to HK$2,000 (US$260) per home in 2002 (costing HK$5bn) and raise the ceiling for the tax allowance on home mortgage interest payments from HK$100,000 to HK$150,000 (costing HK$1bn). The government will set aside HK$300m (US$38m) to set up a Community Investment and Inclusion Fund to promote mutual help among community members.

Improving education has been a consistent theme for Mr Tung and in the 2001/02 budget he announced an extra HK$5bn to subsidise continuing education and training programmes. Secondary schools will receive an additional HK$200m to employ teachers. The Native-speaking English Teacher Scheme, which employs native English-speakers to teach English courses at secondary level, will be extended to all elementary schools. To improve the business environment, the government will spend HK$1.9bn to create four funds that will assist smaller firms to train workers, enter new markets, improve competitiveness and buy capital equipment. Infrastructure will be strengthened by building a HK$2bn exhibition centre at Chek Lap Kok and spending HK$600m on road and rail links over the next 15 years.

Unionists and businesses Trade unionist legislators said that the proposal to create 32,000 jobs in the show disappointment 2001 policy address included jobs already planned. They said that the proposed infrastructure and public works projects also included previously announced projects. The business community considered the initiatives in the policy address to be of minimal use in reviving the economy or providing relief to businesses. The Hong Kong Association of International Co-operation of Small and Medium Enterprises and the Hong Kong Small and Medium Enterprises General Association said that the initiatives would not save many smaller businesses on the verge of bankruptcy.

Celebrations are muted for James Tien, the chairman of the Liberal Party, wrote an article in the South China’s WTO entry China Morning Post, an English-language local newspaper, attacking Mr Tung’s hope that China’s entry into the World Trade Organisation (WTO) would bring

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recovery as “wishful thinking at best and delusion at worst”. A survey conducted by Mindtheme Consulting, a research and advisory company based in Hong Kong and Singapore, found that 70% of the 442 executives questioned expected China’s WTO entry to reduce their firms’ profitability and expected foreign firms to base their operations in China, not Hong Kong. According to the Census and Statistics Department, however, the number of foreign firms’ regional headquarters and offices based in Hong Kong reached 3,237 in 2001, compared with 2,514 in 1997 when Hong Kong reverted to Chinese sovereignty. The number of regional headquarters in Hong Kong rose to 944, the highest figure since the survey began in 1990.

The budget deficit widens The deteriorating economic environment has caused the government to review its fiscal deficit projection. The central government recorded a budget deficit of HK$63bn between April and October 2001, a huge increase from its original HK$3bn deficit estimate made in March 2001. The financial secretary, Antony Leung, said that budgeted revenue from land premiums and Mass Transit Railway Corporation (MTRC) share issues, and investment returns from the Exchange Fund, the assets backing the Hong Kong dollar’s fixed exchange rate, were all doubtful given the sharp economic downturn. The government had received only HK$5bn of the HK$28bn budgeted revenue from land premiums by end-October, more than half-way through the fiscal year. The government is expected to delay selling a second batch of MTRC shares worth HK$15bn until 2002 because of poor market conditions. Weak financial markets also lowered investment returns to the Exchange Fund, valued at HK$986bn (US$126bn) at end-October, HK$37bn lower than at the start of 2001. The fund had gained HK$34bn in value in 2000. Mr Leung warned that the budget deficit for fiscal year 2001/02 might reach HK$100bn. He also said that the public would be consulted over the appropriate size of Hong Kong’s fiscal reserve (government assets accumulated from years of budget surpluses), because the 2001/02 deficit might reduce the fiscal reserve from HK$370bn in September to HK$300bn.

The domestic economy

Output and demand

Hong Kong is on the brink Real GDP in Hong Kong contracted by 0.3% year on year in the third quarter of recession of 2001, the first year-on-year contraction since the first quarter of 1999. The seasonally adjusted quarter-on-quarter figures suggest that Hong Kong has passed the worst; these data show that GDP grew by 0.4% in the third quarter after a 1.4% decline in the previous quarter. Given that these data are often revised, however, such a judgment would be premature. An apparent revival of investment-supported GDP in the third quarter, growing by 3.7% year on year; however, much of the investment growth is attributable to a 9.4% year-on-year increase in spending on machinery and equipment, which is mainly attributable to the one-off effect of the purchase of new aeroplanes for Hong Kong’s two largest airlines. The government acknowledged the poor economic

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outlook by cutting its GDP growth forecast for 2001 from 1% to stagnation, warning that the full economic impact of the September 11th attacks had yet to be felt.

Goods exports fell rapidly on a national accounts basis in the third quarter of 2001, by 4% year on year, and goods imports declined by nearly the same rate. The government forecast for 2001 implies that goods trade will decrease even faster in the fourth quarter. Private consumption increased, but at a much slower rate, rising by 1.3% year on year in the third quarter after a 3.6% year- on-year increase in the second quarter. The government said that it expected the economy to recover in the medium term owing to the robust economic growth anticipated for the mainland with which Hong Kong enjoyed increasingly strong economic ties.

