MATERIALES

further, and the current account surplus will remain stable. Sharp increases in US interest rates

could, if instituted, derail economic recovery, with the property market particularly at risk.

Economic performance

GDP growth slowed to 1.9% in 2016 from 2.4% in 2015, though growth in the fourth quarter reached 3.1% year on year. Resilient domestic demand underpinned the expansion in 2016. Supported by steady real incomes, low inflation, and a stable labor market, private consumption grew by 1.6% and contributed 1.1 percentage points to GDP growth, while government consumption added another 0.3 percentage points (Figure 3.10.1). Investment rebounded in the second half of 2016 on strong inventory restocking and resilient construction outlays to contribute 1.1 percentage points to GDP growth. Trade benefitted from improving regional trade flows in the latter part of the year, with exports growing year on year by 0.9% and imports by 1.2% (Figure 3.10.2). Net exports staged a turnaround in the last quarter of 2016 but still ended up shaving 0.5 percentage points off overall growth. Construction and services were the primary drivers from the supply side. Construction grew by 2.4% in 2016, while services expanded by 2.3%, despite a lackluster performance by retail trade owing mainly to a decline in tourist arrivals.

The current account surplus widened to equal 4.5% of GDP in 2016. A narrower merchandise trade deficit reflected in part a fall in retained imports in the first half of the year and partly a pickup in the value of goods exports in the latter part of the year. An increase in the net inflow of primary income offset shrinkage in net service receipts as exports of travel services declined more steeply. With net outflow of portfolio capital, the overall balance of payments surplus in 2016 equaled 0.4% of GDP. Gross official reserves rose to $386.2 billion at the end of 2016, or cover for 7.8 months of imports.

Consumer price inflation slowed to 2.4% (Figure 3.10.3). External price pressures remained benign with subdued international prices for food and other commodities and a weak renminbi holding down imported inflation from the People’s Republic of China (PRC).

Steady labor costs and subdued rent increases helped contain domestic costs. Residential property prices fell by 11% year on year in late 2015 and early 2016, but they rebounded and by December 2016 were slightly above their September 2015 peak (Figure 3.10.4).

3.10.1 Demand-side contributions to growth

Percentage points 1.7 3.1 2.8 2.4 _1.9 –4 0 4 8 2012 2013 2014 2015 2016 Private consumption Government consumption Investment Net exports Gross domestic product

Source: CEIC Data Company (accessed 25 February 2017).

3.10.2 External trade Net exports of services Net exports of goods

–8 –4 0 4 8 –100 –50 0 50 100 Q1 2015 Q2 Q3 Q4 2016Q1 Q2 Q3 Q4 % HK$ billion Export growth Import growth

The government revised the estimate of the budget surplus for FY2016 (ended 31 March 2017) to the equivalent of 3.7% of GDP from an initial budget forecast of 0.5% (Figure 3.10.5). The higher revised surplus resulted from additional receipts of HK$81.5 billion, equal to 3.3% of GDP and mainly revenues from land sales and stamp duties from a buoyant property market. Government expenditure continued to increase modestly, primarily on higher provision for social welfare and capital works projects, but is likely to be lower than initially budgeted. Fiscal reserves on 31 March 2017 were expected to stand a tad higher at 37.6% of GDP.

Monetary conditions remained accommodative, though the Hong Kong Monetary Authority (HKMA) adjusted its benchmark base rate twice in December 2016 and March 2017, cumulatively from 0.75% to 1.25% in tandem with increases in the US federal funds rate. Domestic credit grew by 7.3%, and growth in broad money (M2) supply accelerated to 7.7%. The local equity market staged a rebound after the sharp correction in early 2016, falling to a 4-year low in February but ending the year 0.5% higher than in 2015 (Figure 3.10.6). Hong Kong, China remained in 2016 the top market for initial public offerings even though the total funds raised dropped to a recent low.

