U.S. and Hong Kong (1997)

U.S. Department of State

Hong Kong Country Commercial Guide for FY 95-96

Office of the Coordinator for Business Affairs

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CHAPTER II. ECONOMIC TRENDS AND OUTLOOK

A. Major Trends and Outlook

Hong Kong's real GDP increased by 5.5% in 1994, to reach US$131.8 billion, in line with government projections. GDP per capita reached US$21,750. GDP increased by 6% in the first quarter of 1995, bolstered by strong exports and spending on infrastructure. However, retail sales have been flat as consumers belt-tightened in response to last year's rising interest rates and declining equity and property prices. The Hong Kong Government projects GDP in 1995 will grow by 5.5%. The government projects a small (US$333 million) deficit for the current fiscal year (4/1/95-3/31/96) against a surplus of US$984 million realized in 1994.

Unemployment, which was a seasonally adjusted 1.9% of the labor force in 1994, increased to a nine-year high of 3% in April 1995. The increase in the number of jobless has been attributed primarily to a slowdown in the retail and restaurant sectors against the backdrop of a continuing shift of manufacturing to China. Inflation in 1994 was 8.1%. For the twelve months ended May 1995, the inflation rate was 8.9%.

Hong Kong's merchandise, or visible, trade deficit increased three- fold in 1994 to US$10.9 billion as imports surged while exports maintained essentially steady growth. Substantial surpluses on services trade have traditionally more than offset merchandise trade deficits. In 1994, the combined overall trade surplus was only US$2.4 billion, or 1.3% of the value of goods and services, marking the lowest overall trade surplus since 1983.

Total exports grew by 10%. Re-exports, which account for 80% of the territory's total exports, increased 14%. (Goods made in foreign countries, principally China, which officially enter Hong Kong's customs territory for shipment onward to other countries are classified as re- exports.) In the first quarter of 1995, Hong Kong's total exports jumped 18% over the year earlier figure as demand revived in Hong Kong's major markets. Domestic exports also surged as the declining U.S. dollar enhanced Hong Kong's export competitiveness. China is Hong Kong's principal export market, followed by the United States, Japan, Germany and the U.K.

Total imports grew by 14% in 1994 to reach US$162 billion. Retained imports -- those not shipped onward to China or elsewhere -- grew by a similar rate. Total imports in the first quarter of 1995 jumped 22% over the year earlier figure to reach US$42.2 billion. The growth reflected the surge in raw materials and equipment needed for growing exports and an increase in retained imports of capital goods and materials for infrastructure and building projects. China is the largest supplier of imports, followed by Japan, Taiwan, and the United States.

Since 1983, the Hong Kong dollar has been linked to the U.S. dollar at a rate of HK$7.8 = US$1. The link, which authorities instituted to ensure exchange rate stability vis-a-vis the U.S. dollar, requires local interest rates to generally track those in the United States. As the U.S. dollar has weakened against the yen and deutschmark, this has increased the competitiveness of Hong Kong's domestic exports to those economies, while correspondingly raising the cost of imports from those countries, other things being equal. It will also increase the competitiveness of U.S. products vis-a-vis Germany and Japan, and should create additional opportunities to expand U.S. exports to Hong Kong, which totaled US$11.5 billion in 1994.

B. Principal Growth Sectors

Services dominate. Hong Kong's economy is services-dominated, accounting for some 80% of GDP and employing over 70% of the work force. Services represent some 50% of total domestic exports, twice the level of a decade ago. Between 1984 and 1994 exports of services grew at an average annual rate of 8% in real terms, while services imports increased at 11%. Major sectors include travel/tourism, transportation, trading and financial services. Finance, insurance, real estate and business services contributed 26% of GDP in 1993, up from 20% in 1990. See VII (O) for a discussion of the banking/financial services sector.

Manufacturing continues to decline. Manufacturing now accounts for only about 11% of GDP and 20% of the work force, down from 28% in 1990. The textile and clothing/apparel industries remain the backbone of Hong Kong's manufacturing sector. These industries employ 39% of the work force and accounted for 39%, or US$11.4 billion of Hong Kong's 1994 domestic exports. Other principal manufactures include electronics, watches and clocks and chemical and industrial machinery. Manufacturers continue to shift production facilities primarily to China to take advantage of lower labor and land costs.