Hong Kong: gross domestic product (% change year on year) 2000 2001 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr Private consumption 8.7 5.1 5.6 2.6 5.5 3.0 3.6 1.3 Government consumption 3.7 2.7 2.5 –0.6 2.1 3.9 4.1 6.2 Gross domestic capital formation 5.7 5.4 14.8 13.1 9.8 11.5 1.3 3.7 of which: building & construction –14.9 –10.8 –1.3 –2.3 –7.7 –1.2 1.9 –6.8 real estate developers’ margin –19.5 –17.5 –2.4 4.0 –9.4 –5.7 4.3 –4.2 machinery & equipment 32.9 21.2 27.3 23.4 25.8 22.6 0.3 9.4 Goods Exports 20.7 17.7 17.7 13.3 17.1 4.2 –1.9 –4.0 Imports 22.9 18.8 18.4 13.4 18.1 5.3 –0.7 –3.4 Services Exports 15.8 18.2 14.0 9.5 14.1 6.2 6.3 1.5 Imports –0.9 3.3 3.4 2.7 2.1 3.9 1.0 –2.0 GDP 14.1 10.7 10.8 7.0 10.5 2.2 0.8 –0.3 Source: Census and Statistics Bureau.

Retail sales decline Declining sales of big-ticket items and a fall in tourism after the September 11th attacks have contributed to poor retail sales. The value of retail sales fell by 4.4% year on year in September. The figures also showed that sales volume dropped by 1.7% after discounting the effects of deflation, reversing a 1.8% gain in August. The decline was attributed to the rising unemployment rate and gloomy prospects for the future.

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Employment, wages and prices

Unemployment increases The seasonally adjusted unemployment rate increased to 5.5% in the three- month period from August to October, the fourth consecutive monthly rise. The government has warned that this trend might continue because of the economic downturn, exacerbated by the September 11th attacks. University graduates are facing a tough employment situation. The University of Hong Kong said in mid-November that the demand for university graduates had dropped by 60% since September. A survey conducted by the Institute of Human Resources Management, which covered 105 firms with 124,000 employees, found that more than 45% of the companies surveyed planned to freeze wages and that 25% were prepared to lay off staff. The survey also found that the average pay rise in 2001 was 2.6% but that the projection for 2002 was for less than 0.5%.

Hong Kong: employment by sectora (‘000) 2000 2001 Mar Jun Sep Dec Mar Jun % changeb Manufacturing 233,700 238,800 229,400 226,200 217,000 218,700 –8.4 Construction (manual workers only) 74,500 79,300 80,700 83,900 87,800 80,300 1.3 Wholesale, retail & import/export trades, hotels & restaurants 1,027,900 1,036,400 1,053,300 1,009,100 1,017,100 1,034,900 –0.1 Transport, storage & communications 175,800 180,600 183,300 176,900 181,800 185,900 2.9 Finance, insurance, property & business services 414,800 429,300 437,000 434,100 428,900 442,500 3.1 Community, social & personal services 345,000 346,200 348,900 354,500 360,500 372,500 7.6 a Data refer to numbers engaged rather than employment. b June 2001/June 2000.

Source: Census and Statistics Department.

A call for a civil service pay The Liberal Party chairman, James Tien, has called for a 10% cut in civil service cut is rejected salaries, estimating that it would save the government HK$16bn (US$2.1bn).

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The government has rejected this demand, although an executive councillor, Rosanna Wong, agreed that the civil service pay structure should be reviewed after a consultation period. Liberal legislators had taken the lead with a 10% reduction in their salaries and urged other legislators and civil servants to follow suit. Other legislators demurred, arguing that Liberal Party members were wealthy individuals that had other sources of income, while many other legislators depended on the income provided by the government. Sceptics suspected that the real intention behind the Liberal Party’s proposal was eventually to drive down salaries and wages in the private sector, which would benefit employers. The Liberal Party receives its political support mainly from the business sector.

Low-wage earners may Low-wage earners could become worse off. The deputy secretary for education become worse off and manpower, Philip Chok, has said that a review is under way that could lead to a lowering of the minimum monthly wage for foreign domestic workers from the current level of HK$3,670 (US$470) by late January 2002. This might in turn lead to lower wages for other low-skilled jobs. The Philippine government has asked the Hong Kong government not to reduce the minimum wage—155,133 Filipino domestic helpers work in Hong Kong—and is discussing the submission of a written request with Indonesia and Thailand, which also have many citizens working in Hong Kong.

The workforce is found to Hong Kong needs to upgrade the quality of its workforce, a point stressed in lack good English skills the 2001 policy address (see The political scene). According to a survey conducted by TMP Worldwide eResourcing, an international recruitment agency, the Hong Kong education system does not produce enough people with good spoken English and high-technology skills. Of the more than 600 human resource managers surveyed, nearly 30% of respondents said that weak spoken English was a problem in recruiting workers in the retail, media and public relations sectors, and 36% said that suitable computer skills were scarce.

The income gap widens The 2001 census revealed that the Gini coefficient (a measure of the distribution of income, with a score of zero indicating perfectly equitable distribution and a score of one indicating a concentration of income in the hands of a single person) increased from 0.48 in 1991 to 0.53 in 2001. Over the same period average monthly household income increased from HK$9,964 to HK$18,705. Perceptions of inequality are also worsening. In a survey conducted by the Association for Democracy and People’s Livelihood, a political group in the Legislative Council (Legco, Hong Kong’s legislature), 82% of the 601 respondents rated the income gap in Hong Kong as serious; 35% believed that a widening income gap would lead to social unrest.

