The Hong Kong Special Administrative Region should experience solid growth with low average inflation in the 2001 calendar year.

Our detailed, initial forecasts for the year are contained in the accompanying two tables (see pages 6 and 7 of this statement).

While the predicted growth rate for the year ahead is much slower than the expected 10 per cent plus real growth outcome for 2000, this was an exceptional year, marking the rebound of the SAR from the recession of 1999 and 1998.

Nevertheless, our forecast expansion for 2001, at 4.8 per cent, is in line with the medium-term trend growth rate for the local economy and should be regarded as a positive outcome for the year.

This real growth in 2001 will be more evenly spread across the whole economy than was apparent in 2000, it will be coming off a solid base and will be achieved in an economic environment where deflation has disappeared from the equation.

Domestically, the forecast takes into account the fact that disposable income will remain under pressure in the year ahead. While modest wage rises are likely in early 2001, these will be offset to some extent by initial contributions to the MPF.

It is also based on interest rates being stable or moving moderately lower in the first half of the coming year.

The forecast could be upgraded from 4.8 per cent if interest rates were to move considerably lower than they are at present. With the local prime rate at 9.5 per cent there is plenty of room to move should US rates be cut.

On the other hand, a move to significantly lower interest rates in Hong Kong as a result of a decline in US rates, would probably indicate the US economy slowing even more dramatically than is currently anticipated.

Internationally, there were some clouds on the horizon during the second half of the current year, including the obvious slow down in the US, equity market volatility, higher global oil prices and the emergence of apparent currency misalignments against a strong US dollar.

More recently some of these concerns have appeared to ease, with oil prices moderating, the US Federal Reserve appearing to take an easier line on the prospect for interest rate cuts, and a recovery in some currencies against the US dollar, especially by the Euro.

The risk of a more severe slow down in the US economy still remains a concern, however, as does the potential fragility of US (and, therefore, global) equity markets. Oil prices could also rise again were winter demand to increase or the Middle East situation threaten supplies.

From a Hong Kong SAR perspective, these factors can only be monitored closely.

However, given that our forecast growth rate of 4.8 per cent is achieved in the coming year, there should be noticeable improvements in local sentiment.

As mentioned above, there will be a modest (up to 2 per cent) increase in wages and salaries during the year although this will be offset by MPF contributions of 5 per cent for many employees from the February start-up for payments.

The 5 per cent contribution from employers for those employees not already covered by existing, exempt provident fund schemes, will also add to business costs, despite being tax deductible.

There should be some improvement in the property market over the year and this should help community sentiment, but with values still so far below their 1997 peak there is a long way to go before the "wealth effect" re-emerges.

Employment should continue to improve throughout the year, albeit only gradually and the unemployment rate should drop to around 4 per cent of the workforce from the present level of 4.8 per cent.

Its impact, however, will be gradual and effected by other economic events, for example, the pace of growth globally and, especially, in the US.

The background to the present economic situation is that the Hong Kong SAR had an extraordinarily good year in 2000, even if it was not as good as the "headline" or "real" (deflation adjusted) growth rates imply.

At perhaps any other time, real growth in GDP of 10 per cent plus might have been expected to produce unbounded optimism in the local economy. The recovery Hong Kong has seen to date has not been able to achieve this. Why?

One of the key factors is that the recovery has been to a large extent externally driven, with big increases in external trade (especially exports) of goods AND services taking time to have an impact on the broader economy.

The chief culprits in the failure of a broad-based improvement in sentiment to emerge, however, appear to have been continuing deflation and the relatively lacklustre performance of the residential property market.

Of these two, the second is the easiest to explain. Property owners, especially residential property owners, saw the value of their key assets tumble when the Asian financial crisis eventually hit the SAR in late 1997.

This produced a negative "wealth effect" that was bad for consumer and investment sentiment, and which has not yet been purged from the system. With luck and good economic management things should improve in 2001.

The effect of the deflationary situation is far more complicated.

While ostensibly positive for consumers (lower general price levels stretch disposable income), deflation is clearly bad for overall sentiment and the cash flow of businesses.

It has therefore had the rather unusual effect of inflating the "headline" or real rate of growth in GDP, which should have been positive for sentiment, while not benefiting the broader community too much.

The nominal (current dollar value) growth rate has recovered (it will come in at under 4 per cent for the year compared with a negative 2.2 per cent in 1999), but it has been far less spectacular than the recovery suggested by the headline "real" growth rate.

At the same time, increases in disposable income have been limited by the fact that wage and salary increases have been modest or non-existent, meaning consumers have been able to take only minimum advantage of lower prices.

There also has been something of a dichotomy between the some parts of domestic economy and the powerful growth externally (with trade in goods and services, especially re-export trade with the Mainland, being very strong).

For example, while the retail trade has gained strongly in terms of volume (the throughput of goods, admittedly at lower prices), revenues have been poor. And in tourism, while visitor arrivals are up strongly, revenues have not kept pace.

Within some other sectors there also have been vast differences. For example, in investment (gross fixed capital formation), building and construction has been weak, while machinery and equipment spending has been extraordinarily strong.

Even within the machinery and equipment element of investment, the performance has been mixed with computer and computer related equipment leading the way, but other equipment lagging behind.

Despite this unusual (and uneven) economic situation, the Hong Kong SAR should be generally well pleased with the recovery that occurred in the local economy during the past year.

Things have generally improved, albeit more gradually than most people might have hoped for.

The residential property market clearly stabilised as the year progressed, despite concerns over likely future supply, and other sectors of the market (commercial, retail) clearly saw an improvement in sentiment.

Employment also improved throughout the year and the unemployment numbers and therefore the unemployment rate declined, although not as quickly as some (including the Hong Kong SAR Government) had been expecting.

The local share market continued to perform fairly well despite being adversely affected by the volatility in the US markets, particularly the bursting of the high-tech "bubble" and the decline in sentiment towards IT and e-commerce stocks.

Although the deflationary phenomena persisted year-long, it showed signs of easing as the year progressed and, barring any unforeseen economic setbacks, seems set to disappear from the equation in the coming months.

Building and construction investment, especially in the private sector, was weak throughout the year, but did show signs of improvement in the second half and this trend should continue. Government investment also picked up.

In summary, then the outlook for the year ahead is:

• Solid sustainable growth in line with the medium term growth trend in the SAR economy.
• This implies it will be slower than the "exceptional" real growth in 2000, as the economy rebounded from recession in 1998 and early part of 1999.
• Growth in Gross Domestic product will be 4.8 per cent compared with 10 per cent plus in 2000 (the Chamber forecast is 10.3 per cent, the Government forecast is 10 per cent).
• Deflation to disappear and average inflation for the year is likely to be between 1 and 2 per cent.
• Nominal (current dollar value) GDP growth will be close to 6 per cent for the year compared with less than 4 per cent in 2000.
• The Chamber is prepared to upgrade its forecast if certain events occur: