Hong Kong's economy turned positive in real terms in the second quarter of this year after three consecutive quarters of decline, but the global economic and political background -- and domestic malaise -- suggests there are plenty of uncertainties ahead.

Internationally, the future is clouded with the global economic slowdown looking far from over, the campaign against terrorism ongoing and prospect of some action against Iraq, whether its turns out to be full scale war or not.

Domestically, economic growth is still slow and the government faces budget problems. Local demand remains sluggish and unemployment is at record levels. Incomes and profits are both restrained, the property market is lacklustre, and government spending, if anything, higher.

At first sight, the second quarter economic report from the Government Economist, Tang Kwong-yiu, gave some cause for optimism, with positive real (or deflation adjusted) growth of 0.5 per cent for the quarter bringing to an end three consecutive quarters of decline.

[There also has been, since the end of the quarter, a significant improvement in external trade, although unemployment, retail sales, investment and the property market -- despite some lift in flat sales at low prices -- still look weak. Tourism numbers also continue to be strong.]

A closer look at the second quarter figures, which were issued at the end of August, does, however, raise some concerns.

Although real GDP growth was a positive 0.5 per cent for the quarter, nominal (or current dollar) GDP actually declined by another 1.6 per cent year-on-year, making it the fifth consecutive quarter of decline in dollar terms -- that is, before deflation is taken into account.

And while deflation is undoubtedly good for consumers, it makes things difficult for business profits and for the government, which needs good nominal, or current dollar, expansion in the economy to boost its tax take.

Also seemingly positive at first glance was the government's decision to raise its annual 2002 growth forecast to 1.5 per cent from its original 1 per cent, but this owes more to revised and better GDP data than to any improvement in the underlying economy.

Finally, it is apparent in the opening six months of the year, the local economy basically stood still when compared with a year earlier. The 0.5 per cent rise in GDP in the second quarter did no more than cancel out the revised 0.5 per cent decline in the opening three months.

This is not say that things will not get better in the second half of the current year. They well may. [At this stage, the Chamber is still holding to its 2 per cent growth forecast made in December last year, but the uncertainties surrounding such forecasts have increased recently, rather than subsided.]

There were also worrying signs in numbers published elsewhere, with the quarterly report on the general household survey conducted by government showing that median household income slipped to $16,500 a month in the second quarter.

This is down more than 8 per cent on the median household income in the same quarter of last year, despite average (median) wages holding steady at $10,000 a month for the quarter.

The culprit was probably the higher unemployment, with average unemployment for the quarter at 263,400 (up 72 per cent on the 152,600 unemployed in the same quarter of last year) and underemployment at 100,500 (up 34 per cent).

In his own report on the second quarter outcome and the immediate prospects, the SAR Government's Chief Economist, Tang Kwong-yiu, was uncharacteristically blunt in his assessment, when he said:

"But the near-term outlook for the domestic economy remains bleak. Consumers may still be less willing to spend, while companies may continue to hold back on their investment plans."

Highlights of the second quarter report, most of which back his view, included:

GDP growth resumed after three negative quarters, mainly propelled by a visible pick-up on the external front. GDP rose 0.5 per cent in real terms year-on-year after a revised 0.5 per cent fall in the first quarter. For the first half, GDP was therefore flat (actually a very modest rise of 0.04 per cent).

Exports of both goods and services performed better, with firmer regional demand and some improved price competitiveness from a weaker U.S. (and therefore Hong Kong) dollar. Exports of goods rose 5.9 per cent in real terms after having declined for four consecutive quarters. Exports of services rose 8.6 per cent, lifted by inbound tourism and offshore trade.

Domestically, consumer spending was, however, restrained by higher unemployment and moderating wages, and fell 2.4 per cent. Investment spending remained weak and fell 1.7 per cent. Machinery and equipment investment was held back by a subdued business climate and an overhang of excess capacity, which more than offset a moderate increase in building and construction output upon intensification of work on some major projects. There was a moderate replenishment of inventories.

The labour market worsened with unemployment averaging 7.7 per cent compared with 7 per cent in the first quarter. It has since risen further. The underemployment rate, however, declined from 3.2 per cent to 2.9 per cent.

Looking ahead, the domestic economy looks like remaining weak, and the Government Economist pointed to a series of domestic and external uncertainties that could restrict growth.

Externally, these include the likely impact of the weak U.S. stock market and the worrying corporate issues that have arisen, as well as some weaker economic data, which have led to concerns about the pace and sustainability of recovery in the U.S. economy.

He noted that the trend in U.S. consumer spending would be a key factor, with any spending decline having inevitable knock-on effects on the rest of the world, including the European and East Asian economies.

Within Hong Kong, apart from the continued weakness in the labour market, there is also concern about the extent to which the better performance in exports may be able to filter through to give a boost to local demand.

He said there might, however, be upside potential if the growth momentum in exports of goods and services, helped by a now weaker U.S. dollar, could be sustained, and if the transmission process to the local economy could be beneficial in due course.

On the price front, the recent weakening in the U.S. (and Hong Kong) dollar may affect import prices only with a time lag. Moreover, renewed downward pressure on wages and rentals will keep local prices down, with deflation for the full year now expected to be 2.8 per cent.