Hong Kong Business Forecast Report Q4 2008

Economy Facing Mounting Challenges

Although Hong Kong will hold Legislative Council (LegCo) elections on September 7 2008, full democracy is still a distant prospect (Beijing has ruled out universal suffrage until 2017 for the Chief Executive and 2020 for the LegCo at the earliest), and with several key seats uncontested, we expect little to change as a result of the vote. At present, only half of the 60 seats on the LegCo are directly elected in five geographical constituencies. The other 30 members are drawn from 28 so-called functional constituencies, representing various sectors of the community that are considered to play a crucial role in the development of the territory. Of these, 11 seats are uncontested in the upcoming elections.

Despite experiencing an unexpected acceleration in economic growth in Q108, with real GDP expanding 7.1% year-on-year (y-o-y), there are mounting signs of moderating economic activity in Hong Kong. The external sector is facing growing headwinds, with export performance across the region disappointing of late. Hong Kong's exports fell for the first time in over two years in June 2008, and remain vulnerable in the face of slowing global growth and continued financial market turbulence. Domestically, inflation remains a key concern, with average growth in the composite consumer price index accelerating to 5.7% y-o-y in Q208 from 4.6% in Q108. Positively, additional government relief measures announced in July should go some way towards offseting the negative effects of soaring prices on domestic demand - a key driver of economic growth. BMI is forecasting real growth in GDP to slow to 5.0% in 2008, from 6.4% in 2007.

Hong Kong's ageing population poses a key long-term challenge to the authorities going forward. According to the United Nations' median variant population projections, the proportion of Hong Kong's working age population (those aged 15-65) is expected to shrink from 72.2% in 2010 to 56.1% in 2050. As a result, Hong Kong's dependency ratio (the ratio of the economically dependent part of the population to the economically active part) is projected to more than double from an estimated 35 in 2010 to 78 in 2050. While the authorities have stressed the importance of continuing to attract skilled migrants to sustain productivity increases and improve the territory's demographic composition, additional policy changes in the areas of healthcare and pensions will be needed to mitigate the effects of population ageing on public finances and the economy.

Hong Kong continues to attract high levels of foreign direct investment due to its unique position as a business-friendly gateway to mainland China. It benefits from a transparent legal system and highly skilled workforce that has made the city a major hub for international finance. This strong position will be maintained following the government's decision to further lower the corporate tax rate. The pro-investor climate is also augmented by the absence of red tape, significant corruption and any major security threats. Finally, the preferential access that Hong Kong enjoys with the mainland ensures that the territory will carry on drawing substantial overseas investment.