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We Have Turned the Corner

The Chamber's Chief Economist forecasts that we can look forward to a relatively good year in 2004, but that record fiscal deficits in Hong Kong and the U.S. might dampen our new year cheer

Following is the abridged speech by the Chamber's Chief Economist, David O'Rear, at the Business Summit.

The year 2003 is likely to be remembered as a turning point in the economy, a year when some of our long-held assumptions finally ran their course. As we move forward, it is becoming increasingly difficult to find an economic forecast that isn't very, very bullish. So let's start with the U.S., where there are still some bears lurking around in the woods.

The forecast by the Organisation for Economic Co-operation and Development (OECD) in November shows the outlook for less developed economies as well as the developed economies is picking up considerably from the low point in 2000 and 2001.

In the U.S., we are seeing a situation very much like we saw in the mid-1980s. Eighteen years ago, trade and fiscal balances were so far out of line that the richest countries in the world got together and decided that they needed to realign the exchange rates. Today, those imbalances are even larger and we are in the middle of another major realignment of exchange rates. The U.S. fiscal deficit is the largest in history as a percentage of GDP, but even more shocking is the turn around that has come from what was a surplus. Moreover, the current account deficit has been breaking records almost every quarter.

What is different this time is the very poor state of household finances in the U.S. Just as the U.S. current account and fiscal deficits have been breaking records almost every time the numbers are reported, so too have the household debt and saving ratios.

China is managing to come out of deflation without too much difficulty. Last time we saw a major turnaround in the direction that prices were going was back in the mid 1990s, when then-Premier Zhu Rongji brought down the inflation rate, at the expense of economic growth. This time what we are seeing is a fairly comfortable move from mild deflation to mild inflation, although we are still concerned about China's high dependence on investment and exports, which makes the economy vulnerable to what happens in the United States.

Because of the importance of exports in creating jobs in China, we do not believe that Beijing will make any adjustments to the exchange rate level or regime next year.

For the rest of Asia, it is not as clear, particularly for Korean where the Won now looks very under valued. In the rest of East Asia -- Korea, Taiwan and Southeast Asia -- countries have been enjoying booming exports both to the United States and to China in the past year. Now even Japan is beginning to move forward, which is the best news we have seen out of that country in a very long time.

Hong Kong

For Hong Kong, we think that the economy will grow 3.8 percent in 2004. It is not going to be difficult to achieve the government's 3 percent target for 2003 if we get anything like the same results in Q-4 as we saw in Q-3. Nominal GDP, however, is still contracting. Even though we did have the positive 4 percent growth number in real terms, that was all due to deflation.

Our outlook for 2004 is that deflation will ease off. We have run our course. When we get to the summer of 2004, and we are facing the base from this year which was the deepest period of deflation, then we will see some recovery in movement of prices back towards zero. That is why our forecast is not any higher than it is, because as deflation eases, the real GDP figure becomes much more difficult to achieve.

On the retail side, we are seeing some steady increases in retail sales, but jobs have not been growing well lately. The labour force growth rate has been tremendous in the last three years, in particular in the late part of 2002 and early 2003 we saw the labour force grow at a rate four times as fast as growth for the total population. We managed to create jobs pretty well up until the summer, but now we will have to get back into job creation, and that looks to be a real challenge.

The budget deficit is going to be the number one challenge in the next couple of years. The reserves are going to drop down to about HK$50 billion towards the later part of the decade, which will be about a quarter of public spending each year.

To sum up, we have a relatively good year to look forward to in 2004. There is a risk that deflation does not improve as quickly as we thought, in which case my 3.8 percent forecast gets up into 4 percent range. But it is clear that we have turned the corner, that the sentiment is there and that our main concern for the next year or two is going to be making sure we reduce spending on the budget faster than we increase the tax revenues.

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- Q&A Session with the General Committee Panel