(1) Tourism and Retail Sales

Tourism is Hong Kong's largest earner of foreign exchange after the textile and apparel industries. Tourism provided revenues of US$8.3 billion during 1994, up 7.1% from the year earlier. Visitor arrivals exceeded 9.3 million in 1994, up 4.4% compared with 1993. Visitor arrivals from China accounted for 20.4% of the territory's total arrivals followed by Taiwan with 17.3%, Japan at 15.4%, Southeast Asia with 12.8%, and Western Europe with 12.1%. Visitors from the U.S. increased 8% to 776,000. Hotel room occupancy rates nudged down two percentage points to 85% in 1994, and fell to 75% in April 1995 due to higher room rates.

Retail sales grew by 12% in 1994. Those sectors which enjoyed strong growth included clothing and footwear, up 36%, and jewelry, watches and gifts, up 13%. Car sales, though, have been quite lethargic, slumping 4% in 1994. Tourism revenues as well as retail sales were both sluggish in the first quarter of 1995 registering a meager 0.5% growth.

(2) Property

Hong Kong's property market has cooled from the sizzling levels attained in mid-1994 that earned it dubious distinction as the world's most expensive business location. Residential property prices have declined by more than 20% from their peak levels of April 1994. A combination of government administrative measures, rising interest rates, and the negative wealth effect of declining equity prices during 1994 took the steam out of relentlessly advancing private and commercial property prices. A series of measures the Hong Kong Government introduced in June 1994, which remain in place, have curbed property market speculation. They are also designed to increase new home supply through accelerated construction, fast-tracking major housing projects and releasing more land for building.

As of June 1995, monthly rental prices for Grade A office space in Central and Wan Chai North, two of the most popular commercial districts for multinationals on Hong Kong Island, had fallen by 10.5% and 23% respectively since their August 1994 peak. Office space, however, still is expensive by regional standards. While office space in Central now fetches on average US$9.60 per square foot (p.s.f.) per month, similar accommodations at Wan Chai North will cost an average US$6.20 p.s.f. Across the Harbor in Kowloon, prime office space is available for US$4.50 to 5.20 p.s.f. According to local property agents, Grade A office rents in all three areas are projected to fall downwards of 30% by 1996 as an increased supply of Grade A office space becomes available outside Central.

Adding to the downward pressure on office rents is the fact that increasing numbers of companies, which are trying to cut overhead costs, are moving away from the prohibitively expensive, high occupancy Central business district to outlying areas where rents are lower. Finally, tenants are becoming more and more resistant to high rents. Given this trend, landlords in Central and Wan Chai North are either lengthening the rental-free periods or simply lowering their rental premiums on their three year leases in order to prevent the further exodus of tenants.

Prices in the residential property market this year moved in parallel to prices on office space. As of June 1995, rents on new luxury flats, that is units over 1000 square feet with some added amenities, had dropped 30% since their July 1994 peak, while prices for existing flats fell 22.5%. In May alone, rental prices fell 10%. Monthly rentals for luxury units on the Peak, in Wan Chai, and the South-side of Hong Kong Island, the three most popular living quarters for expatriates, averaged US$4.77, $3.40, and between $2.70-$5.00 p.s.f. in that order. Because there is presently an "oversupply" of luxury units -- many flat owners have put their properties up for lease -- it is now a "tenants market" and rental prices are quite negotiable.

(3) Infrastructure (Construction, telecommunications, environmental

See II.e below for a discussion of these sectors

C. Government Role in the Economy

The Hong Kong Government pursues a generally non-interventionist approach to economic policy that stresses limited government interference and the predominant role of the private sector. However, public housing, land sales, and infrastructure development are areas in which the government does play an active role.

Hong Kong has consistently supported an open multilateral trading system. The Government was a firm proponent of the recent Uruguay Round of trade talks in the GATT and looks forward to participating in the new World Trade Organization. Hong Kong maintains no anti-dumping laws, countervailing duty laws, import quotas or tariffs. It urges similar open trade policies on its neighbors and trading partners.

The tax system in Hong Kong is simple and tax rates are low. No one pays more than 15% of their income in salaries tax. As a result of generous allowances under the law, almost half the work force pays no salaries tax. The business profits tax is 16.5%. It is payable only on net profits arising in Hong Kong or derived from business carried on in Hong Kong. There are no taxes on capital gains, dividends, or interest. Other revenue sources include stamp duty on property and stock market transactions, betting duties and estate duty and hotel accommodation tax. The Hong Kong Government's low taxes and prudent fiscal policy have enabled it consistently to achieve surpluses on its consolidated account over the past decade.

Hong Kong Government-funded core projects including those related to Chek Lap Kok replacement airport and environmental protection have further fueled the development of Hong Kong's economy. Although the Hong Kong Government is spending heavily on projects of this nature, the financial structure is fit. In the 1994 fiscal year which ended March 31, 1995, government expenditure accounted for about 16.8% of GDP. Government expenditure has never exceeded 20% of GDP. Prudent fiscal management and strong reserves have obviated the need for the Hong Kong Government to incur debt to finance expenditures.

D. Balance of Payments Situation

As indicated in II(A), Hong Kong's visible trade deficit widened significantly during 1994. This trend has continued in 1995 as imports have surged, albeit against the backdrop of a strong growth in exports as Hong Kong's terms of trade have improved. The invisible, or services, trade balance, has continued to be sufficiently positive to offset the merchandise trade deficit. In 1994, the surplus on invisible trade totaled US$13.3 billion against a merchandise trade deficit of US$10.9 billion. The overall trade surplus represented approximately 1.5% of total imports. If current trends continue, it is possible that Hong Kong will experience a current account deficit in 1995. That said, the fixed capital formation related to the new airport and other major infrastructure projects will significantly boost Hong Kong's competitiveness and generate longer-term earnings from investment, trade, tourism, and other services.

Hong Kong does not track capital flows from foreign investments. However, net capital inflows from transfers, foreign direct investment and investment income increased foreign currency reserves in the Exchange Fund by HK$49 billion (US$6.3 billion). At year-end 1993, foreign currency reserves stood at US$49.2 billion, giving Hong Kong the world's seventh-largest foreign exchange reserves.

E. Infrastructure Situation

Hong Kong's well-developed, modern, and efficient infrastructure has supported the territory's leading role as a trade entrepot and regional financial and services center. However, rapid growth has placed severe demands on that infrastructure, particularly transportation and shipping facilities.

Public- and private-sector spending on major infrastructure is projected to exceed US$45 billion over the next decade. The centerpiece is the new Chek Lap Kok airport. Other significant projects include a planned expansion of container terminal facilities, bridges, railways, sewage facilities, telecommunications and power stations.

New Airport Core Program

Hong Kong's single-runway airport, Kai Tak, is second in the world in terms of cargo handled (behind Tokyo's Narita) and third in terms of international passengers. 1.25 million tons of cargo and 19.9 million passengers passed through the airport in 1994.

The Hong Kong Government announced in 1989 plans to build Chek Lap Kok, a completely new international airport on the north shore of Lantau Island. Besides Chek Lap Kok, the airport core program includes nine additional integrated projects. Among these are a railway link, one of the world's longest suspension bridges, a third cross-harbor tunnel, new roads, land reclamation, and a new town adjacent to the airport.

After protracted negotiations over several years, The U.K. and China agreed in November 1994 on overall financing arrangements for the airport and connecting railway. In late June 1995, the two sides finalized terms for financial support agreements for the projects, thus removing the last significant obstacle to full funding for the megaproject. However, because of the delay in reaching agreement, the airport is not scheduled to become operational until April 1998, almost one year after the original target date of June 30, 1997.

The new airport will initially be capable of handling 35 million passengers and 1.5 million tons of air cargo annually. With the later addition of a second runway, annual passenger and air cargo handling capacity would be raised to 80 million and nine million tons, respectively. Work on transport links and land reclamation for the US$21 billion airport project is well underway and at the end of April 1995, over 58% of the airport engineering projects had been completed.

Construction of the new airport and related infrastructure projects has generated a boom for the building and construction market. Infrastructure development has likewise increased the territory's demand for capital goods, which should remain strong over the next decade.

Shipping and Port Activities

Hong Kong enjoys perhaps the best natural deep-water port on the Chinese coast. It serves as a transit point both for exports and re- exports to south China in both capital and consumer goods and for re- exports of merchandise to North America, Europe and elsewhere. With continued high economic growth and industrialization in China, the development of deep water ports at Yantian and Gaolan in south China should be complementary to Hong Kong over the medium term. Over the longer term increased competition should generate greater efficiencies in service.

Hong Kong's container port is the world's busiest. In 1994, Hong Kong's eight privately operated container terminals and mid-stream operators handled 11.05 twenty foot equivalent units (TEU) of cargo, a 20% increase over 1993. The Port Development Board projects container throughput is expected to continue to increase by 10.9% through the year 2011.

Hong Kong's container throughput will continue to experience double-digit growth through the turn of the century. Hong Kong projects it will require some 20 new container berths by the year 2006, providing new annual terminal capacity for 8 million TEU. There are currently eight terminals with 19 berths. Construction of CT9, which the Hong Kong Government had hoped to have operational by mid-1995, has as of April 1995 been put on hold indefinitely by Beijing's concerns with the award of the contract to a consortium involving a well known British trading firm and also the manner in which the project was originally tendered. China has also not yet given its approval to proceed with construction of container terminals 10 and 11, citing environmental concerns.

