COUNTRY REPORT

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

OVERVIEW Hong Kong’s generally well received budget may boost the low popularity of the government of the chief executive, Tung Chee-hwa. The economy will begin to recover in 2002, driven by external demand, but will be held back by weak domestic demand. Real GDP will grow by 1.5% in 2002 after growth of 0.1% in 2001, and then accelerate to 3.4% 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 • Mr Tung’s recent appointment to a second five-year term as Hong Kong’s leader has surprised few people. He is unlikely to undertake any radical changes to the political system. Economic policy outlook • The new budget did not contain any significant measures to tackle the large budget deficit in 2002/03, except for a proposed cut to public-sector pay in the middle of the fiscal year. Economic forecast • The Economist Intelligence Unit has revised down its real GDP growth forecast for 2002 to 1.5% from 1.7% because of the worsening outlook for private consumption. Unemployment is rising, consumer confidence is low and there is little prospect in the short term of a property market revival that would support household balance sheets.

March 2002

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.

London New York Hong Kong The Economist Intelligence Unit The Economist Intelligence Unit The Economist Intelligence Unit 15 Regent St The Economist Building 60/F, Central Plaza London 111 West 57th Street 18 Harbour Road SW1Y 4LR New York Wanchai United Kingdom NY 10019, US Hong Kong Tel: (44.20) 7830 1007 Tel: (1.212) 554 0600 Tel: (852) 2585 3888 Fax: (44.20) 7830 1023 Fax: (1.212) 586 0248 Fax: (852) 2802 7638 E-mail: [email protected] E-mail: [email protected] E-mail: [email protected]

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Copyright © 2002 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author’s and the publisher’s ability. However, the EIU does not accept responsibility for any loss arising from reliance on it.

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 21 The domestic economy 21 Output and demand 23 Employment, wages and prices 24 Financial indicators 26 Sectoral trends 28 Foreign trade and payments

Macau

30 Political structure 31 Economic structure 31 Annual indicators 32 Quarterly indicators 33 Outlook for 2002-03 33 Political outlook 33 Economic forecast 35 The political scene 36 Economic policy and the economy

List of tables

10 Hong Kong: international assumptions summary 11 Hong Kong: forecast summary 13 Hong Kong: gross domestic product by expenditure 18 Hong Kong: consolidated budget summary 21 Hong Kong: gross domestic product 22 Hong Kong: retail sales

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25 Hong Kong: financial indicators 28 Hong Kong: external trade 29 Hong Kong: balance of payments

List of figures

14 Hong Kong: gross domestic product 14 Hong Kong: Hong Kong dollar real exchange rates 22 Hong Kong: selected components of GDP 23 Hong Kong: unemployment rate 24 Hong Kong: composite consumer price index 34 Macau: gross domestic product 34 Macau: pataca real exchange rates 38 Macau: consumer price inflation, 2001 39 Macau: merchandise trade

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Summary

March 2002

Hong Kong

Outlook for 2002-03 The 2002/03 budget obtained popular approval, largely because the government did not fulfil the expectations that it had generated of an imposition of major new taxes in the current fiscal year. The secretary for justice, Elsie Leung, has sparked fears that the government may push on with the enactment of laws against treason, secession, sedition and subversion, potentially limiting the freedoms enjoyed by Hong Kong residents. Real GDP will grow by only 1.5% in 2002, despite recovery in the global economy, as domestic demand will be weak. The current account will remain in surplus in 2002-03.

The political scene Tung Chee-hwa has secured a second five-year term as chief executive of Hong Kong. Political parties within the Legislative Council have united to put forward budget proposals. The main outstanding case in the right of abode controversy has been settled. Legal reform proposals have been aired.

Economic policy The budget did not include major revenue-raising measures, but did include limited relief measures. Mr Tung has outlined an ambitious infrastructure plan. Help is being provided to homeowners suffering from negative equity. Government revenue has dropped because of the weak economy. A range of views have been aired on a proposed sales tax. Casinos have been ruled out in Hong Kong. A pay review for public-sector employees is under way. Streamlining the civil service has proved costly. Transport fares have been frozen until the year-end.

The domestic economy The economic slowdown has been led by the external sector. Retail sales have declined further. Consumer confidence has been fragile. Unemployment has reached a record high. A survey has shown that firms perceive costs as high and workers as having poor English. Consumer price deflation has accelerated in recent months. The Hang Seng Index performed poorly in 2001. The Enron scandal has led to a tightening of accounting rules. High renumeration packages awarded to themselves by executives have caused concern in Hong Kong. Changes to corporate governance rules have been proposed. Gambling revenue fell in 2001. More visitors arrived in Hong Kong in 2001, but they stayed for shorter periods. Banks have proposed to share selected information about clients to minimise lending risks. The telecommunications regulator has announced that the fixed-line telephone market is to be liberalised. The number of property transactions has risen but the market remains weak. The government is considering setting aside land for foreign investment. A controversial project to build a new transport route has passed the first stage of legislative approval.

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Foreign trade and The value of both merchandise exports and imports has decreased. The balance payments of payments moved into deficit in the third quarter of 2001 because of a huge net outflow of financial non-reserve assets. Net direct investment inflows have also dropped.

Macau

Outlook for 2002-03 The political situation will remain stable as the chief executive, Edmund Ho, enjoys the support of both the people and the Chinese government. The economy is undergoing a sharp slowdown led by the external sector, but will benefit from increased numbers of gamblers visiting from the mainland and the recovery of the world economy in 2002.

The political scene Chinese officials have expressed their support for Mr Ho, who has also had high approval ratings in Macau. Arson and bomb attacks have raised the spectre of a return to disorder. Macau has gained prominence in China-Taiwan relations. Hong Kong journalists have claimed that the Macau police assaulted them. The liberalisation of the gambling industry is under way. China’s ban on gambling has encouraged visitors to travel to Macau.

Economic policy and the Unemployment remains high. Consumer price deflation has worsened. economy Merchandise exports have fallen whereas merchandise imports have risen. The number of visitor arrivals has grown. The merchandise trade deficit was probably partly, if not completely, offset by a stronger services balance in 2001.

Editors: Duncan Wrigley (editor); Leo Abruzzese (consulting editor) Editorial closing date: March 12th 2002 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 45 years. Presided over by a chief executive appointed by China

The executive Thirteen-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 mainly consisting of delegates chosen by functional constituencies such as business groups and unions

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 and the SAR has autonomy in other affairs

Elections The most recent Legco election was in September 2000. The next legislative election is due in 2004. Tung Chee-hwa was reappointed as chief executive in March 2002 after his unopposed election by an 800-member committee. The next chief executive election is due in 2007

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

1997 1998 1999 2000 2001a GDP at market prices (HK$ bn) 1,323.9 1,259.3 1,227.0 1,266.7 1,262.6b GDP (US$ bn) 171.0 162.6 158.2 162.6 161.9b Real GDP growth (%) 5.0 –5.3 3.0 10.5 0.1b Consumer price inflation (av; %) 5.7 2.8 –4.0 –3.8 –1.6b Population (m) 6.5 6.5 6.6 6.7 6.7b Exports of goods fob (US$ m)c 192,191 175,833 174,719 202,698 186,231 Imports of goods fob (US$ m)c 209,489 183,666 177,878 210,891 202,884 Current-account balance (US$ m) –6,159 3,905 11,483 8,843 5,056 Foreign-exchange reserves excl gold (US$ m) 92,804 89,606 96,236 107,542 111,155 Total external debt (US$ bn) 40.4 48.3 38.2 42.2 46.2 Debt-service ratio, paid (%) 1.5 2.5a 2.7a 1.9 a 2.3 Exchange rate (av) HK$:US$ 7.74 7.75 7.76 7.79 7.80b

March 11th 2002 HK$7.8:US$1

Origins of gross domestic product 2000 % of total Components of gross domestic product 2001 % of total Primary industries 0.1 Private consumption 58.5 Manufacturing 5.8 Government consumption 10.3 Utilities 3.0 Gross fixed capital formation 25.8 Transport, storage & communications 10.1 Stockbuilding 0.0 Construction 5.3 Exports of goods & services 143.9 Wholesale & retail import & export trade 26.3 Imports of goods & services –138.6 Finance, insurance, real estate & business services 23.5 Total at current market prices 100.0 Total incl others at factor cost 100.0

Principal domestic exports fob 2001 US$ bn Principal imports cif 2001 US$ bn Clothing 9.3 Electrical machinery & appliances 33.7 Electrical machinery & apparatus 2.6 Telecommunications & sound equipment 20.3 Textiles, yarn & fabric 1.1 Office machinery 19.0 Jewellery 0.6 Clothing 16.1 Office machinery parts & accessories 0.6 Textiles, yarn & fabric 12.2 Total incl others 19.7 Total incl others 201.1

Main destinations of exports 2001 % of total Main origins of imports 2001 % of total China 36.9 China 43.5 US 22.3 Japan 11.3 Japan 5.8 Taiwan 6.9 UK 4.1 US 6.7 a EIU estimates. b Actual. c Balance-of-payments basis.