Financial indicators

The stockmarket is volatile Although the Hang Seng Index (HSI) fell by about 10% between September 11th after September 11th and September 21st 2001 in the aftermath of the terrorist attacks on the US, the Hong Kong stockmarket was the quickest of the major world markets to recover. By end-September the HSI had rallied to 9,951 points, just 4.5% below its pre-

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September 11th level. The recovery was attributed to Hong Kong’s exposure to Chinese stocks, given the robustness of the Chinese economy. The rebound, which continued until mid-November, was also helped by a better outlook for the property sector, which anticipated further measures from the 2001 policy address to help the property market. On November 15th the HSI rose above 11,000 point as a result of bullish data on the US economy and speculation that Osama bin Laden, the Saudi-born militant Islamist believed to be behind the attacks on the US, might have been captured or killed. For the rest of the month the stockmarket remained steady, closing at 11,279 on November 30th. Investors are worried that the Hong Kong Monetary Authority (HKMA) may sell more of the stock portfolio of the Exchange Fund (the assets backing the Hong Kong dollar’s fixed exchange rate) in the near future to finance the bulging budget deficit, thus weakening the market.

The Hong Kong government and financial regulators in China have been examining possible ways of boosting capital flows between Hong Kong and China. One proposal is for the Hong Kong Stock Exchange to create a new class of shares to be traded in renminbi. This move would conflict with China’s policy of strict currency control but improve the liquidity of the Hong Kong market. The Hong Kong stockmarket has had a low daily turnover of HK$7bn-8bn (US$1bn) in recent months, compared with an average of HK$10bn in the last two years. On November 19th the financial secretary, Antony Leung, said that he had asked the Chinese government to consider issuing its US dollar bonds in Hong Kong rather than overseas to boost Hong Kong’s debt market. Furthermore, according to the HKMA chief executive, Joseph Yam, the Chinese government is prepared to place more of its US$200bn foreign-exchange reserves under the management of Hong Kong financial institutions.

The SFC introduces The Securities and Futures Commission (SFC) on October 19th implemented regulation early early a measure, initially expected to come into effect by the start of 2002, to give small shareholders more protection. The measure lowered the threshold that triggers a corporate takeover from 35% to 30%. The lower trigger point limits major shareholders to controlling less than 30% of a company, unless they are prepared to make a general offer at the same purchase price to all shareholders.

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A politician will push the The government has appointed Tsang Yok-sing, chairman of the Democratic financial bill through Alliance for the Betterment of Hong Kong (DAB), as a non-executive director of the SFC. This seems to be an attempt to build support in the Legco before a vote on the controversial Securities and Exchange Bill, due later in December. Financial firms complain that the bill would make the market over-regulated.

Hong Kong: customer deposits by currency and foreign-exchange reserves (HK$ bn unless otherwise indicated) 2000 2001 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Customer deposits with all authorised institutions HK$a 1,743.7 1,777.6 1,812.9 1,847.8 1,840.1 1,843.3 1,849.2 Foreign currencyb 1,446.7 1,516.9 1,567.0 1,634.8 1,548.7 1,590.6 1,586.2 Total 3,190.4 3,294.4 3,379.9 3,482.6 3,388.9 3,433.9 3,435.4 HK$ as % of total 54.7 54.0 53.6 53.1 54.3 53.7 53.8 Foreign-currency assets Total (US$ m) 93,829 97,099 101,496 107,583 114,602 114,091 113,434 Import cover (no.)c 17.9 17.6 17.5 18.0 19.1 19.1 19.5 Ratio to currency in circulation 7.1 7.4 7.7 8.0 8.5 8.3 7.9

Note. Please note that the definitions of HK$ and foreign-currency deposits have been changed by the Hong Kong Monetary Authority, altering historic data in this table a Adjusted to include foreign-currency swap deposits. b Adjusted to exclude foreign-currency swap deposits. c Ratio to monthly retained imports.

Sectoral trends

Property prices drop Property prices have been dropping, acting as a major drag on household further consumption. A survey conducted by C B Richard Ellis, a commercial property firm which has its headquarters in the US, found that property prices had fallen by 11.1% in the first three quarters of 2001, and were 50.8% below the peak in 1997 before the Asian economic crisis. Further changes in the government Home Ownership Scheme (HOS), which subsidises house prices, may provide relief to the market. In September the chief secretary, Donald Tsang, said that the government had to resolve three long-term issues concerning the HOS: how much to increase the ratio of government-provided interest-free loans to the number of HOS flats; the eligibility criteria for the HOS; and the allocation of the scheme’s sites. An official of the Housing Authority said that the authority was planning to tighten income and asset limits for HOS applications, which would disqualify 37,000 families from buying government-subsidised flats. At present the HOS and Home Purchase Loan Scheme have the same limits (a monthly salary of HK$25,000, or US$3,200, and HK$600,000 in assets) for a family of two to eight members. The Housing Authority official said that the authority was considering lowering the HOS limits for income by 20% and those for assets by 15%. This change would force more families to purchase their homes from private developers by joining the loan scheme because they were no longer eligible for HOS flats, thereby stimulating the private-sector housing market.

Collusion in 3G licence Hong Kong has been criticised for allowing too great a share of its economy to auction is denied be controlled by a few business conglomerates amid suspected collusion among big firms. On September 23rd the Office of the Telecommunications Authority (Ofta) denied that there had been collusion among operators in the auctioning

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of third-generation (3G) mobile telephone licences. There were four licences awarded in Hong Kong’s first auction of 3G telecommunications licences but there were only four companies registering any interest, all incumbent operators. With no competing bids the licences were sold at reserve price.