Roads

Hong Kong's roads have one of the highest vehicle densities in the world. At the end of 1994, there were 454,932 licensed vehicles and about 1661 kilometers of roads, hence 274 vehicles per kilometer of road. This high vehicle density, combined with difficult terrain and dense building development, poses a constant challenge to transport planning, road construction and maintenance. To cope with worsening traffic congestion, largely due to the rapid growth in the number of private cars, the Highways Department has launched an extensive road construction program. Roughly 60 road projects are under way and 30 are planned. The department's budget for the financial year ending March 1995 totals HK$9.26 billion (US$1.1 billion). Of this, HK$8.69 billion is slated for major highway construction and HK$569 million for road and public lighting maintenance work.

Telecommunications

Hong Kong's telecommunications infrastructure ranks among the most technically advanced in the world. During the summer of 1995, the government will open local voice service to three new operators. Thereafter, the only remaining telecommunications service under monopoly control will be international voice service. American service and equipment providers will have substantial opportunities in the Hong Kong telecommunications market. In fact, many are already doing very well. Moreover, year-end 1995, Hong Kong Telecom will offer video-on-demand over its telecommunications lines, making the territory a pace-setter on the information superhighway. As telecommunications and broadcasting technologies converge, the demand and opportunities for TV programming will also increase.

One misperception about the Hong Kong telecommunications market is the belief of some that by establishing oneself in Hong Kong, one will automatically gain access to the China market. Setting up shop in Hong Kong does provide excellent exposure to and experience with the China telecom market. However, after Hong Kong reverts to Chinese sovereignty in 1997, operating in Hong Kong will not automatically permit one to operate in China since post 1997, as Hong Kong will continue to retain its own telecommunications law and regulations.

Environmental

Over US$1 billion of environmental infrastructure project awards will be made in 1995. Projects currently being awarded include: Refuse transfer stations (US$450 million), municipal sewage systems and related equipment (US$300 - 400 million), landfill restorations ($200 million), special waste incinerators ($30 million), indoor air quality baseline study ($1.5 million), and low-level radioactive waste storage ($1.5 million). As of June 1995, all of these projects are in advanced stages of the bidding process.

The next round of environmental infrastructure projects to be awarded by the government will include a US$1 billion livestock slaughterhouse with a significant portion of air and water pollution control equipment (to be awarded in 1996) and several municipal solid waste incinerators, each valued at US$1 billion (awards possible beginning in 1998 or 1999). Overall, however, the value of public project awards related to environmental infrastructure is expected to drop beginning in 1996 due to the 1997 transition of Hong Kong's sovereignty from Great Britain to China.

Additional niche markets exist in Hong Kong for the following types of environmental technology:

• Electric Vehicles (US$5 million in 1996, US$50 million by 2002)
• Diesel particulate control equipment (US$5-10 million)
• Energy-efficient building technology (US$5-10 million), including lighting, insulation, and air conditioning systems
• Industrial air pollution control (US$5 to 10 million)
• Indoor air pollution equipment (US$5 to 10 million)

The following is a list of major projects underway in Hong Kong. Authorities have awarded many of the major contracts. Even in these cases, however, significant opportunities for subcontractors remain.

MAJOR INFRASTRUCTURE DEVELOPMENTS IN HONG KONG

PROJECT		TARGET COMPLETION DATE
Airport Core Program
Chek Lap Kok Airport		1998
Northern Lantau Expressway		1997
Tung Chung New Town Phase 1		1997
Lantau Fixed Crossing		1997
Route 3 (Tsing Yi & Kwai Chung Sections)		1997
West Kowloon Reclamation		1997
West Kowloon Expressway		1997
Airport Railway		1998
Central-Wanchai Reclamation		1997 & Beyond
Western Harbor Crossing		1997
Port Facilities
Container Terminal 9		1996 1
Container Terminals at Lantau Island		Through 2011
River Trade Terminal at Tuen Mun		1997
Transport
Ting Kau Bridge		1997
Country Park Section - Route 3		1998
Mass Transit Railway Extension		2001
Western Corridor Railway		2001
Other
Drainage and sewage facilities		2003
Redevelopment of Kai Tak and Kowloon Bay Reclamations		1997 and Beyond
Telecommunications		2003
Power Stations at Lamma Island		1998
Black Point Power Station and upgrading of Transmission Networks		1999
Estimated Total Cost		HK$350 billion

¹ Delayed Indefinitely

Source: Economic Report, 5/94 Hong Kong Bank (with updates)

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