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Quarterly indicators

2000 2001 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr General government finance (HK$ bn) Revenue 77.53 27.03 22.02 56.63 73.05 27.87 17.95 n/a Expenditure 48.50 45.13 46.64 46.74 53.66 47.92 51.39 n/a Balance 29.03 –18.10 –24.62 9.89 19.39 –20.05 –33.44 n/a Output GDP at constant 1990 prices (HK$ bn) 209.0 213.2 234.8 236.4 213.5 214.8 233.7 232.6 % change, year on year 14.1 10.7 10.7 7.0 2.2 0.8 –0.4 –1.6 Manufacturing index (1986=100) 90 103 110 107 90 103 102 n/a % change, year on year –1.1 –1.0 –0.1 –0.2 –0.2 –0.1 –7.1 n/a Employment and prices Employment (end-period; ’000) Internal tradea 1,027.9 1,036.4 1,053.3 1,009.1 1,017.1 1,034.9 1,027.3 n/a Financial servicesb 414.8 429.3 437.0 434.1 428.9 442.5 437.3 n/a Manufacturing 233.7 238.8 229.4 226.2 217.0 218.7 209.3 n/a Unemployment rate (% of the labour force; seasonally adjusted) 5.8 5.2 4.9 4.5 4.5 4.5 5.0 5.8 Consumer prices (1999/2000=100) CPI (A)c 100.1 99.5 99.2 99.0 98.1 98.4 98.4 96.2 % change, year on year –4.1 –3.4 –2.0 –2.2 –2.0 –1.1 –0.8 –2.9 Composite CPI 100.0 99.6 99.0 98.9 98.1 98.2 97.9 96.9 % change, year on year –5.2 –4.5 –2.8 –2.5 –1.9 –1.4 –1.1 –2.1 Financial indicators Exchange rate HK$:US$ (av) 7.78 7.79 7.80 7.80 7.80 7.80 7.80 7.80 HK$:US$ (end-period) 7.79 7.79 7.80 7.80 7.80 7.80 7.80 7.80 Interest rates (av; %) Prime lending 8.75 9.33 9.50 9.50 8.50 7.17 6.42 5.29 Money market 5.69 6.04 5.90 6.17 5.48 3.96 3.54 2.75 M2, HK$ (end-period; HK$ bn)d 1,864.7 1,894.7 1,947.3 1,980.4 1,971.7 1,976.1 1,988.2 1,992.4 % change, year on year 4.1 4.2 6.5 5.2 5.7 4.3 2.1 0.6 Hang Seng stockmarket index (end-period; Jul 31st 1967=100) 17,407 16,156 15,649 15,096 12,761 13,043 9,951 11,397 % change, year on year 59.1 19.4 22.9 –11.0 –26.7 –19.3 –36.4 –24.5 Sectoral trends Building work completed (private; usable floor area; ‘000 sq m) Total 355 408 234 479 275 351 312 n/a Passenger arrivals (‘000) 16,729 17,924 18,793 18,588 18,001 18,311 19,013 n/a Retail sales (1994/95=100) (Value; % change, year on year) 7.5 4.9 2.0 0.9 0.0 2.4 –2.0 –5.3 (Volume; % change, year on year) 14.1 10.9 5.6 3.2 2.5 4.9 0.5 –3.0 Foreign trade (HK$ bn) Exports fob 339.9 382.1 432.6 420.0 347.5 363.9 401.6 369.5 Re-exports fob 298.3 337.7 382.2 375.2 312.4 324.6 360.1 331.8 Imports cif –363.6 –406.8 –449.4 –440.3 –376.8 –393.1 –420.0 –381.4 Trade balance –23.7 –24.7 –16.8 –20.3 –29.3 –29.2 –18.4 –11.9 Foreign reserves (US$ bn) Reserves excl gold (end-period) 93.81 97.08 101.48 107.54 114.59 114.07 113.42 111.16 a Wholesale, retail and import/export trades, restaurants and hotels. b Financing, insurance, real estate and business services. c Low-income group. d Local definition.

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

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Outlook for 2002-03

Political outlook

Domestic politics The 2002/03 budget, presented in early March 2002 by the financial secretary, Antony Leung, received high approval ratings (70-80%) in snap surveys of public opinion conducted immediately afterwards by local newspapers. This is because he did not impose major new taxes, the introduction of which the public had been led to expect in the weeks before the budget. Government officials had warned that the current huge fiscal deficit, extrapolated over seven years, would exhaust fiscal reserves. A task force had also concluded that the deficit had become structural—that is, that the budget would not be balanced across the economic cycle as a whole. The government is obliged under the Basic Law, Hong Kong’s mini-constitution, not to run a structural deficit. Mr Leung met this obligation by pledging to bring the budget into balance by 2006/07, but was short on details of how this would happen. Although the budget has been well received by most groups in Hong Kong, civil service unions were upset by the budget “assumption” of a mid-financial year (October 2002) 4.75% cut to the wages of civil servants and other public- sector employees financed by the government budget. The government will not make a formal decision on public-sector wages until the pay review process is completed in May, but the outcome is likely to be in line with the budget assumption. Civil service unions would be unlikely to be able to arouse much sympathy should they protest against a pay cut, as unemployment is rising and many in the private sector have taken pay cuts over the last year.

In late February Elsie Leung, the secretary for justice, announced that she had recently discussed the drawing up of legislation prohibiting treason, secession, sedition and subversion with mainland officials, giving rise to fears that the process might be coming to a conclusion. Article 23 of the Basic Law requires Hong Kong to enact such laws. The Department of Justice has been examining how other legal systems treat the issue. However, such laws could conflict with Hong Kong’s civil and political freedoms by, for instance, limiting Hong Kong residents’ freedom to speak out against the Chinese regime or by defining the Falun Gong—a spiritual group banned on the mainland but permitted in Hong Kong—as an unlawful cult. In early March pro-China elements in Hong Kong put pressure on the government to restrict the Falun Gong’s use of public venues. The government has so far avoided pushing through Article 23 legislation, aware of the dilemma between framing it to please the government in Beijing and restricting rights in Hong Kong, thereby drawing a torrent of international criticism. This dilemma remains and, despite recent media attention, there is no obvious reason for the government to push ahead now.

Chief executive watch Tung Chee-hwa has been reappointed by China’s State Council (cabinet) for a second five-year term as chief executive of Hong Kong after an uncontested selection procedure. He had no challengers. Any challenger would have needed the public endorsement of 100 members of the 800-strong Election Committee, who would thereby have revealed themselves to be opponents of

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Mr Tung, who was the firm favourite of the government in Beijing. In his second term he is unlikely to push for a fully elected legislature or reforms that would make the government more accountable to the legislature or the people.

Economic policy outlook

Policy trends Hong Kong’s fiscal position deteriorated sharply in 2001/02, and there will also be a large budget deficit in 2002/03. In the medium term the government will seek to exploit the opportunities—and minimise the risks—arising from China’s membership of the World Trade Organisation (WTO), which became effective on December 11th 2001. In the 2002/03 budget statement Mr Leung stressed the need to develop high value-added economic activities, in particular financial services, logistics, tourism, business support and professional services. It is hard to argue with his emphasis on moving towards higher-value economic activities to support Hong Kong’s high standard of living, but the government has yet to reveal a convincing game plan on how it will accomplish this. Of the four areas mentioned, only tourism has the potential to make a dent in the high rate of unemployment.

Fiscal policy Hong Kong’s consolidated budget deficit for fiscal year 2001/02 (April-March), at HK$65.6bn (US$8.4bn) or 5.2% of GDP, was much higher than originally forecast by the government. The government now officially recognises the deficit to be structural—that is, that it will not be balanced over the business cycle. Therefore, under the Basic Law, the territory’s mini-constitution, the government must act to eliminate the structural element of the deficit. In the 2002/03 budget, however, Mr Leung refrained from any significant revenue- raising measures. Instead, he announced targets of balancing the budget (both the consolidated and operating accounts) and reducing government expenditure to below 20% of GDP by 2006/07 (from 22% in 2001/02). The government budget expects the consolidated deficit to narrow to HK$45.2bn in 2002/03 from HK$65.6bn in 2001/02. Consolidated revenue is forecast to rise to HK$214.6bn in 2002/03 from HK$174bn in 2001/02, but this is based on three bold assumptions. The first is that the revenue of the capital works revenue fund, mainly earnings from land sales, will increase to HK$25.6bn from HK$10bn in 2001/02. This is unlikely given the weak property market. The second is that the sale of a second tranche of Mass Transit Railroad Corporation (MTRC) equity will raise HK$15bn. The government delayed the sale in 2001/02 because of adverse market conditions and it is far from certain that it will proceed in 2002/03. The third is that the government secures Legco approval for a 4.75% cut in public-sector wages in the middle of the fiscal year, as the budget assumes. Civil service unions are bound to oppose such a cut, but such a measure is gathering support in the context of recent announcements of private-sector pay cuts.

Large budget deficits are not, however, a major short-term threat. Hong Kong has in the past run fiscal surpluses and has accumulated a large fiscal reserve— the government expects it to stand at HK$369.8bn on March 31st, the end of the fiscal year. It will therefore have no trouble financing budget shortfalls for years to come.

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Monetary policy The benchmark base rate of the Hong Kong Monetary Authority (HKMA, the Hong Kong equivalent of a central bank) will shadow its counterpart in the US, the federal funds target rate, owing to the fixed link between the Hong Kong and US dollars. Interest rates in the US, and hence in Hong Kong, will not begin to rise markedly again until the US recovery is well under way in 2003. Mr Leung affirmed the fixed-link policy in his budget speech and it is credible at present. The main risk is of a sharp or sustained fall in the yen, perhaps precipitated by changes in rules at the start of the Japanese financial year leading to a loss of investor confidence in the Japanese financial system—but this is not the Economist Intelligence Unit’s central forecast. Should the yen experience severe weakness, however, that would put pressure on regional currencies, including the Hong Kong dollar, to devalue.

Economic forecast

International assumptions The worst of the current downturn in the global economy has passed. Annual average world growth in 2002, at 1.4% (at market exchange rates), is not expected to be much higher than in 2001, when the world economy expanded by 1.3%, but the pattern is one of accelerating growth throughout the year. Real economic growth in the US—Hong Kong’s second largest export market— is estimated to have been 1.1% in 2001. The US recovery is now deepening and a faster rate of growth is expected in 2002. The Chinese economy, Hong Kong’s main export market, will decelerate slightly to grow by 7.2% in 2002, before picking up to 7.6% in 2003. World goods trade in 2002 will expand by just 0.9%, little better than in 2001, before rebounding to grow by 7% in 2003. As an extremely open economy, Hong Kong will benefit greatly from the recovery in international trade growth.

Hong Kong: international assumptions summary (% unless otherwise indicated) 2000 2001 2002 2003 Real GDP growth World 4.7 2.2 2.5 4.1 OECD 3.8 1.0 1.1 2.9 EU 3.4 1.6 1.3 2.5 Exchange rates (av) ¥:US$ 107.8 121.5 135.3 129.8 US$:¤ 0.924 0.896 0.885 0.970 SDR:US$ 0.758 0.785 0.800 0.769 Financial indicators ¥ 2-month private bill rate 0.24 0.18 0.00 0.00 US$ 3-month commercial paper rate 6.32 3.59 1.98 4.88 Commodity prices Oil (Brent; US$/b) 28.5 24.5 19.6 20.5 Gold (US$/troy oz) 279.3 271.1 281.7 287.0 Food, feedstuffs & beverages (% change in US$ terms) –6.1 –1.0 11.4 13.6 Industrial raw materials (% change in US$ terms) 13.4 –9.7 1.3 14.8

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

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Economic growth We have lowered our forecast for real GDP growth in Hong Kong in 2002 to 1.5% from 1.7%. The revision comes in response to the gloomier outlook for private consumption, as unemployment has grown swiftly and consumer confidence is at a low ebb. The outlook for the property market is poor; developers are holding back new flats from the market in the New Territories because prices are so low. Therefore households’ balance sheets will remain weak, fuelling reluctance to spend on large items. This is borne out in recent consumer confidence surveys and data for retail sales. The retail figure for January 2002 was especially poor because of the timing of the Chinese New Year, which fell in February this year but in January in 2001. Nonetheless, the previous four months all recorded year-on-year drops in retail sales value of around 5%. Manufacturing is faring no better: industrial production fell by 7.1% year on year in the third quarter of 2001, the sharpest decrease since the first quarter of 1999. As the economic outlook at home and abroad is unlikely to improve in the short term, investment will stagnate.