The transport network will If Hong Kong is to become China’s leading financial and business centre, it must be enhanced improve its transport links with China. The transport and logistics industry accounted for about 20% of Hong Kong’s economic output in 2000. A government commissioned-study by the engineering and construction firms, McClier of the US and Maunsell of the UK, found that, despite having excellent international airports and seaport facilities, Hong Kong’s supporting network was weak, fragmented and expensive. In response, the Airport Authority unveiled a plan to make Hong Kong a premier tourism destination and trade transport centre. The plan is to develop Sky City next to the airport and a logistics park near the airport at Tung Chung. Sky City would have an exhibition centre, nine hectares of office and retail space, and a passenger ferry terminal. The project will cost the government HK$2bn (US$260m) with a further HK$2bn to be raised from the private sector. The authority’s chief executive, David Pang, said that the volume of express goods passing through Hong Kong was growing twice as fast as traditional air cargo and that the plan would increase the airport’s annual capacity by 200,000 tonnes.

Foreign trade and payments

Merchandise imports and Domestic export earnings dropped by 15.3% year on year in the first ten months exports drop of 2001, compared with the year-earlier period. Imports of big-ticket items such as electrical appliances, office machinery and professional equipment fell faster than other categories. Re-exports, representing 90% of Hong Kong’s total exports, decreased by 3.4% year on year in January to October, but by 13.5% year on year in October alone. October’s data reflect the disruption to trade with the US after the September 11th terrorist attacks: 85% of small and medium enterprises in Hong Kong said that US importers had put orders on hold in that period, according to Frontline Business Information, a local risk management company. The effect of the events of September 11th on Hong Kong’s import demand is evident in the 14.9% year-on-year fall of merchandise imports in October compared with a 3.9% year-on-year decrease in January to October.

Re-exports also decline A large proportion of Hong Kong’s re-exports originate in China. The global economic slowdown has been hurting China’s export growth. China’s minister of foreign trade and economic co-operation, Shi Guangsheng, warned that China’s exports would slow down because of the fall-out from the September 11th attacks. China’s export growth has already slowed in 2001—exports rose by only 7.9% year on year in the first ten months, compared with a 28% increase for the whole of 2000. As a result, Hong Kong’s re-exports to the US and the EU have dropped in 2001, although re-exports have been less affected than domestic exports by the economic downturn.

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The border is to open for The government announced on November 9th that the Lowu and Lok Ma Chau longer hours border checkpoints would open from 6.30 am to midnight, starting from December 2001. Previously, the Lowu checkpoint opened from 6:30 am to 11:30 pm and Lok Ma Chau from 7 am to 10 pm. The government expects longer opening to increase the number of travellers crossing the border each day by 3,000-5,000 from 280,000. Transport operators and some businesses welcome the change. But other businesses worry that local consumption will be reduced by easing crossborder shopping and that property prices in the New Territories will fall further as people choose to live in China. Nearly 200,000 people with the right to live in Hong Kong reside in Shenzhen, the much cheaper city across the border in China, but work or go to school in Hong Kong. The deputy director of the China National Narcotics Control Bureau has also warned that 24-hour border opening could lead to an increase in crossborder drug trafficking.

Deregulation of parallel The deputy director of intellectual property, Peter Cheung, has said that the imports is contemplated government is contemplating the deregulation of parallel imports of copyright articles by eliminating criminal sanctions and statutory civil proceedings against such imports of computer programs. The Business Software Alliance, a business association, has argued that this change might not lower software prices, as many software makers set universal prices for their products, but would encourage more counterfeiting.

The current-account The current-account surplus decreased by 21.4% year on year in the first half of surplus falls sharply 2001 to HK$18.6bn (US$2.4bn). The main driver of the decline was the increasing trade deficit, which grew by 25.5% year on year to HK$48.5bn, reflecting the slowdown in demand for Hong Kong’s merchandise exports in key markets, such as the US and the EU. This was partly offset by an improved services balance, which rose by 12.5% year on year to HK$59.8bn, as Hong Kong’s service exporters benefited from China’s strong economy.

Hong Kong: balance of payments (HK$ m) 2000 2001 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Current account 11,074 12,612 22,127 22,971 11,095 7,528 Goods –19,344 –19,329 –10,487 –14,860 –24,646 –23,888 Services 24,540 28,632 32,835 37,969 27,476 32,366 Factor income 9,226 6,378 2,901 3,035 11,951 2,142 Current transfers –3,347 –3,069 –3,122 –3,173 –3,686 –3,092 Capital and financial account –3,863 –16,019 –26,531 –12,956 –504 –11,597 Capital transfers –1,938 –3,641 –3,716 –2,534 –1,438 –3,116 Financial non-reserve assets (net change) –20,100 12,990 16,154 20,213 61,891 1,443 Direct investment –1,440 58,667 21,947 –68,169 59,090 37,372 Portfolio investment 87,045 5,476 1,996 132,335 –108,070 –52,268 Financial derivatives –41,504 15,644 –1,088 22,300 –9,209 21,147 Other investment –64,201 –66,797 –6,701 –66,253 120,080 –4,807 Reserve Assets (net change) 18,175 –25,368 –38,969 –30,636 –60,958 –9,924 Net errors & omissions –7,212 3,407 4,404 –10,014 –10,590 4,069 Overall balance of payments –18,175 25,368 38,969 30,636 60,958 9,924 Source: Census and Statistics Department.

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 26 Macau

Macau

Political structure

Official name The Macau Special Administrative Region (SAR) of the People’s Republic of China

Form of state Formerly a Portuguese territory, Macau has been a Special Administrative Region (SAR) of the People’s Republic of China since December 20th 1999. A post-handover mini- constitution, the Basic Law, is designed to ensure that many of the political, economic and social structures established during the 442-year rule of the Portuguese remain unchanged for at least 50 years

The executive The chief executive, appointed by a selection committee, presides over the government. The chief executive appoints a cabinet, the Executive Council, of between seven and 11 members

Head of state Jiang Zemin, president of the People’s Republic of China

National legislature The Legislative Council has 27 members: 10 directly elected, 10 indirectly elected and 7 appointed. The current members took office in October 2001. The Basic Law envisages an eventual rise in the number of legislators to 29

Legal system The legal system is based largely on Portuguese law. The territory has its own independent judicial system, with a high court. Judges are selected by a committee and appointed by the chief executive. Foreign judges may serve in the courts

National elections October 2001 (Legislative Council); the next election is scheduled for 2005

Main political organisations A number of civic associations operate as de facto political parties: Electoral Union (UNE); Pro-Macao and Flower of Friendship and Development of Macao (Fadem); Associação para a Defesa dos Interesses de Macao (Adim); Centro Democrático de Macao (CDM); Grupo Independente de Macao (Gima); Macau Economic Promotion Association; Progress Promotion Union; Development Union

Chief executive Edmund Ho Hau Wah

Secretaries Administration & justice Florinda da Rosa Silva Chan Economy & finance Francis Tam Pak Yuen Security Cheong Kuoc Va Social affairs & culture Fernando Chui Sai On Transport & public works Ao Man Long Commissioner against corruption Cheong U Others Commissioner of Audit Fatima Choi Mei Lei Commissioner-general designate of the police services Jose Proenca Lo Branco President of the Legislative Council Susana Chou President of the Court of Final Appeal Sam Hou Fai Macau Monetary Authority president Anselmo Teng

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 Macau 27

Economic structure

Annual indicators

1996 1997 1998 1999 2000 Real GDP growth (%) –0.4 –0.3 –4.6 –2.9 4.6 Population (year-end; ‘000) 415.9 422.0 430.5 437.5 437.9 Consumer price inflation (av; %) 4.8 3.5 0.2 –3.2 –1.6 Exports fob (US$ m) 1,995.6 2,142.6 2,135.7 2,197.5 2,539.3 Imports cif (US$ m) 1,999.7 2,076.8 1,949.8 2,037.5 2,254.9 Trade balance (US$ m) –4.1 65.8 185.9 160.0 284.4 Exchange rate (av; MPtc:US$) 8.0 8.0 8.0 8.0 8.0

December 5th 2001 MPtc8.0:US$1

Origins of gross domestic product 1999 % of total Components of gross domestic product 2000 % of total Manufacturing 9.4 Private consumption 39.3 Administration & personal services (incl gambling) 46.1 Government consumption 10.5 Construction 3.6 Gross fixed capital formation 13.0 Trade, hotels & restaurants 9.7 Stockbuilding 0.1 Finance & real estate, etc 26.1 Exports of goods & services 89.8 Total incl others 100.0 Imports of goods & services –52.7 Total 100.0

Principal exports fob 2000 US$ m Principal imports cif 2000 US$ m Clothing & textiles 1,820.6 Raw materials & semi-manufactured goods 1,174.9 Footwear 79.0 Consumer goods incl foodstuffs, beverages & tobacco 662.6 Machinery & parts 52.1 Capital goods 246.5 Cement 13.2 Mineral fuels & oils 170.8 Total incl others 2,539.3 Total 2,254.9

Main destinations of exports 2000 % of total Main origins of imports 2000 % of total US 48.3 China 41.0 EU 28.4 Hong Kong 15.2 China 10.2 EU 9.6 Hong Kong 6.5 Taiwan 9.5

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 28 Macau

Quarterly indicators

1999 2000 2001 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Government finance (MPtc m) Current revenue 2,148.7 1,908.8 2,092.4 2,249.8 2,190.2 2,084.9 2,567.6 n/a Current expenditure 2,865.5 1,076.7 2,472.0 1,805.7 2,129.7 1,892.2 1,688.5 n/a Balance –716.8 832.1 –379.6 444.1 60.5 192.7 879.1 n/a Employment & prices Unemployment rate (%) 6.7 6.7 7.1 6.7 6.6 6.3 6.4 6.3 Consumer prices (Oct 1999/Sep 2000=100) 97.7 100.1 99.6 99.2 99.1 98.4 98.0 97.5 % change, year on year n/a n/a n/a –2.3 1.4 –1.7 –1.6 –1.8 Financial indicators Exchange rate MPtc:US$ (av) 8.00 8.01 8.02 8.03 8.03 8.03 8.03 n/a Interest rates (end-period; %) Deposit 3.50 4.00 4.50 4.50 4.50 3.00 2.00 n/a 3 month interbank 5.86 n/a 6.48 6.33 5.93 4.94 3.81 n/a M1 (end-period; MPtc m)a 5,153.4 4,920.5 4,785.8 4,508.0 4,408.7 4,929.0 4,994.6 n/a % change, year on year –9.0 n/a n/a n/a –15.5 0.2 4.4 n/a M2 (end-period; MPtc m) 90,140 90,728 85,240 87,768 89,305 90,571 92,219 n/a % change, year on year 4.6 n/a n/a n/a –0.9 –0.2 8.2 n/a Sectoral trends Electricity production (kwh m) 332.9 306.5 387.0 44.4 339.8 312.3 390.2 456.2 Tourism Visitor arrivals (‘000) 1,933 2,175 2,190 2,475 2,322 2,454 2,556 2,689 Construction (‘000 sq m) Buildings started 9.6 49.0 59.3 62.9 31.6 31.7 73.2 30.3 Buildings completed 167.1 29.4 52.0 126.2 162.7 171.1 48.2 112.0 Foreign trade (MPtc m) Exports fob 4,282 4,022 5,252 5,995 5,111 3,637 4,873 5,304 Imports cif –4,230 –3,529 –4,961 –4,717 –4,891 –4,304 –5,304 –4,827 Trade balance 52 493 291 1,278 220 –667 –431 477 a From 2001 1 Qtr, currency in circulation and demand deposits only.