Economic prospects

GDP growth is projected to pick up to 2.0% in 2017 and recover further to 2.1% in 2018 (Figure 3.10.7). Domestic demand supported by building and construction will remain the engine of growth. Private consumption will benefit as well from continued stable employment and strong incomes. Large public infrastructure projects will lift overall investment, but private investment will remain sluggish. Business sentiment remains fragile, weighed down by moderation in the PRC, developments in the euro area, and the normalization of US interest rates. The purchasing managers’ index slipped back into contraction in the first 2 months of 2017 after finally and briefly breaching in December 2016 the threshold at 50 indicating expansion. Business surveys in the first quarter of 2017 showed pessimism still entrenched, particularly in retailing and construction (Figure 3.10.8). On the supply side, growth will come from construction and services, in particular financial and professional services, the latter benefitting especially from strengthening ties with financial markets in the PRC and opportunities arising from the Belt and Road development initiative.

Inflation will moderate this year and next to about 2.0%. A strong local dollar will dampen imported inflation, while local cost increases will be contained by a negative output gap and moderate economic growth. Together, these factors will dampen upward pressure from rising global prices for oil and other commodities.

The FY2017 budget includes a package of pro-growth fiscal measures equal to 1.3% of GDP that the government forecasts will prop up 2017 GDP by 1.1%. The package includes one-off tax reductions for households and firms, waivers of rates, and extra social security allowances and, more permanently, recurrent social benefits and a tax reduction for

3.10.3 Inflation –2 0 2 4 6 Jul Jul % Jan 2015 2016Jan 2017Jan Transport

Electricity, gas, and water Housing

Food Overall Others

Adjusted

Note: Adjusted overall inflation refers to the rate once the effects of temporary subsidies by the government are removed.

Source: CEIC Data Company (accessed 11 March 2017).

3.10.4 Property market indicators Property price 0 3 6 9 80 90 100 110 Thousands Index, Jan 2015 = 100 Jan

2015 Apr Jul Oct Jan2016 Apr Jul Oct2016

Residential sales and purchase agreementsa

a_{3-month moving averages.}

Source: CEIC Data Company (accessed 28 March 2017).

3.10.5 Fiscal indicators Estimate % of GDP Expenditure Revenue Surplus 0 5 10 15 20 25 2012 2013 2014 2015 2016 2017

Note: Years are fiscal years ending 31 March of that year.

Sources: The Government of the Hong Kong Special Administrative Region of the PRC. The 2016–2017 Budget, and other years. http://www.budget.gov.hk; Hong Kong Monetary Authority; Asian Development Outlook database.

home loan interest. When compared with the revised estimate of FY2016, the budget further includes a 0.7% increase of capital outlays. On balance, budgetary revenues are estimated to fall by 9.3% and expenditures to rise by 5.3%, shrinking the FY2017 fi scal surplus to the equivalent of 0.6% of GDP. This is a step in the right direction given the negative output gap and the need to counter monetary tightening resulting from expected US interest rate hikes.

The stabilization of global demand and growing demand in the PRC for high tech products, especially semiconductors, should off er some support to exports of goods and services in 2017. However, further strengthening of the US dollar, to which the local dollar is tied, could limit export gains. Imports are likely to return to growth as the decline in investment continues to moderate and a depreciating renminbi lifts import demand. The resulting trade defi cit will be off set by an improving surplus in the services account as tourist numbers begin to revive and demand for professional and fi nancial services grows. On balance, the current account surplus is forecast to remain stable at 3.1% this year and next.

Despite the recent decline in off shore renminbi activity in response to prevailing expectations of renminbi depreciation, the role of

Hong Kong, China as the premier center for off shore renminbi trading remains secure. Trading will most likely be further strengthened by the December 2016 launch of a cross-boundary investment channel with the Shenzhen Stock Exchange in the PRC, following the launch in 2014 of a similar channel with the Shanghai Stock Exchange.

The main risks to the outlook are negative spillover from monetary tightening in the US, given the currency link between the two

economies, and the potential impact of changes in US trade policy, which could hurt exports and undermine Hong Kong, China as a regional trading hub. Deepening integration with the PRC is benefi cial on the whole, but it renders Hong Kong, China more vulnerable to adverse economic developments in the PRC. However, if any of these risks materialize, the government has ample fi scal and macroprudential tools to limit the buildup of systemic vulnerabilities.

Policy challenge—responding to rising