Real GDP contracted by 1.6% year on year in the fourth quarter of 2001, after falling by 0.4% year on year in the third quarter. The slowdown has been led by the external sector. In year-on-year terms, merchandise exports on a national-accounts basis fell by 8.8% in the fourth quarter of 2001, continuing a year-long deterioration. This was matched by a 9.1% year-on-year decline in merchandise imports. Exports of goods and services were worth about 144% of nominal GDP in 2001.

Hong Kong: forecast summary (% unless otherwise indicated) 2000a 2001b 2002c 2003c Real GDP growth 10.5 0.1a 1.5 3.4 Industrial production growth –0.6 –9.0 –3.7 –2.5 Gross fixed investment growth 9.8 2.1a 1.2 4.5 Unemployment rate (av) 5.1 5.1 a 6.4 5.5 Consumer price inflation Average –3.8 –1.6 a –1.8 –0.5 Year-end –2.1 –3.5a –0.8 –0.2 Short-term interbank rate 9.5 5.1 a 5.2 6.6 Government balance (% of GDP) –0.3 –5.2 –5.8 –5.6 Exports of goods fob (US$ bn) 202.7 186.2 186.4 204.7 Imports of goods fob (US$ bn) 210.9 202.9 204.6 227.6 Current-account balance (US$ bn) 8.8 5.1 4.1 3.4 % of GDP 5.4 3.1 2.6 2.1 External debt (year-end; US$ bn) 42.2 46.2 50.8 58.9 Exchange rates HK$:US$ (av) 7.79 7.80a 7.80 7.80 HK$:¥100 (av) 7.23 6.42a 5.77 6.01 HK$:¤ (year-end) 7.25 6.94 a 7.25 7.88 HK$:SDR (year-end) 10.16 9.80 a 9.95 10.30

a Actual. b EIU estimates. c EIU forecasts.

Hong Kong has been sheltered from the global downturn by its integration with the strong mainland economy, which grew by 7.3% in 2001. The growth

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of China’s merchandise exports has been surprisingly robust given the weak international economy, growing by 6.8% in 2001 and by 14.1% year on year in January-February 2002. However, merchandise exports from China’s Guangdong province, the prime source of Hong Kong re-exports originating in China, grew by only 2.6% in 2001; Hong Kong’s re-exports fared even worse, contracting by 4.6% in Hong Kong dollar terms. This points to the danger that Hong Kong’s logistics and trade-support services sector will fail to compete with mainland ports unless it improves its competitiveness.

The cyclical downturn will ease later in 2002, as external demand rises and the effect of a fiscal stimulus feeds through. US growth already appears to be gathering momentum, although there is a risk of a slide back into recession if US consumers lose confidence (this is not our main forecast). Prospects for Hong Kong’s other main trading partners will improve in 2002-03, and external demand will be the engine of Hong Kong’s recovery. Hong Kong’s advantageous relationship with China, which entered the WTO in December 2001, will facilitate a resurgence of investment growth in Hong Kong in 2003 and beyond. We forecast that real GDP growth will pick up from 1.5% in 2002 to 3.4% in 2003 as Hong Kong is pulled along by China’s economic strength.

Inflation Deflationary forces in Hong Kong have continued and will persist for much of 2002. In year-on-year terms, the composite consumer price index (CPI) fell by 3.5% in January 2002 and by 3.6% in December 2001 after a 1.4% decline in November. The government attributed the accelerating deflation to one-off factors—a waiver on public housing rentals, a reduction in rate payments (a charge on property use) and a rebate on electricity charges (see The domestic economy). Even once these are excluded, consumer prices still decreased by an average of 1.5% in December-January, faster than the average of the previous three months, 1.2%.

Four underlying factors are pushing down the CPI: deflation in China, which is depressing prices in Hong Kong as the two economies increase trade and economic links; weak domestic demand; soft world commodity prices, especially for oil; and a strong Hong Kong dollar relative to the yen and other Asian currencies. Combined with weak domestic demand, imported deflation will prolong consumer price declines in 2002/03, although prices will fall at a slower rate in 2003. An export-led recovery starting in late 2002, together with accelerating price rises on the mainland, will slow the fall of consumer prices in 2003. Consumer prices fell by 1.6% in 2001. We expect them to fall by 1.8% in 2002 and by 0.5% in 2003.

Exchange rates Although growth prospects are poor, another regional financial crisis leading to renewed attacks on the Hong Kong dollar is not forecast. Even if such an onslaught were to recur, the authorities would now be better prepared for it than they were in 1997-98 and would doubtless be able to fight it off successfully. As the need for stability in the business environment is the main priority of the authorities, the pre-crisis discussion on optimal exchange-rate regimes will continue to be shelved, along with proposals for alternatives such as dollarisation or pegging the Hong Kong dollar to a trade-weighted basket of currencies. Argentina’s decision to eliminate its currency board and float the

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peso is unlikely to have any residual effect on Hong Kong’s currency board regime. The Hong Kong dollar will therefore remain linked to the US dollar at the rate of HK$7.8:US$1 in 2002-03 and well beyond.

Hong Kong: gross domestic product by expenditure (HK$ m at constant 1990 prices; % change year on year in brackets unless otherwise indicated) 2000a 2001a 2002b 2003b Private consumption 492,018.0 501,824.0 496,805.8 501,773.8 (5.4) (2.0) (–1.0) (1.0) Public consumption 65,529 68,840 72,282 75,173 (2.1) (5.1) (5.0) (4.0) Gross fixed investment 255,260 260,691 263,819 275,691 (9.8) (2.1) (1.2) (4.5) Final domestic demand 812,807 831,355 832,907 852,638 (6.5) (2.3) (0.2) (2.4) Stockbuilding 14,791 –1,785 2,000 2,500 (3.2) c (–1.9) c (0.4) c (0.1) c Total domestic demand 827,598 829,570 834,907 855,138 (10.0) (0.2) (0.6) (2.4) Exports of goods & services 1,889,227 1,849,050 1,886,031 2,031,255 (16.7) (–2.1) (2.0) (7.7) Imports of goods & services –1,823,562 –1,784,033 –1,812,578 –1,946,708 (16.7) (–2.2) (1.6) (7.4) Foreign balance 65,665 65,017 73,453 84,547 (1.2) c (–0.1) c (0.9) c (1.2) c GDP 893,263 894,587 908,361 939,685 (10.5) (0.1) (1.5) (3.4)

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

External sector The slowdown in exports will not have a large impact on the current-account balance, which is expected to maintain a small surplus (2.6% of GDP in 2002 and 2.1% in 2003) over the next two years. One reason is that a high proportion of exports are import-dependent, as re-exports of goods imported from elsewhere account for most (89.6% by value in 2001) of Hong Kong’s merchandise exports. Therefore, a slowdown in exports necessarily entails a corresponding slowdown in imports. Another reason is that domestic demand will lag behind the external recovery because households will be reluctant to spend in the context of high unemployment and weak balance sheets, as they seek to rebuild wealth lost in falling property values. Wage decreases also tend to lag behind economic slowdowns, holding back recovery in domestic demand. The recovery of total trade in 2002 will be gradual, but will get firmly under way in 2003. Services imports will also grow more slowly as a result of slower merchandise trade growth, helping to maintain a small surplus on the current account, while services exports pick up in line with tourism from the mainland.

EIU Country Report March 2002 © The Economist Intelligence Unit Limited 2002 14 Hong Kong

The political scene

Mr Tung secures a second The “election” for Hong Kong’s top official, the chief executive, in effect ended term as chief executive on the day that nominations opened, February 15th 2002, when it became clear that the incumbent, Tung Chee-hwa, would not face a challenger. Mr Tung secured nominations from 712 of the 794 members of the Election Committee, which comprises politicians and representatives of business and social groups. (Under the Basic Law, Hong Kong’s mini-constitution, there are 800 Election Committee members, but some people occupied more than one eligible post.) Nominations for chief executive candidates require the public endorsement of at least 100 members of the Election Committee, each of whom is allowed to back only one candidate. Mr Tung went to Beijing on March 7th to be appointed formally to his second five-year term.

Mr Tung had kept everyone guessing about his intentions until mid-December 2001. Then, before a select audience of supporters, mainland cadres and businessmen, Mr Tung declared that he would run for the office again. He admitted his shortcomings and promised to do better. The composition of the audience differed little from the Election Committee. Only 24 of the 794 committee members have been directly elected—24 of the 60 members of the Legislative Council (Legco, or Hong Kong’s legislature). The committee includes around 200 ex officio members of such bodies as Legco and the National People’s Congress (NPC, the Chinese legislature) and 600 represent- atives elected by 200,000 members of business, religious and other social groups. The committee members were not required to put themselves forward specifically for the privilege of playing a part in the chief executive election, as Mr Tung’s government had proposed. Instead, Legco agreed that the Election Committee formed in July 2000 to return six members to Legco would also be charged with selecting the second-term chief executive.

Two factors contributed to the overwhelming nomination of Mr Tung for a second term. The first was the stipulation that nominators must publicly attach their names to a candidate, and thus risk retaliation from Mr Tung’s supporters among the business community and mainland officials such as

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China’s president, Jiang Zemin, who endorsed Mr Tung in November 2000 and then several times in 2001. The second factor was that the known opponents of Mr Tung wished to avoid giving the election a semblance of legitimacy by advancing a rival candidate, given that, in their view, the election result was a foregone conclusion. Mr Tung was not nominated for his popularity. Before the election, opinion polls had shown Mr Tung to be unpopular. Polls published in December 2001 showed that public satisfaction with his performance was running at 25% and support for his standing for a second term at 16%.

Legco unites to put The re-elected chief executive is facing an increasingly obstreperous Legco. After forward budget proposals Mr Tung’s October 2001 policy address, legislators formed an eight-party coalition, with a large majority in Legco, expressing the belief that the government’s priority should be to address the economic downturn and its effect on people’s living standards. Its proposals—no new taxes or increases in government-administered fees and charges—were largely met in the 2002/03 budget (see Economic policy). The coalition also called for a reduction in civil service costs and numbers and imposed a freeze on directorate grade civil servant positions. The coalition is led by James Tien, the chairman of the Liberal Party, a group regarded as pro-business. The coalition includes the usually pro- government “patriotic” parties, the Democratic Alliance for the Betterment of Hong Kong (DAB), the Hong Kong Progressive Alliance (HKPA) and the left- wing union party, the Federation of Trade Unions (FTU), as well as opponents of the government, the Hong Kong Democratic Party (DP) and the Frontier party.

Legislators have also been less willing to rush through approval of government- proposed legislation. By mid-March 14 bills had been approved. Around 34 bills are still being vetted, 18 of these left over from the 2000/01 session, and the government plans to submit 17 more bills this session. Legco has become far less willing to trust the government’s legal drafts since the copyright ordinance had to be suspended in April 2001. The copyright ordinance caused a public uproar because of its stringent restrictions, including copying of newspaper clippings by schools and businesses. At a fine of HK$50,000 (US$6,400) per infringed article and even a potential jail sentence, copying one newspaper article for a class of students or a group of colleagues could have resulted in stiff penalties. The consequent public outrage at the restrictions and penalties led to apologies from Legco members.

The right of abode On January 10th 2002 the Court of Final Appeal (CFA, Hong Kong’s highest controversy is settled judicial body) ruled on the main outstanding case in the long-running battle over right of abode in Hong Kong. The issue began in January 1999, when the CFA issued a sweeping ruling claiming the power to determine its own jurisdiction and granting abode rights to mainlanders who were the children or spouses of Hong Kong residents. The government, estimating that up to 1.6m mainlanders would gain this right, appealed against the CFA ruling to the NPC standing committee (NPCSC), the decision-making body of the mainland legislature and the highest political organ under China’s constitution. The NPCSC in June 1999 reversed the CFA ruling in a terse, two-page instruction. The incident cast doubt on the rule of law in Hong Kong, the independence of its courts and its autonomy from the mainland government.

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Although mainland officials meant their interpretation to cover all aspects of right of abode cases, it failed to clarify specific cases, including those where mainland children had been adopted by parents with right of abode in Hong Kong; the cases of mainlanders whom the government had persuaded in 1998 not to seek legal aid; and a case involving more than 5,000 litigants in circumstances identical to those of the litigants in the original CFA-ruled case. The NPCSC interpretation did not apply retroactively to the original litigants. Government officials had promised before the CFA made its first ruling that the other 5,000 people would be covered by the judgement. After the June 1999 NPCSC reinterpretation, the government reneged on its promise and took the matter to the CFA. The government argued that the CFA had exercised the power of final adjudication only over those named in the original suit.

The CFA ruled in January 2002 that all but about 500 of the 5,114 claimants did not have the right of abode in Hong Kong. Only those who had received certification of their status or who could demonstrate proof of having registered for right of abode before January 1999 could remain. The government has said that the others must leave by the end of March and has assured them that they will not be punished by mainland authorities on their return. Tensions have ridden high over the issue, sparking hundreds of demonstrations and sit-ins by supporters and an attack in August 2000 on immigration headquarters that resulted in the fiery deaths of an immigration officer and a mainland applicant. The seven attackers were sentenced in February 2002 to various jail terms. Whether applicants denied right of abode will leave peaceably by the deadline is an open question. Many have said that they will appeal to the UN and mainland authorities on the basis that China and Hong Kong are signatories to human-rights conventions that protect family formation and the right of family reunification. The prospects of their gaining the right of abode by these means are dim.

Legal reform proposals are The secretary for justice, Elsie Leung, has launched an unprecedented public aired consultation on the legal system. The government has also pressed the law schools at Hong Kong University and City University to raise standards and tighten admittance rules. City University has dismissed a large number of teachers in the law faculty in a revamp. The government also issued an interim report on civil justice reform in December 2001 that includes proposals to reform the system for appointing judges and to enhance public access to the world’s most costly litigation system. Most litigants, unable to afford counsel, are left to defend themselves in the lower courts.

After the mainland’s accession to the World Trade Organisation (WTO) in December 2001, Hong Kong lawyers were promised clearer guidelines from the State Council (China’s cabinet) on their role in the mainland’s legal system. These guidelines are expected to be issued in late 2002 or early 2003. This step would allow Hong Kong lawyers to practice law on the mainland, perhaps in partnership with mainland law firms. Currently, Hong Kong lawyers are not allowed to sit for mainland Ministry of Justice examinations to obtain a certificate of practice and can only work in an advisory capacity on the mainland.

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Economic policy

The budget excludes major On March 6th 2002 the financial secretary, Antony Leung, presented the revenue-raising measures 2002/03 (April-March) budget, which contained a package of measures aimed more at providing relief from the economic downturn than immediately addressing the large budget deficit. The budget assumes real GDP growth of 1% in 2002. Consolidated government revenue is budgeted at HK$214.6bn (US$27.5bn) in 2002/03 compared with consolidated government expenditure of HK$259.8bn, leaving a deficit of HK$45.2bn. The estimated consolidated deficit for 2001/02 was revised from the original HK$3bn projected in the 2001/02 budget to HK$65.6bn because of large revenue shortfalls in land premiums and investment income and the postponement of the second Mass Transit Railroad Corporation (MTRC) share placement. The fiscal reserve (accumulated from previous budget surpluses) was expected to stand at HK$369.8bn on March 31st 2002, equivalent to about 19 months of government expenditure.

The budget contained no major revenue-raising measures for 2002/03, but it was “assumed” that public-sector wages would be cut on October 1st 2002, in the middle of the fiscal year, by 4.75%. The formal decision on public-sector pay will follow the private sector pay trend survey due to be completed in May, but the government appears to have an approximate idea of its probable outcome now. The pay cut would save the government HK$3bn in 2002/03 and HK$6bn in a full year. Mr Leung also pledged to reduce the size of the civil service to 181,000 in 2002/03. (According to the Civil Service Bureau, the government employed 184,300 civil servants in January 2002, a decrease of 7% compared with March 2000.) Personnel-related expenses account for about 70% of government operating expenditure.

Despite the pay cut, the government budget forecasts a real increase in total expenditure of 7.7% in 2002/03 compared with the revised estimate for 2001/02. The government plans large increases in expenditure on education, economic services, environment, food safety and social welfare; spending on housing is to fall. To control medium-term expenditure, Mr Leung proposed to cap the real growth in government expenditure to an average of 1.5% in each year between 2003/04 and 2006/07, which is below forecast real GDP growth of 3% a year. His main strategy to restore fiscal balance, as spelt out in the budget, is to reduce the growth rate of government expenditure to below that of the economy as a whole. Much then depends on restored growth and the government’s ability to resist political pressure to continue to increase spending once the cycle is over. He left open, however, the option of introducing major new taxes, such as a sales tax, once economic recovery is under way. His aim is to reduce government expenditure from the forecast 22.9% of GDP in 2002/03 to 20% of GDP or below by 2006/07.

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Hong Kong: consolidated budget summary (HK$ bn) Fiscal reserves Net transfer Budget Fiscal reserves opening balance Expenditure Revenue between funds balance closing balance 2001a 2002b 2001a 2002b 2001a 2002b 2001a 2002b 2001a 2002b 2001ac 2002b General revenue account 129.9 83.1 203.7 218.5 155.7 171.7 0.0 –18.0 –48.0 –64.8 83.1 18.3 Capital works revenue fund 31.2 12.0 29.6 34.4 10.1 25.6 0 20.0 –19.5 11.3 12.0 23.3 Capital investment fund 1.8 4.2 0.3 5.6 2.8 2.2 0 1.0 2.5 –2.4 4.2 1.9 Civil service pension reserve fund11.611.70000.50000.4811.712.2 Disaster relief fund 0.01 0.03 0.01 0.00 0.00 0.00 0.03 0.02 0.02 0.02 0.03 0.05 Innovation & technology fund 4.9 4.6 0.4 0.6 0.0 0.2 0 0 –0.3 –0.4 4.6 4.3 Loan fund 7.1 6.9 5.7 3.8 5.5 4.3 0 –3.0 –0.2 –2.5 6.9 4.4 Land fund 243.8 247.1 0 0 0 10.100010.1247.1 257.2 Totald 430.3 369.8 239.7 262.8 174.0 214.6 0 0 –65.6 –48.2 369.8 321.6 a Revised estimates in 2002/03 budget; fiscal year ending March 31st 2002. b Forecasts in 2002/03 budget; fiscal year ending March 31st 2003. c Includes write-back of provision for loss in investments with the Exchange Fund. d Totals may not add owing to rounding.

Source: Government of Hong Kong.

Limited relief measures are To cushion businesses and households from the economic downturn, proposed Mr Leung proposed to reduce rates payments (charges on property use), water and sewage charges and trade effluent surcharges, to waive business registration fees and to freeze government fees and charges. These measures will cost HK$6.4bn. Legislators welcomed the measures but urged the government to provide further relief.

The budget contained a number of optimistic, if not unrealistic, revenue forecasts. These include: HK$25.6bn from the capital works revenue fund (mainly land premiums), which is two and a half times the revised estimate for 2001/02; HK$13.7bn of investment income on the fiscal reserves, 20 times more than in 2001/02; and HK$15bn from selling MTRC shares, postponed in 2001/02 because of the bearish stockmarket. Mr Leung believes that land premiums will be inadequate to meet future capital expenditure. He therefore stressed the importance of achieving surpluses on the operating account over the longer term to finance a part of capital expenditure.

The budget included two minor revenue-raising measures. First, the duty rate on wine was increased from 60% to 80%, effective immediately, and it is estimated that this will generate an extra HK$70m (US$9m) each year. Second, the quantity of duty-free tobacco that Hong Kong residents can bring in will be reduced by 40% and the quantity of duty-free wine will be reduced by 25%. These measures were estimated to generate an additional HK$330m in 2002/03. Mr Leung said that the government would bring a bill before Legco to introduce a boundary facilities improvement tax, a kind of exit tax. The tax, if introduced in 2003-04 as planned, would be set at HK$18 (US$2.30) per head and would raise an estimated HK$1bn each year.

The government adopts a Mr Leung affirmed the government’s belief in a market economy, but also said “pro-active” economic role that the government would take a “pro-active” economic role. He said that the

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government would set up a steering committee to promote development in financial services, logistics, tourism and business-support services, the four areas considered most important to the economy. He also said that he would chair an inter-bureau working group to promote the development of the local community economy—cultural, recreational, sports, social and personal services—thereby supporting domestic consumption and employment.

An ambitious plan for The chief executive, Mr Tung, outlined on February 20th a HK$600bn proposal infrastructure is outlined for infrastructure development over the next 15 years. The proposal includes 1,600 separate projects and he claimed that it would create 30,000 jobs by end-2002. The government will pay for most of the costs, but will encourage private involvement. Proposed projects include railways to be built between 2002 and 2007, road projects, development around the Victoria Harbour, environmentally friendly new towns, urban renewal projects and port development. Critics such as Urban Watch, a non-governmental organisation, have questioned the costs and efficiency of these projects and whether they would add too much to the existing budget deficit.

Help comes for negative- The government proposed on January 18th 2002 a 12-month suspension of equity sufferers mortgage loan repayments for negative-equity properties bought under the government’s Home Starter Loan Scheme and Sandwich Class Housing Loan Scheme. This would require Legco approval. No start date was given. However, applicants would have to pass certain asset and income tests in order to qualify.

Government revenue drops Public revenue from land sales and investment dropped in fiscal year 2001/02 because of a weak economy because of the sluggish property market and the bearish stockmarket. On February 4th 2002 the government sold two sites for HK$301m in the last land auction of the financial year. The five previous land auctions in 2001/02 raised HK$2.7bn. Revenue raised from land sales in 2001/02 was the second lowest total in the last ten years. In the 1990s the government was usually able to raise HK$10bn-20bn each year from land sales, but this source of revenue has been hit hard by the weak property market since the Asian financial crisis unfolded in 1997-98. The government now estimates that total land revenue, which also include charges derived from tenders, land exchanges and land modifications, will reach HK$8.5bn in 2001/02 compared with the original budget projection of HK$27.5bn. The investment return in 2001 on the Exchange Fund, the assets backing the Hong Kong dollar’s fixed exchange rate, was the lowest since its establishment in 1993. The rate of return on the fund in 2001 was 0.7%; the return of HK$7bn was down by 84% compared with the equivalent return in 2000.