Source: Statistics & Census Services, Monthly Bulletin of Statistics.

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 Macau 29

Outlook for 2002-03

Political outlook

Domestic politics A new Legislative Assembly (Macau’s legislature) was convened following an election in October 2001. Although a pro-democracy group won the largest number of votes in the election, this will not constitute a parliamentary challenge to the appointed government of the chief executive, Edmund Ho, as pro-government groups will still dominate the legislature.

Rising unemployment as Macau is affected by the current world economic downturn could, however, engender popular dissatisfaction with the government. So far, however, Macau’s close economic relationship with China has buffered it from the worst of the slump. China also recently announced several initiatives that could help to bolster Macau’s economy, in particular easing restrictions on Chinese citizens wishing to visit Macau.

Political stability will be enhanced by the liberalisation of the gambling sector, which will take place from the start of 2002. The long-standing monopoly of Sociedade de Turismo e Diversões de Macau (STDM, the Macau Tourism and Amusement Company) will be replaced by three operators, probably including large international companies. One risk is that gangs, who have retrenched their previously violent activities to controlling Very Important Person (VIP) rooms at casinos and other low-profile concerns, will battle for influence over the new gambling entrants. In anticipation of potential activity originating in Hong Kong, the government announced in late November 2001 that it was preparing a new law to prevent suspected or convicted criminals from entering Macau. The police force has also stepped up anti-crime co-operation efforts with counterparts in Hong Kong and China.

In extreme circumstances the government might be tempted to turn for help to the local unit of China’s military, the People’s Liberation Army (PLA). Such action would be seen as a challenge to Macau’s autonomy under the “one country, two systems” model, as Macau is meant to be responsible for its own internal security, leaving the PLA to look after external security. The risk of either serious renewed gang violence or PLA action is low, but will depend on the government’s management of the transition and the ability of the gambling companies to deal with criminal pressure.

Another dilemma for the government is what approach to take towards the Falun Gong, a spiritual group that has been outlawed and suppressed on the mainland. The group has been quiet in recent months in Macau, and as long as the Falun Gong remains quiescent on the mainland the government is likely to be left to deal with the probably small number of local followers as it chooses. The differing freedoms accorded to religious and other social groups by Macau and China will, however, probably lead to new challenges.

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 30 Macau

Economic forecast

Economic policy The return to economic growth in 2000, after four years of contraction, depended heavily on the booming international economy. Expansion in 2000 was driven by those sectors—gambling, tourism and certain merchandise exports—that rely on external demand. In the first half of 2001 Macau was less affected by the international slowdown than might have been expected given this dependency. The sharp fall in the value of net merchandise exports in January to August (exports fell by over 10% year on year, while imports grew at a similar rate) is, however, bound to have a negative effect on overall growth in the first half of 2001, even adjusting for price movements. The government expects real GDP to grow by 0.5-1% in 2001 after 4.6% in 2000. From mid-2002 and especially in 2003 Macau will benefit from the recovery of growth in the world economy as well as the domestic demand-stimulating effect of multiple domestic interest-rate cuts in 2001, mirroring the movement of US interest rates; Macau interest rates are based indirectly on US bank rates, reflecting the fixed link between the pataca and the US dollar. World real GDP growth in market exchange-rate terms is expected to pick up to 1.6% in 2002 from 1.2% in 2001, before accelerating to 3.3% in 2003. Over the longer term the relocation of manufacturing from Macau to the neighbouring Chinese province of Guangdong will extend to textiles and garment production as China’s entry into the World Trade Organisation (WTO) gives China increased direct access to international markets. Mainland competition, along with the phasing out of the Multi-Fibre Arrangement (MFA) quotas, which provide a near-guarantee of export markets, over the next few years, will eventually spell the end of Macau’s low-end mass production of textiles, which comprise the bulk of Macau’s merchandise export earnings. The best opportunities may lie in providing services—shipping, finance, legal— to facilitate mainland exports through Macau to the rest of the world, and conversely inflows of goods and investment to the mainland. The government is acting to promote the logistical sector, but this will be highly competitive. Tourism and associated gambling, however, will remain the keystone of Macau’s economic growth. It will be crucial to attract higher-end tourists by encouraging the development of non-gambling attractions, building an image of an orderly society and managing the liberalisation of gambling smoothly.

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 Macau 31

The political scene

A democratic group tops Macau’s first post-handover popular election took place on September 23rd the poll 2001 for the ten directly elected seats in the Legislative Assembly (Macau’s legislature). The campaign was competitive, with 96 candidates from 15 political groups contesting the directly elected seats. Macau has no political parties; political groups are usually set up only for the duration of the election. Few people turned out for rallies and speeches, however, as the election campaign was overshadowed by the aftermath of the terrorist attacks on the US. The New Democratic Macau Association, led by Antonio Ng, won the largest share of the vote, 21%, and two seats, doubling its legislative presence. Two pro-China groups followed, each also winning two seats. One group representing labour interests won 16% of the vote; another standing for neighbourhood interests won 14% of the vote. The remaining four directly elected legislators come from three groups that represent the gambling and entertainment sector, which is central to the economy.

