Hong Kong's economy was showing considerable weakness, due to both internal and external influences, even before the horrific terrorist attacks on the United States and their aftermath began to have their negative impact on the global economic outlook.

This was apparent in the gross domestic product (GDP) figures for the second quarter, which showed the domestic SAR economy growing at only 0.5 per cent for the period compared with (a downward revised) 2.3 per cent growth in the opening three months of the year.

But the slowdown, and particularly its external causation before the U.S. attacks, was even more apparent in the broader gross national product (GNP) figures issued in mid-September.

These revealed that the economy, by this broader measure, actually shrank 0.9 per cent in real terms (after adjustment for price changes) and 1.3 per cent in money terms in the second quarter.

This compares with growth of 3.2 per cent in real terms and 1.4 per cent in money terms in the first quarter.

Despite this slowdown, GNP for the first half of the year was still therefore 1.1 per cent higher in real terms than a year earlier, not much below the 1.4 per cent GDP growth in that period.

The difference between GDP and GNP is that while GDP only measures output within an economic territory (domestic production), GNP measures the total income earned by residents of a territory, irrespective of where the economic activities providing the income take place.

Furthermore, as Hong Kong's investments and economic activity outside the SAR have grown over recent years (particularly in regard to the Mainland, but also elsewhere), GNP has emerged as a far more important measure of overall economic activity than it was in the past.

Put simply, GNP is obtained by adding to GDP the income earned by residents from outside its borders and deducting factor income earned by non-residents within it.

For the second quarter of this year, Hong Kong's GNP was measured at HK$310.3 billion compared with GDP of HK$308.2 billion.

Income inflow into Hong Kong for the quarter was estimated at HK$104.9 billion (up 2.1 per cent on a year earlier), while income outflow was HK$102.8 billion (for a more substantial rise of 6.6 per cent). This cut the net contribution from these income flows to the overall GNP number to HK$2.1 billion from HK$6.4 billion in the same quarter in 2000.

According to the government, the greater income outflow in the second quarter was due in large part to increased direct investment income outflow to the non-operating entities set up by some of the Hong Kong companies in the tax haven economies. Also, there was a surge in dividend pay-outs from some publicly-listed resident companies to non-residents.

Within the total income inflows, direct investment income (DII) rose by 12.3 per cent in the second quarter of 2001 over a year earlier. This was mainly due to the increased earnings of certain large local enterprises from investment abroad, notably in Mainland China.

Portfolio investment income (PII) increased by 2.2 per cent, mainly attributable to larger interest pay-outs on non-resident debt securities on increased holdings of such securities by resident investors. Other investment income (OII), however, fell by 9.2 per cent, due mainly to reduced revenue from offshore loans and deposits held by the local banking sector, as well as a decline in the amount of such external assets and lower interest rates.

On the outflows side of the account, DII increased by 11.7 per cent in the second quarter, due mainly to increased earnings of certain foreign enterprises from investment in the local economy. PII increased by 16.9 per cent due to larger dividend pay-outs by a number of publicly-listed resident companies. OII fell by 12.7 per cent due to reduction in external liabilities held by the local banking sector and lower interest rates.

During the second quarter, the Mainland overtook the British Virgin Islands to become the largest source of Hong Kong's external income inflow in the second quarter, accounting for 20.4 per cent of the total value. But the British Virgin Islands, as a tax haven territory where many Hong Kong companies had set up holding companies, remained a major source of the income inflow, with a share of 18 per cent. Other major sources were the United States and the United Kingdom, with shares of 12.3 per cent and 9.6 per cent respectively.