Different views are aired In early February the IMF recommended that the Hong Kong government on sales tax introduce a sales tax when the economy recovers in order to balance the budget. The Taxation Institute of Hong Kong, a private organisation of interested professionals, however, has a different view. It says that the priority of tax reform should be to counter the widening income gap rather than to increase government revenue. The institute released a report in early February arguing that Hong Kong has a highly polarised society in terms of income distribution and considered a sales tax as regressive. If government revenue is

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raised through a sales tax rather than a progressive income tax system, the poor would end up paying a higher percentage of their income in tax than would the rich.

Casinos are ruled out in Mr Tung has ruled out opening a Las Vegas-style casino on Lantau Island to Hong Kong raise more revenue for the government. The proposal had been made by Ronnie Yuen, the chairman of the Travel Industry Council, a business association, citing the successes of similar undertakings in Malaysia and South Korea to bolster tourism. The mainland government has previously indicated its preference for Hong Kong not to open casinos to compete with Macau. In 1999 the then financial secretary, Donald Tsang, proposed the building of casinos but gave up the idea after it was criticised by a Chinese vice-premier, Qian Qichen.

A pay review is under way The government has come under criticism for overpaying the staff of publicly for public bodies funded bodies. According to a survey conducted by the Hong Kong and Kowloon Trade Union Council published on January 4th 2002, the Equal Opportunities Commission pays its employees an average of HK$74,000 (US$9,500) per month. Other public bodies found to offer high pay include the Hong Kong Monetary Authority (HKMA, Hong Kong’s equivalent of a central bank), the Securities and Futures Commission and the Mandatory Provident Fund Schemes Authority. Mr Tung announced on January 3rd that public bodies would face a pay review. On January 9th the government announced that the pay review would be widened to cover the rank and salaries of top executives of about 100 government-funded groups. The review originally involved only nine major public bodies.

Streamlining the civil The government has been trying to make the civil service leaner and more service proves costly efficient through various reforms. The government revealed on February 9th that ten senior officials had been compensated with a total of HK$20m for compulsory retirement under a scheme to lay off mediocre staff introduced in September 2000. The government has said that it would calculate the cost of the alternative, retaining such officials until their retirement age. The government had previously refused to comment on the compensation pay-outs and came under attack for keeping legislators in the dark on the issue.

Transport fares are frozen Although both the MTRC and the Kowloon-Canton Railroad Corporation until the year-end (KCRC) had planned to increase their fares in 2002, the MTRC announced on February 8th that its fares would be frozen until the end of the year. The KCRC has also hinted at a similar decision. The MTRC announcement drew praise from legislators. Both corporations had come under attack for proposing to raise fares.

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The domestic economy

Output and demand

Economic slowdown is led Real GDP declined by 1.6% year on year in the fourth quarter of 2001, by the external sector dragging down economic growth for the year as a whole to 0.1%. After surprising resilience in the first three quarters of 2001—perhaps because of public investment—investment fell by 6.4% year on year in the fourth quarter. The global slowdown was compounded by the effects of the September 2001 terrorist attacks on the US, causing both merchandise exports and imports to fall by about the same rate (around 9% year on year) in the fourth quarter. As a result, the change in net exports had little impact on GDP growth. Import growth tends to follow export growth because most of Hong Kong’s exports are re-exports.

Marginally positive economic growth in 2001 as a whole was supported by services export growth of 3.5% (much lower than the 14.1% recorded in 2000), owing to rising tourist receipts and greater demand for trade-related services from China. Government consumption also increased sharply, by 5.1%, in 2001. Private consumption and gross fixed investment exhibited a slowing trend across the year, growing in each case by around 2% in 2001, reflecting the knock-on effects of the abrupt slowdown in trade activity.

Hong Kong: gross domestic product (real terms; % change, year on year) 2000 2001 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4-Qtr Year Private consumption 8.7 5.1 5.6 2.7 5.4 3.0 3.5 1.2 0.3 2.0 Government consumption 3.7 2.7 2.5 0.6 2.1 3.9 4.1 6.2 6.1 5.1 Gross domestic capital formation 5.7 5.4 14.8 13.1 9.8 11.5 1.2 3.2 –6.4 2.1 of which: building & construction –14.9 –10.8 –1.3 –2.3 –7.7 –1.2 1.9 –6.8 –2.6 –2.5 real estate developers’ margin –19.5 –17.5 –2.4 4.0 –9.4 –5.7 4.3 –4.2 0.5 –1.9 machinery & equipment 32.9 21.2 27.3 23.4 25.8 22.6 0.3 9.4 –8.5 5.2 Goods Exports 20.7 17.7 17.7 13.3 17.1 4.2 –1.9 –4.0 –8.8 –3.0 Imports 22.9 18.8 18.4 13.4 18.1 5.3 –0.7 –3.4 –9.1 –2.4 Services Exports 15.8 18.2 14.0 9.5 14.1 6.3 6.3 1.6 0.5 3.5 Imports –0.9 3.3 3.4 2.7 2.1 3.9 1.0 –2.0 –2.3 0.1 GDP 14.1 10.7 10.7 7.0 10.5 2.2 0.8 –0.4 –1.6 0.1 Source: Census and Statistics Department.

Business confidence begins According to one leading indicator, the economy may have bottomed out. The to revive Purchasing Managers’ Index (PMI) of business confidence stood at 48.2 in January 2002. Any score below 50 indicates a decline in economic activity. This was the 15th consecutive month that the PMI has been below 50. However, the score represented an improvement compared with December 2001, when the PMI was only 45.7, and was the least pessimistic score since March 2001.

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Retail sales decline further The value of retail sales decreased by 11.7% year on year in January 2002 following a 5.4% year-on-year fall in December 2001 and a decline of 1.2% for 2001 as a whole. The decrease in January was exceptionally large because of the timing of the Chinese New Year, a high point of festive spending, which fell in February this year but in January in 2001. Even accounting for this, retail spending has been weak and has been deteriorating markedly since the fourth quarter of 2001. The fall in retail sales, despite a slight increase in visitor arrivals in 2001, indicates that domestic household demand remains extremely weak. Sales of luxury items such as cars, jewellery and watches, and furniture and fixtures have been especially poor.

Hong Kong: retail sales (% change, year on year) Month Value Volume Jan 2001 +1.6 +4.1 Feb –4.2 –1.2 Mar +1.9 +4.1 Apr –0.2 +1.9 May +3.7 +6.6 Jun +3.5 +6.0 Jul –0.9 +1.3 Aug –0.8 +1.8 Sep –4.3 –1.6 Oct –6.2 –3.8 Nov –4.1 –1.6 Dec –5.4 –3.3 Jan 2002 –11.7 –10.3 Source: Census and Statistics Department.

Consumer confidence is Consumer confidence was also shown to be fragile in a survey conducted by fragile ACNielson, a US-based market research firm. According to the survey, 39% of respondents deferred a major buying decision in the second half of 2001 and 48% plan to curb their spending in the first half of 2002. The survey also found that 88% of respondents believed that the world economy was entering a recession and that only 51% expected the world economy to recover in 2002, making Hong Kong people the most pessimistic in the Asia and Australasia

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region. The MasterCard International MasterIndex Survey of consumer confidence indicated a similar attitude of pessimism among its respondents.

Employment, wages and prices

Unemployment reaches The rate of unemployment rose from 6.1% in October–December 2001 to 6.7% record high in November 2001–January 2002, surpassing the previous highest rate, which was recorded during the1997-98 Asian financial crisis. The underemployment rate also increased from 3% to 3.2%. Although the total labour force grew by 8,100, the total number of employed people fell by 1,100. Job creation has not kept up with the expanding labour force because of the weakening economy. The largest declines in employment occurred in manufacturing, construction, trade and restaurants; employment grew in community, social and personal services. The deteriorating employment situation has affected not only low- skilled workers but also professionals and executives. According to the recruitment firm, EL Consult, demand for executives, measured by job vacancy advertisements, dropped by 58% year on year in January 2002.

Costs are too high and Business costs are high and the language ability of the workforce is poor, workers have poor English according to businesses responding to the Better Hong Kong Foundation annual business confidence survey for 2001. According to the survey, 77% of businesses consider Hong Kong’s business costs too high and 65% rated the workers’ spoken English skills as unsatisfactory. Both figures represent small rises compared with the 2000 survey.

Consumer price deflation Consumer prices fell at a much faster pace in January 2002 (–3.5%) and accelerates December 2001 (–3.6%) than in previous months. The average year-on-year change in consumer prices in the previous three-month period was –1.2%. Government spokesmen attributed the large declines in consumer prices in December and January to one-off factors. In January these included a reduction in rate payments (a charge on property use) for 2002 and a rebate on electricity charges applied in January and February. In December 2001 a waiver on public housing rentals added to deflationary pressure. The Census and Statistics Department calculates that, without these special factors, the rate of consumer

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price inflation would have been –1.4% in January and –1.6% in December. This analysis indicates that the underlying pace of deflation is still accelerating, which is consistent with indicators of weakening real demand and the strength of the Hong Kong dollar relative to Asian floating currencies. The timing of the Chinese New Year, when festive spending tends to drive prices up, also contributed to deflation in January. The Chinese New Year fell in February this year, but in January in 2001.

Financial indicators

2001 is a bad year for the The Hang Seng Index (HSI) dropped by 25.5% to 11,397 at end-2001, making Hang Seng Index the Hong Kong stockmarket the worst performer of the major world markets last year. It performed so poorly because of the Hong Kong economy’s exceptionally high exposure to the global economic downturn. Exports of goods and services represent about 144% of nominal GDP. Debt issuance on the Hong Kong dollar bond market, however, reached US$9.7bn in 2001, an increase from US$2.7bn in 2000, which can be explained by the interest-rate cuts and the difficulty of raising capital in the falling stockmarket. The collapse of the US-based energy company, Enron, caused investors to sell stocks on the Hong Kong stockmarket—on January 30th 2002 the HSI dropped by 2.3%, to 10,757 points. The index reached a 2002 low of 10,425 on March 1st, before rebounding to 11,210 by March 15th on improving sentiment in US and global markets.