Popular concerns are jobs Not too much should be read into the high popularity of Mr Ng’s pro- and corruption democracy group. Its main campaign issues are indicative of popular concerns in Macau: providing social welfare, tackling unemployment and rooting out corruption. In the second week of September as the 14-day campaign got under way, Commission Against Corruption officials detained 56 people on suspicions of vote-buying. More raids took place just before the election. After the election Mr Ng said that the result was proof that the election had taken place in a “sound environment” and attributed his success to a fall in voter fraud. Community issues and cutting red tape were also prominent in Mr Ng’s campaign. The call for more democracy—under the Basic Law, Macau’s mini- constitution, amendments could provide for more directly elected legislators from 2009—was not a core part of Mr Ng’s campaign. The pro-China groups had some popular candidates and, unlike most rivals, enjoyed the support of well-financed grassroots organisations to canvass voters.

In a similar system to Hong Kong, corporate groups fill ten of the 27 legislative seats, all of which were uncontested in the September election, and the chief executive appoints seven assembly members. The 17 non-directly elected members of the legislative are pro-business, pro-China and conservative, ensuring that the executive-led government has the co-operation of the assembly and that political debate can operate with near-consensus. The Legislative Assembly passes government bills, has a limited supervisory function over government actions, and can introduce its own legislation as long as it does not relate to public expenditure or the political structure of Macau and does not conflict with government policy. Legislators’ speeches can, however, sometimes be an effective expression of popular complaints.

Voter turnout was only 52%, lower than in the 1996 poll when 64% of a much smaller electorate took part. The 1996 election, which was held under Portuguese rule, was, however, tainted by claims of vote-buying and other irregularities such as the forgery of ballot papers, so the voter turnout figure for the election may not be reliable. Over 70% of respondents believed that the

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 32 Macau

legislative election was honest, fair, and just, according to a survey of 1,285 people conducted by the University of Macau after the election. About the same proportion said that they were at least satisfied with how the government held the election. People said that they voted based on candidates’ performance and plans or by class.

Economic policy and the economy

The chief executive The chief executive, Edmund Ho, announced the 2002 budget on announces tax cuts November 21st 2001, relying on tax cuts to counter the current economic downturn. Central government expenditure is budgeted to fall to MPtc12.4bn (US$1.5bn) in 2002 from MPtc13.5bn in 2003. He announced stimulatory measures including tax cuts worth MPtc250m (US$31m) and infrastructure spending of MPtc1.2bn. According to Mr Ho, the budget deficit will be MPtc700m-800m, or about 1.5% of nominal GDP, in 2002 after a surplus of MPtc400m-500m in 2001. The probable budget surplus in 2001 was attributed by Mr Ho to higher than expected revenue from direct taxes on gambling and delayed expenditure on public infrastructure projects. (The revised 2001 budget had predicted that revenue and expenditure would be in balance.)

The government expects Mr Ho did not announce the budgeted revenue figure, but it can be derived growth of 0.5-1% in 2001 from the expenditure and deficit figures that he did announce. If the deficit grows by MPtc700m (moving from budgeted balance in 2001 to a deficit of MPtc700m in 2002), while expenditure is cut by MPtc1.1bn, this implies that revenue will fall by MPtc1.8bn. Of that fall, MPtc250m is accounted for by stimulatory tax cuts, but that still leaves a MPtc1.5bn decrease in government revenue. This is equivalent to more than 10% of revenue under the revised 2001 budget. The decline in revenue is presumably caused by an officially forecast slowdown in growth to 0.5-1% in 2002.

Mr Ho also announced an increase in the gross revenue tax rate on casinos from 31.8% to 35% when the gambling industry liberalisation comes into effect in 2002. The gambling industry was the source of 60.5% of government revenue in January to October 2001 and the higher than expected rise in revenue from this source was one of the reasons the chief executive gave for the expected fiscal stimulus. Although he announced MPtc1.2bn of public infrastructure spending, slow spending on this was the other reason for the tighter than intended fiscal position in 2001. By October the government had spent only 22.7% of budgeted capital expenditure for the whole of 2001.

Unemployment rises In July-September 2001 the unemployment rate (seasonally adjusted) rose by 0.1 percentage points to 6.3% compared with June-August and the peak of 7.1% reached in the second quarter of 2000. The hotel and catering sector reported increased employment, its prosperity driven by the strength of the strong tourism sector. The construction and manufacturing sectors are experiencing labour shortages, according to the government, while real estate employers have been laying off workers.

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 Macau 33

Consumer prices fall Consumer prices fell by 1.8% year on year in January to October. In October prices fell by 2.7% year on year, compared with the 1.5% fall in prices in September. The drivers behind consumer price deflation include declining import prices and falling rents as a result of the weak property market. China’s factory gate price index for industrial products, an indicator of price deflation in exports to Macau, fell by 3.1% year on year in October, after falling by 2.9% in September.

New gambling regulations New regulations, collectively known as the Gaming Industry Regime, came are set out into effect in mid-September, governing the gambling sector, the core of Macau’s economy. Three-quarters of the 9.1m visitors to Macau in 2000 came to gamble in its 11 casinos, according to government figures. The regulations, specifying that a maximum of three companies could operate in the sector, spelled the end of the current monopoly of Sociedade de Turismo e Diversões de Macau (STDM, the Macau Tourism and Amusement Company). According to the new regime, operators will gain licences through public tender, which will be valid for 20 years, with a possible extension of five years. Under the new rules casinos must pay a tax rate on gross revenue of 35%, compared with the current rate of 31.8%, and contribute up to 5% of gross revenue to community projects or urban construction. The income of casino workers will also be taxed.

The government accepted bids from 22 companies in the public tender that closed on December 7th 2001. The huge interest expressed is not surprising because revenue per table is reckoned to be the highest anywhere in the world for lawful gambling; an STDM director has estimated the profit margin at 10%, although that will fall after the monopoly ends. The head of STDM, Stanley Ho, announced in early November that he would set up a subsidiary of STDM, Sociedade de Jogos de Macau (SJM, Macau Gambling Company) to bid for a licence. He would own 10% of SJM, STDM would hold 80%, and the remaining 10% would be held by SJM management. It is believed that he already controls about one-third of STDM, with the rest owned by Hong Kong business people, such as Henry Fok. Given STDM’s 40-year experience and connections to the Macau government and influential members of the Chinese government— despite a public relations blunder in August when Stanley Ho was quoted as saying that he had a licence reserved for him—it is highly likely that the new STDM unit will win a licence.

Air Macau has expansion Although the international airline industry has been badly affected by the plans terrorist attacks on the US in September, the airline sector in Macau is benefiting from China’s economic growth and the demand generated for transport to and from China. Air Macau Air Transport has also been affected by the loss in passenger confidence since September, in particular on its mainstay route to Taiwan. The route accounts for about 70% of Air Macau’s traffic (passengers and cargo), but the load had fallen by 50-60% by late October, according to Henry Leung, the Air Macau executive director. In 2000 Air Macau carried 1.6m passengers and 19,480 tonnes of cargo. The second pressure on Air Macau to diversify is the prospect that Taiwan and China may agree to open direct transport links. At present, for national security reasons, the

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 34 Macau

Taiwan government bans direct flights to China. The Macau airline sector has thus benefited from increased economic integration between Taiwan and China, which has created demand, particularly from Taiwanese business travellers visiting China, for flights via Macau.

The Singapore government-linked carrier, Singapore Airlines, operates three A logistics centre may boost cargo flights each week to Los Angeles via Macau. Macau’s airport operator, the air freight sector Sociedade do Aeroporto Internacional de Macau, has proposed to develop a free-trade logistics centre to enable Macau to benefit from increased trade flows resulting from China’s entry to the World Trade Organisation (WTO) in December 2001. The proposal would create a zone where cargo would be stored and consolidated without going through customs, thus lowering handling costs, which are already lower than in Hong Kong. The volume of air freight passing through Macau airport increased by 6.3% year on year in the first half of 2001 to 38,000 tonnes; cargo tonnage grew by 28% in 2000.

Goods trade is hit by the Merchandise export earnings decreased by 10.5% year on year in January to global downturn August to MPtc12.3bn, as a result of the world economic slowdown. In June, July and August the year-on-year percentage declines in exports were all in double figures, whereas in the preceding three months, they were in single figures. The growth of merchandise imports has followed the export trend, but with a considerable lag. A large proportion of imports are of inputs that are assembled for re-export in Macau, and demand for such items would therefore be directly linked to export volumes. Merchandise imports grew by 10.3% year on year in the first eight months of 2001 to MPtc12.9bn, but rose by only 0.7% year on year in August after a year-on-year increase of 4.7% in July. The trade balance, which had been in deficit in February to May, registered increasing surpluses in June to August.

Tourism growth to slow The government expects visitor arrivals to rise by 14% in 2001, which is probably overoptimistic. In January to September 2001 7.7m visitors came to Macau, an increase of 12.6% year on year. Although the number of visitors fell by 25.8% between August and September, there were exceptional factors behind this. August is usually the peak month in the year because of the holiday season. Moreover, Macau’s first outbreak of dengue fever began on August 30th, with over 1,000 cases reported by mid-October, by which time the number of new cases each day was slowing. This was a mild form of dengue fever and no one has died in this outbreak. Even with the outbreak, the number of visitors still rose in year-on-year terms in September 2001.

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001 Macau 35

The government seeks to The Macau Government Tourist Office is seeking to diversify the tourism diversify tourism sector’s reliance on gambling visitors by promoting the city as a destination for corporate meetings and trade fairs. In 2000 the number of such events grew by 20% to 248, with each event on average attracting more participants. The total number of participants was 20,108 and, although that is a tiny fraction of the total number of visitors to Macau, such corporate and trade visitors generate more revenue than the average visitor. Macau’s main selling point in this field is its mixed culture, making it a natural venue for contact between Portuguese- speakers, particularly Brazilians, and Chinese entrepreneurs wishing to do business with the Portuguese-speaking world. This is a niche sector at best, although as conference and convention facilities improve Macau may benefit from its more relaxed and European environment compared with Hong Kong. STDM claims to share the Tourist Office’s goal of wishing to encourage tourists to visit not just to gamble, but to spend money on other leisure pursuits. STDM has therefore built the Macau Tower Convention and Entertainment Centre, due to open in December 2001. The tower will be the tenth tallest in the world and will include corporate meeting, exhibition and sightseeing facilities as well as a rotating restaurant and theatre. STDM also began building the Macau Fisherman’s Wharf in September, a theme park-like project along the lines of attractions at Las Vegas in the US.

EIU Country Report December 2001 © The Economist Intelligence Unit Limited 2001