Last week's Viewpoint drew attention to Hong Kong's record current account surplus, produced by the export and tourism boom. This week's Viewpoint addresses some of the complexities involved in interpreting the surplus.
Last week I drew attention to the large and increasing current account surplus that Hong Kong has been running. I pointed out at the same time that, since the balance of payments account must be in balance, corresponding to that large surplus in the current account there must have been an equally large deficit in the capital account, or capital outflow. A few people who have an interest in the economic well-being of Hong Kong sought advice from me about what further interpretation could be put on the figures, for example, on the Hong Kong economy or on the currency.
This is difficult. At a time when there are so many uncertain factors at work in the external environment, the performance of the Hong Kong economy is likely to exhibit great volatility, given its highly externally oriented nature. While there undoubtedly is a large cyclical element in the economy, it is nevertheless likely that there are also structural issues in the economy, as manifested in continuing deflation, high unemployment and the large fiscal deficit, which have greatly reduced the reliability of predictions based on the "behavioural equations" of the economy established from historical observation. The margins of error in economic forecasts are likely to be much higher now than before.
But the large and increasing current account surplus is a fact, derived from statistics that are compiled with a respectable degree of sophistication by the Census and Statistics Department (where I had the privilege of working for five years at the beginning of my public service career). And much of the surplus came from trade in services, reflecting in part the rapid increase in the number of tourists from the Mainland. The gradual relaxation of controls on Mainland residents visiting Hong Kong is, I am sure, a significant explanatory factor, and to the extent that this is a "structural" change the larger current account surplus cannot be attributable to any change in the competitiveness of Hong Kong. But it is important to note that, with deflation and an exchange rate fixed to a currency that has recently been depreciating, the real effective exchange rate has fallen quite a bit - by 20% since 1998. This must have strengthened significantly Hong Kong's competitiveness and contributed to the sharp increase in the current account surplus, doubts in the reliability of the behavioural equations notwithstanding. Indeed, the traditional deficit that Hong Kong runs in trade in goods has also been falling quite dramatically.
What I have found difficult to interpret are the implications of the increasing current account surplus for the economy and the community. Changes in employment, wages and domestic consumption are now much less sensitive to changes in exports. An export boom now benefits Hong Kong through sharp rises in the profits of those Hong Kong entrepreneurs who had the foresight to relocate their manufacturing operations north of the border, but not through larger take-home pay for factory and ancillary workers in Hong Kong. That is why the unemployment rate remains stubbornly high and why domestic consumption remains depressed. But, however insensitive these indices are, I imagine the elasticity would still be positive, and so if the export boom is big enough the community at large will still benefit. On the other hand, the large current account surplus may also reflect the weak domestic demand in the first place, which led to domestic savings exceeding domestic investment. This suggests that the surplus should decline when domestic activity starts to recover. Meanwhile, given the way in which the GDP figures are compiled (based on what is called the expenditure approach) the increasing current account surplus will, statistically, be reflected readily in the GDP figures, which will need to be interpreted against this complex background.
Let me turn to the implications of the large and increasing current account surplus for the currency. The textbook prognosis is that there may be pressure for the currency to strengthen, or if the exchange rate is fixed through currency board arrangements, for domestic interest rates to fall below those for the anchor currency, inducing capital outflow in search of higher return in foreign assets. Although one can never be sure about the underlying intentions and considerations, the large capital outflow does appear to be largely endogenous, in other words, a consequence of the current account surplus, rather than exogenous, arising from concerns about the budget deficit or the sustainability of the currency link. One cannot, of course, rule out the possibility of exogenous capital outflow for the reasons identified, hence the many alerts to the urgency in tackling the budget deficit. But to the extent that there was an exogenous outflow, it seems to have been small and overwhelmed by the large current account surplus that Hong Kong has been running.
Joseph Yam
27 March 2003
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