The Enron scandal causes The collapse of Enron has led to a fresh look at accounting standards in Hong a tightening of rules Kong. In mid-February 2002 the Hong Kong Society of Accountants (HKSA) signed a memorandum with the Hong Kong Stock Exchange to clarify the regulation of auditors. Under the memorandum, the HKSA would continue to regulate auditors serving listed companies, whereas the stock exchange and the Securities and Futures Commission (SFC) would have the power to conduct preliminary reviews of dubious accounting cases. If the SFC found wrongdoing, it would be able to refer the case to the HKSA for investigation and possible punishment. The SFC subsequently released for public consultation draft rules on record-keeping. They would require intermediaries, such as brokers,

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insurance agents and their associated entities to keep sufficiently detailed records to explain their business activities and to account for client assets.

Hong Kong: financial indicators (end-period) Hang Seng Index 3-month HIBOR 28 Feb 2001 14,787.9 4.96 30 Mar 12,760.6 4.94 27 Apr 13,386.0 4.32 31 May 13,174.4 3.88 29 Jun 13,042.5 3.80 31 Jul 12,316.7 3.63 31 Aug 11,090.5 3.34 28 Sep 9,950.7 2.50 31 Oct 10,074.0 2.09 30 Nov 11,279.3 2.50 31 Dec 11,397.2 2.03 31 Jan 2002 10,725.3 2.06 28 Feb 10,482.6 – Source: Bloomberg.

New rules are to improve On January 28th 2002 the SFC introduced new disclosure and selection criteria investor protection for index funds in order to enhance transparency and investor protection. Under the new regulations, index fund managers are required to choose only heavily traded stocks and the index must be easily accessible by investors; presumably it must be published in a daily newspaper or on a website. The regulation also required clear risk disclosure in the fund prospectus and fund managers were required to report to the SFC and notify holders of significant changes, such as adjustments in the method of index calculation.

The high remuneration of The Hong Kong stock exchange has proposed that companies review the executives causes concern salaries of their directors in order to give small investors better protection. This followed an outcry over directors awarding themselves generous compensation packages, as revealed in recent annual reports. The telecommunications company, Pacific Century CyberWorks (PCCW), was reported to have rewarded its board with HK$768m (US$98m) in compensation in 2001, equivalent to 38.5% of the total remuneration received by the boards of all 33 Hang Seng Index companies. In 2001 PCCW was the only company on the HSI to record a loss, producing the worst shareholder return.

Corporate governance rules On January 21st the Hong Kong stock exchange proposed 30 changes to listing changes are proposed rules, aimed at improving corporate governance. If they are approved by the Legislative Council (Legco, Hong Kong’s legislature), they will become mandatory. Under the proposals, companies listed on the main board would be required to report financial results quarterly rather than semi-annually, and no company would be allowed to place shares at 20% or more below the market price unless it was in serious financial difficulty. The stock exchange has also called on listed companies not to appoint the same person as both chairman and chief executive of the company but has not made this mandatory.

EIU Country Report March 2002 © The Economist Intelligence Unit Limited 2002 26 Hong Kong

Sectoral trends

More visitors arrive but for The tourism industry has made a quick recovery from the aftermath of the shorter periods September 11th 2001 terrorist attacks on the US. In December 2001, according to the Hong Kong Tourism Board, the territory received 1.3m visitors, an increase of 6.4% year on year and the highest monthly total since records began. This was a turnaround from the 4% year-on-year drop recorded in October. However, visitors have been staying for shorter periods. In 2001 64.7% of visitors stayed for at least one night, compared with 67.5% in 2000. There has been an increase in the number of day visitors from Taiwan, who come to Hong Kong only to make a connection for a destination in China. The number of visitors from China rose to a record 4.4m in 2001, an increase of 17.5% year on year.

Banks are to share client In reaction to the rising number of personal bankruptcies, local banks have information proposed to share more information about their clients. Under the proposed agreement, banks would be able to ask each other for “positive information”, which includes the number of credit cards used by a potential client and the credit limit on the cards, before deciding whether to issue a credit card. The proposal requires approval from the office of the privacy commissioner for personal data.

Foreign banks will get The Hong Kong Monetary Authority (HKMA, Hong Kong’s equivalent of a easier entry terms central bank) announced in December 2001 that the government would encourage more foreign banks to open branches in Hong Kong by reducing the value of required assets by more than 95% to HK$5bn (US$640m). This is the same requirement as that for locally incorporated banks. The number of authorised financial institutions established in Hong Kong has declined by one-third over the last six years. The government is worried that foreign financial institutions may enter the growing mainland market directly rather than going through Hong Kong. The existing minimum asset requirement in Hong Kong is US$16bn, whereas in China it is US$20bn.

Advertising revenue is According to ACNielson, a US-based market research firm, advertising revenue shrinking in Hong Kong rose by 7.5% to HK$29.6bn in 2001. However, this figure is based on published tariffs, which do not take discounts into consideration. According to Optimum Media Direction, an advertising firm also based in the US, advertising revenue may have fallen by 10-15% in 2001, as media companies offered huge discounts to compete for shrinking advertising revenue.

The fixed-line telephone The Office of the Telecommunications Authority, the telecoms regulator, market is to be liberalised announced on January 11th 2002 that it would remove the limit on the number of fixed-line telephone operators in 2003. Potential operators are required to submit a three-year business plan outlining intended coverage areas, types of services, capital expenditure requirements and financial capabilities. Existing operators such as PCCW and New World Telephone have argued that new entrants should also bear a performance commitment to ensure that they have a serious intention of staying in the industry.

Property transactions rise According to statistics compiled by the property agents, Midland Realty and but the market is weak Centraline Property Agency, the number of property transactions in 2001

EIU Country Report 1st quarter 2002 © The Economist Intelligence Unit Limited 2002 Hong Kong 27

increased by 2.8% to 88,200. Although this was the first increase in the past four years, the number of transactions was still the second lowest in the last ten years. The property market is still oversupplied and the economic downturn has sustained market weakness.

The HOS cap is lowered and In September 2001 the chief secretary, Donald Tsang, announced a ten-month eligibility criteria are eased moratorium on the sale of flats under the Home Ownership Scheme (HOS, a government scheme to subsidise housing construction for lower-income households) and capped the sale of flats at 9,000 each year until 2005. The previous cap was 20,000 flats a year. On January 6th 2002 the government further reduced the cap to 6,000 flats each year.

The Housing Authority said on February 7th that it would lower the HOS asset limit—the maximum asset value of households eligible for HOS flats—by 16% and the income limit by 16.7%, after taking into consideration falling property prices and interest rates. This move is expected to disqualify about 21,000 middle-income families from the HOS and to boost sales of private flats worth less than HK$2m (US$256,000). Publicly subsidised flats under the HOS are usually sold at 60% of market value. The government was immediately criticised by a private housing watchdog, the People’s Council on Housing, for forcing people to buy private flats in order to boost the property market. On January 7th legislators rejected a Housing Authority plan to lower the income ceiling for public rental housing by up to 17%, which would have disqualified 14,000 low-income families from renting inexpensive public flats.

The property market The value of new mortgages issued fell by 1.8% month on month in January presents a mixed picture 2002 after two months of rapid growth—41.1% in December 2001 and 18.8% in November. It is therefore too early to conclude that the property market is recovering. Property developers are still offering large discounts to sell properties and there is a large supply of new residential property, especially in the New Territories, being held back by developers until the market strengthens.

The government may reserve In November 2001 Hambrecht and Quist Asia Pacific, a US-owned private land for foreign firms equity investor, announced its withdrawal from a project to build a HK$9.2bn chip-making plant, in part because it could not obtain 200 ha of land for immediate use. To prevent Hong Kong from losing investment again for this reason, the government has said that it is considering setting up a “land bank” to reserve sites for foreign business investors.

A controversial transport Funding to design the controversial HK$22bn Route 10 highway, to connect a route gets first approved planned HK$4.8bn bridge between Shenzhen, in China, and north Lantau, was approved at the subcommittee stage in February because many legislators opposing the project failed to arrive for the early morning Legco meeting. Proponents of Route 10 had initially justified it as facilitating a planned container terminal on the north-east coast of Lantau, which can no longer be built because the site has been designated for a Disney theme park. The project was eventually approved on the basis of population forecasts that were later rejected as overstated, undermining the argument for Route 10. The operators

EIU Country Report March 2002 © The Economist Intelligence Unit Limited 2002 28 Hong Kong

of Route 3, a loss-making toll road running parallel to Route 10, also argued that there was no need for the new highway. The vice-chairman of the Logistics Association, Anthony Wong, added that Route 10 would create an inflexible road system and an inadequate airport link, because cargo coming from the mainland for the airport would need to travel a total distance of 31 km, much longer than the alternative 19.8-km route via Tuen Mun.

Gambling revenue drops The Hong Kong Jockey Club reported that turnover had dropped by HK$1.5bn, in 2001 or 4% year on year, to HK$38.7bn at the racing season’s halfway point at end-January 2002 (the racing season runs from September to June). The club attributed falling gambling revenue to competition from Internet gambling and football betting, and lifestyle changes. The prospect for the second half of the season is dim because of concerns that illegal betting on World Cup football matches (to take place in Japan and South Korea in June 2002) will draw punters away from gambling on horses.

Foreign trade and payments

Merchandise exports and According to trade figures for December 2001, imports tumbled by 13.5% year imports decrease on year, bringing the decrease for 2001 as a whole to 5.5%. Total exports fell by 10.4% in December and by 5.9% in 2001. Domestic exports dropped by 8.5% year on year in December, but by 15.2% in the year as a whole. The decline is attributable to the increasing rate at which manufacturing activity is being moving across the border to take advantage of lower land and labour costs on the mainland. Re-exports declined by 10.6% in December year on year and by 4.7% in 2001. As the mainland continues to develop its logistics industry, Hong Kong risks losing its competitive edge owing to its high cost-structure. Analysed by main destination, weakening demand from the US and the EU hit domestic exports and re-exports. The slumping domestic economy contributed to the declining demand for imports.

Hong Kong: external trade

Imports Domestic exports Re-exports Total exports Balance HK$ bn % change HK$ bn % change HK$ bn % change HK$ bn % change HK$ bn 2001 Jan 120.1 –4.0 12.8 –16.1 108.6 1.8 121.4 –0.4 1.2 Feb 122.4 19.9 10.9 –76. 93.8 12.6 104.7 10.1 –17.6 Mar 134.3 –1.5 11.4 –21.2 109.9 1.5 121.3 –1.2 –13.0 Apr 133.2 –0.4 12.3 –10.7 107.9 –1.4 120.1 –2.4 –13.0 May 136.2 –3.2 14.1 –9.1 114.0 –2.8 128.2 –3.5 –8.0 Jun 123.8 –6.6 12.9 –14.8 102.7 –7.5 115.6 –8.4 –8.2 Jul 141.2 –0.9 14.5 –10.8 118.9 0.6 133.4 –0.8 –7.8 Aug 136.4 –9.3 13.9 –19.8 119.7 –7.7 133.6 –9.1 –2.8 Sep 142.4 –9.0 13.1 –22.6 121.6 –9.5 134.6 –11.0 –7.7 Oct 135.2 –14.9 13.1 –18.1 120.2 –13.5 133.3 –13.9 –1.9 Nov 123.4 –11.5 11.5 –20.4 108.7 –10.3 120.2 –11.3 –3.2 Dec 122.7 –13.5 13.1 –8.5 102.8 –10.6 115.9 –10.4 –6.7 2002 Jan 109.8 –8.6 10.3 –19.4 96.3 –11.4 106.6 –12.2 –3.2 Source: Census and Statistics Department.

EIU Country Report 1st quarter 2002 © The Economist Intelligence Unit Limited 2002 Hong Kong 29

The balance of payments Hong Kong recorded a deficit of HK$26.3bn (US$3.4bn) on its balance of moves into deficit payments in the third quarter of 2001. This is equivalent to 8.1% of GDP and was a turnaround from a surplus of HK$9.9bn recorded in the second quarter. The deficit is attributable to a huge net outflow of financial non-reserve assets of HK$42.9bn, which offset a HK$32bn surplus on the current account. On the financial account, net foreign direct investment in Hong Kong dropped from HK$37.4bn in the second quarter to HK$5bn in the third quarter, whereas the net outflow of portfolio investment increased from HK$52.3bn in the second quarter to HK$71.3bn. Both of these flows are volatile from quarter to quarter, reflecting Hong Kong’s role as an intermediary of financial flows. Weakened sentiment on the international financial markets after the September 11th 2001 attacks on the US contributed to the decrease in direct investment and the increase in net portfolio investment. The surplus on the current account was bolstered by an increase in the invisible trade surplus and a surge in Hong Kong’s direct investment income from the mainland. China was one of the economies least affected by the US-led international economic downturn and still relies on Hong Kong for many aspects of its economic development, including financing, product design, technological transfer and marketing.

Hong Kong: balance of payments (HK$ m) 2000 2001 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Current account 11,698 16,884 23,044 17,273 11,551 7,928 32,019 Goods –17,229 –18,483 –10,681 –17,439 –24,646 –23,888 –11,432 Services 24,540 28,632 32,835 37,969 27,932 32,766 34,780 Factor income 7,794 9,915 4,050 10 11,951 2,142 12,028 Current transfers –3,406 –3,180 –3,160 –3,266 –3,686 –3,092 –3,357 Capital & financial account –8,712 –5,633 –12,889 –30,630 –504 –11,597 –19,458 Capital transfers –2,140 –3,679 –3,707 –2,519 –1,438 –3,116 –2,927 Financial non-reserve assets (net change) –23,224 23,414 29,787 2,525 61,891 1,443 –42,851 Direct investment 8,961 58,136 23,725 –71,055 59,090 37,372 4,958 Portfolio investment 61,403 6,556 8,341 114,482 –108,070 –52,268 –71,339 Financial derivatives –37,707 17,496 –1,146 23,228 –9,209 21,147 15,054 Other investment –55,881 –58,774 –1,133 –64,130 120,080 –4,807 8,476 Reserve assets (net change) 16,652 –25,368 –38,969 –30,636 –60,958 –9,924 26,320 Net errors & omissions –2,986 –11,251 –10,156 13,356 –11,046 3,669 –12,560 Overall balance of payments –16,652 25,368 38,969 30,636 60,958 9,924 –26,320 Source: Census and Statistics Department.

EIU Country Report March 2002 © The Economist Intelligence Unit Limited 2002 30 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 of the People’s Republic of China since December 20th 1999. The Basic Law, a post-handover mini-constitution, 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 Others Commissioner against corruption Cheong U Commissioner of audit Fatima Choi Mei Lei Commissioner-general designate of the police services Jose Proença 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 1st quarter 2002 © The Economist Intelligence Unit Limited 2002 Macau 31

Economic structure

Annual indicators

1997 1998 1999 2000 2001 Real GDP growth (%) –0.3 –4.6 –2.9 4.6 n/a Population (year-end; ‘000) 422.0 430.5 437.5 437.9 n/a Consumer price inflation (av; %) 3.5 0.2 –3.2 –1.6 –2.0 Exports fob (US$ m) 2,142.6 2,135.7 2,197.5 2,539.3 2,309.1 Imports cif (US$ m) –2,076.8 –1,949.8 –2,037.5 –2,254.9 –2,396.3 Trade balance (US$ m) 65.8 185.9 160.0 284.4 –87.5 Exchange rate (av; MPtc:US$) 8.0 8.0 8.0 8.0 8.0

March 11th 2002 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 2001 % of total Main origins of imports 2001 % of total US 48.2 China 48.0 EU 26.6 Hong Kong 13.9 China 11.7 EU 12.6 Hong Kong 6.4 Taiwan 6.7

EIU Country Report March 2002 © The Economist Intelligence Unit Limited 2002 32 Macau

Quarterly indicators

2000 2001 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Government finance (MPtc m) Current revenue 1,908.8 2,092.4 2,249.8 2,190.2 2,084.9 2,567.6 2,563.3 n/a Current expenditure 1,076.7 2,472.0 1,805.7 2,129.7 1,892.2 1,688.5 1,780.5 n/a Balance 832.1 –379.6 444.1 60.5 192.7 879.1 782.8 n/a Employment & prices Unemployment rate (%) 6.7 7.1 6.7 6.6 6.3 6.4 6.3 6.5 Consumer prices (Oct 1999-Sep 2000=100) 100.1 99.6 99.2 99.1 98.4 98.0 97.5 96.2 % change, year on year n/a n/a –2.3 1.4 –1.7 –1.6 –1.8 –2.9 Financial indicators Exchange rate MPtc:US$ (av) 8.015 8.024 8.032 8.033 8.034 8.033 8.034 8.033 MPtc:US$ (end-period) 8.020 8.029 8.031 8.034 8.033 8.034 8.033 8.031 Interest rates (%) Deposit (av) 5.33 5.49 5.32 5.20 4.21 3.02 2.32 n/a Interbank (end-period) 5.88 6.43 6.37 6.20 4.99 3.81 3.00 n/a Lending (av) 8.34 10.22 10.50 10.50 9.53 8.39 7.63 n/a M1 (end-period; MPtc m) 5,045.1 4,921.8 4,726.6 4,968.2 5,073.2 5,244.1 5,257.2 n/a % change, year on year 0.0 3.3 –0.6 –7.4 0.6 6.5 11.2 n/a M2 (end-period; MPtc m) 86,484.5 80,791 83,267 84,941 85,388 87,858 89,599 n/a % change, year on year 4.1 –3.7 –1.5 –1.3 –1.3 8.7 5.5 n/a Sectoral trends Electricity production (kwh m) 306.5 387.0 444.4 339.8 312.3 390.2 456.2 n/a Tourism Visitor arrivals (‘000) 2,175 2,190 2,475 2,322 2,454 2,556 2,689 2,580 Construction (‘000 sq m) Buildings started 49.0 59.3 62.9 31.6 31.7 73.2 30.3 n/a Buildings completed 29.4 52.0 126.2 162.7 171.1 48.2 112.0 n/a Foreign trade (MPtc m) Exports fob 4,022 5,252 5,995 5,111 3,637 4,873 5,306 4,649 Imports cif –3,529 –4,961 –4,717 –4,891 –4,304 –5,304 –4,828 –4,733 Trade balance 493 291 1,278 220 –667 –431 477 –84 a From 2001 1 Qtr, currency in circulation & demand deposits only.

Source: Statistics & Census Services, Monthly Bulletin of Statistics; IMF, International Financial Statistics.

EIU Country Report 1st quarter 2002 © The Economist Intelligence Unit Limited 2002 Macau 33

Outlook for 2002-03

Political outlook

Domestic politics The political situation will remain stable. Despite the impact of the economic downturn on the welfare of the population in Macau, the chief executive, Edmund Ho, is in a strong position with support recently in evidence from both the government in Beijing and local residents. The liberalisation of the gaming industry—the most important government policy for the economy as the sector is directly responsible for over one-third of GDP—is proceeding smoothly. A minor upsurge in violence coincided with the late February 2002 visits of representatives from the two foreign-based gambling concession winners. The recent violence does not, however, seem to presage a return to the pre-handover (December 1999) days of constant gangland violence. However, the new entrants have yet to establish a significant presence in Macau, so it may be that organised criminal groups will yet re-emerge in an attempt to demand money and secure influence in and around casinos. Co-ordination among security forces in Macau, Hong Kong and the neighbouring Chinese province of Guangdong to tackle crossborder criminal activity is improving, but the triads (ethnic Chinese criminal gangs) have deep roots and political connections, especially in China.

Unemployment is likely to rise as Macau is buffeted by the world economic downturn, and this could engender popular dissatisfaction with the government. So far, however, the close economic relationship of the Special Administrative Region (SAR) with China has shielded it from the worst of the slump. China has announced initiatives to bolster Macau’s economy, in particular easing restrictions on Chinese citizens wishing to visit Macau. As a result, a record 10.3m visitors came to the territory in 2001.

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 few 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.

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 2001 merchandise exports (customs basis) fell by 9.1% year on year because of the global economic slowdown led by the US. The merchandise import bill grew by 6.3% year on year, suggesting that domestic demand remained relatively strong. However, the 12.2% increase in the number of visitors to Macau is likely to have sustained the gambling and

EIU Country Report March 2002 © The Economist Intelligence Unit Limited 2002 34 Macau

tourism sectors, assuming that average visitor spending was maintained (see Economic policy and the economy). The government estimates that real GDP grew by 0.5-1% in 2001 after 4.6% growth in 2000. Macau will continue to benefit from the release of pent-up demand for gambling tourism on the mainland as the central government eases restrictions on visitors to Macau. The central government recently announced that more travel agencies would be able to organise trips to Macau. Large inflows of direct investment will also be noticeable from late 2002 or 2003 as the new gambling concessionaires begin to build casinos. From mid-2002, and especially in 2003, Macau will benefit from the recovery of growth in the world economy as well as the 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, because of the fixed link between the pataca and the US dollar. Real world GDP growth in market exchange-rate terms is expected to pick up throughout 2002, although average growth will be only 1.4%, little higher than the 1.3% posted in 2001. Real world economic growth will be markedly faster in 2003, at 3.3%. 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. The best opportunities may lie in providing services—shipping, finance and legal—to facilitate mainland exports through Macau to the rest of the world, and conversely inflows of goods and investment to the mainland. In such service sectors, Macau would face strong competition from Hong Kong, but could compete on the basis of lower wages and by finding niche markets.

The proposed economic co-operation agreement between the mainland and the two SARs could give Macau’s companies advantageous access to the mainland market, but no details have yet emerged. Tourism and associated gambling, however, will remain the keystone of 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 continuing to manage gambling liberalisation smoothly.

EIU Country Report 1st quarter 2002 © The Economist Intelligence Unit Limited 2002 Macau 35

The political scene

Mr Ho enjoys support from Despite the current economic difficulties, the chief executive, Edmund Ho, is China and Macau in a strong position, enjoying support both within the government in Beijing and at home. On December 26th 2001, during Mr Ho’s second visit to Beijing since being appointed chief executive in 1999, China’s president, Jiang Zemin, remarked that Mr Ho was “a very capable person for his position”. China’s premier, Zhu Rongji, has given Mr Ho a “full 100 mark” for carrying out his duties as chief executive.

In an opinion poll conducted by the University of Macau in December, Mr Ho had the support of 72.6% of respondents. However, according to the poll, most people in Macau were concerned about the economy and unemployment. Macau’s legislators also gave their stamp of approval to Mr Ho by unanimously passing the government budget in December.

Arson and bomb attacks In late February 2002 Macau was subjected to four arson attacks and a large raise the spectre of disorder car-bomb explosion, one of the worst outbreaks of crime since the territory’s reversion to Chinese sovereignty in 1999. The media has speculated that the car bombing might be gang related, but the police are still investigating. There has been no suggestion that this eruption of violence had anything to do with the visits of US representatives of the gambling concession winners. The two new entrants into the gambling industry, Wynn Resorts (Macau) and Galaxy Holdings, are expected strongly to resist gang influence because their owners are Las Vegas-based casinos operating under the legal regime of the US state of Nevada, which strictly monitors companies for possible connections with organised crime.

Macau gains prominence in In early February 2002 Chen Yunlin, the director of China’s Taiwan Affairs China-Taiwan relations Office under the State Council (China’s cabinet), opened in Macau an office of the Association for Relations Across the Taiwan Straits (ARATS), the semi-official vehicle for relations with Taiwan. This is the first ARATS office to be based outside of mainland China. This comes in the context of recent overtures towards Taiwan from the government in Beijing since Taiwan’s ruling party consolidated its hold in the election held in December 2001. Macau was preferred over Hong Kong for the office because of Hong Kong’s energetic press—mainland officials would prefer that cross-Strait talks receive as little attention as possible. Macau is also easier for Taiwan officials to visit now that Taiwan citizens do not need a visa to visit Macau for up to 30 days. None of Taiwan’s representatives, either from the unofficial Taipei Economic and Cultural Centre or from the Straits Exchange Foundation (the Taiwan body that handles relations with the mainland), came to the opening of the ARATS office.

Other moves have eased travel between Macau and Taiwan. In early January 2002 the Macau government, with the approval of the Chinese government, allowed Taiwan’s unofficial representative office to issue entry permits to people travelling on to Taiwan. (The Taiwan representative office in Hong Kong already had the power to issue such permits.) Since January 1st Taiwan

EIU Country Report March 2002 © The Economist Intelligence Unit Limited 2002 36 Macau

has allowed Chinese legally resident outside of China to visit Taiwan as tourists. Macau’s aviation sector is heavily dependent on cross-traffic between Taiwan and China. For security reasons, the Taiwan government prohibits direct air links with China, although this issue is under discussion in Taiwan in the light of the ever-closer economic links between Taiwan and China. Visitors from Taiwan accounted for 14.1% of total visitors to Macau in 2001. It is not known how many of the 3m visitors from China travelled on to Taiwan.

Journalists claim that The government said that it would investigate an alleged assault on two Hong police assaulted them Kong journalists by police at the Macau jetfoil terminal on February 16th 2002 during the visit of Li Peng, the chairman of the National People’s Congress (the Chinese legislature). The government did not, however, set in motion an independent inquiry, as called for by the Hong Kong Journalists’ Association in a letter to Mr Ho. The Public Prosecution Department is also conducting an inquiry. The police denied the allegations and laid the blame on the journalists for filming inside the immigration hall despite “polite advice” not to do so.

Police and immigration officials also deported five activists from the April 5th Action Group who had come from Hong Kong to protest against Mr Li’s role in the Tiananmen Square crackdown in 1989. According to Macau law, only residents are allowed to demonstrate in public. Police had earlier arrested a local democracy advocate, Lei Kin Yon, while he was giving an interview to the Hong Kong media.

Economic policy and the economy

The gaming industry is In mid-February 2002 the government announced the winners of the three liberalised gambling concessions that will replace the current monopoly from March 31st 2002. One winner was Sociedade de Jogos de Macau (SJM), a subsidiary of the current monopoly holder, Sociedade de Turismo e Diversões de Macau (STDM), run by Stanley Ho. The other winners were two companies with strong Las Vegas connections, Wynn Resorts (Macau) and Galaxy Holdings. Wynn Resorts (Macau) is dominated by the US-based company, Wynn Holdings, which runs the Mirage and Bellagio casinos in Las Vegas. The main player in the Galaxy Holdings consortium is the US-based company, Las Vegas Sands, which runs The Venetian, a major casino in Las Vegas. Hong Kong and Macau business interests are also thought to have invested in both of the winning US-led consortia. After the announcement ceremony, the winners told the press of plans to invest a total of MPtc17.5bn (US$2.2bn) in the gaming industry, much of which would come in the next three years (some of the STDM proposals are already under way). The Venetian Group announced on February 28th that it would set up a temporary casino at a cost of HK$50m-100m (US$6.4m-12.8m) in the second half of 2002.

The government’s aim in liberalising the industry is to attract foreign investors with know-how to run resort casinos and broaden the clientele. The hope is to expand from gambling—often conducted in seedy venues and heavily dependent on customers from Hong Kong and China—to broader

EIU Country Report 1st quarter 2002 © The Economist Intelligence Unit Limited 2002 Macau 37

entertainment. In 2001 about half of Macau’s 10.3m visitors came from Hong Kong and nearly 30% from China. The kind of investments—theme parks, convention centres, art museums and resort hotels—announced by the winners fit in with the government’s plan. Resort casinos in Las Vegas, the government’s model for Macau, include not just casinos but venues for concerts, boxing matches and circus performances, thereby attracting a wider range of visitors, including families.

China’s ban on gambling Gambling is banned in mainland China, but remains popular there, judging by encourages visitors the prevalence of unlawful gambling. The number of visitors to Macau from China rose by 32.1% to 3m in 2001, reflecting rising incomes among the 300m-strong emerging middle class. The Chinese government has, however, been careful to restrict official involvement in gambling. Qian Qichen, a Chinese vice premier, said in December that Chinese investment in the gambling business was not permitted. Following this, Henry Fok, a Macau representative in and a vice-chairman of the Chinese People’s Political Consultative Conference (the CPPCC, an advisory body that incorporates the few non-communist political organisations allowed on the mainland, as well as non-party social organisations), said in late February that he would sell his 27.7% stake in STDM. Mr Fok has also complained that he has not received a fair share of STDM’s profits.

The disciplinary inspection committee of the Chinese Communist Party (CCP) and the Guangdong provincial prosecutor’s office have imposed stricter rules, banning Guangdong party and government officials from making gambling trips to Macau, it was reported in late January 2002. Gambling trips have been a grey area. A 1994 regulation prohibits officials from gambling, but officials have in reality been allowed to gamble in Macau in their own time. The new rules provide for tougher penalties, ranging up to ejection from the CCP and loss of official position.

Unemployment remains The unemployment rate was 6.5% in the period from November 2001 to high January 2002. The rate has remained unchanged since August-October 2001, when it rose to 6.5% from 6.3% in July-September. Although the unemployment rate did not vary much in 2001, and was an improvement on the 2000 average of 6.8%, underemployment rose from 2.9% in 2000 to 3.5% in 2001.

Consumer price deflation Consumer prices fell by 2% in 2001, a faster rate than in 2000, when prices fell worsens by 1.6%. This reflects retail price deflation in China, the source of 48% of Macau’s imports in 2001. Deflation affected higher-income households more than lower-income households in 2001. The deflationary trend accelerated throughout 2001, in line with deepening deflation on the mainland. In the fourth quarter consumer prices fell by 2.9% year on year, compared with 1.7% year on year in the first three quarters, according to the government’s Statistics and Census Services.

EIU Country Report March 2002 © The Economist Intelligence Unit Limited 2002 38 Macau

Exports fall and imports The value of merchandise exports on a customs basis fell by 9.1% in 2001 to rise MPtc18.5bn, whereas merchandise imports grew by 6.3% to MPtc19.2bn. As a consequence, the trade balance moved from a MPtc2.3bn surplus in 2000 to a MPtc697m (US$87m) deficit in 2001. The explanation for the sharp drop in exports is clear: the US-led global economic slowdown reduced demand for Macau’s exports. The largest falls in monthly exports came in June-August and in December, all of which recorded year-on-year declines in excess of 12%. The declines in September-November were relatively mild, below 8% in each case in year-on-year terms, despite the effects of the September 11th 2001 terrorist attacks on the US.

The rise in imports is attributable to the liberalisation of the mobile telecommunications industry, spurring imports of related equipment, and relatively strong domestic demand owing to increased visitor spending. Imports of telecoms and audio-visual equipment more than doubled to MPtc1.1bn in 2001, and beverages imports increased by 70%. Import categories associated with manufacturing for export, such as textiles used in the garment production industry and electrical machinery and parts, posted large falls in value in 2001.

Visitor arrivals are on a The number of visitors to Macau in January 2002 fell by 12.1% year on year, growth trend but this is explained by the Chinese New Year, which fell in February 2002, but in January in 2001. The underlying trend is a rising one: 10.3m visitor arrivals were recorded in 2001, a 12.2% increase compared with 2000, and year-on-year growth was recorded in every month of 2001, except for February, again because of the timing of the Chinese New Year. Macau’s improved image in terms of much decreased gang violence since the handover to China in 1999 has outweighed the detrimental effects on tourism of the September 2001 terrorist attacks on the US and the international economic downturn. In 2001 the number of visitors to Macau increased from all regions, except for Europe, arrivals from which dropped by 5.3%. Visitors from East Asia recorded by far the largest percentage increase and account for 95.8% of visitors to Macau. Nearly two-thirds of the extra 1.1m visitors in 2001 came from China. China’s economic strength—officially reported real GDP growth in 2001 was 7.3%— has therefore sustained Macau’s domestic economy. There was also a marked

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increase in the number of visitors from Hong Kong, as residents there chose ferry travel to Macau over long-distance air travel to other destinations in the wake of the September 11th attacks on the US and the economic downturn.

Data on visitors’ spending per head in 2001 are not yet available. However, other data indicate that it has risen. Hotel (three-star and above) occupancy rates all rose in 2001, suggesting that visitors were at least as well heeled in 2001 as in 2000. Moreover, the average length of stay rose from 1.33 nights in 2000 to 1.35 nights in 2001.

Trade deficit is not The movement of the trade balance into deficit in 2001 is not of concern in worrying terms of the balance of payments; it was probably partly, if not completely, offset by a stronger services balance owing to higher visitor spending. This analysis is consistent with the 5.6% increase in foreign-exchange reserves observed in 2001, to MPtc28.2bn, according to the Macau Monetary Authority (the equivalent of a central bank).

EIU Country Report March 2002 © The Economist Intelligence Unit Limited 2002