The Outlook for 2004

inSight

01 Jan 2004

The Outlook for 2004

Against a background of strong economic growth in Hong Kong, the mood of the community is improving. But markets are unpredictable, and we need to continue to manage risks prudently.

Let me in this first Viewpoint article in 2004 wish readers of this column a very Happy and Prosperous New Year. The mood of the community, as we move into 2004, seems a lot better. I certainly hope that this can be sustained. There are good reasons for optimism. We are seeing a robust recovery in the global economy and stronger-than-expected economic growth on the Mainland. These trends have greatly benefited Hong Kong's external sector, as indicated in the substantial current account balance of payments surplus that we are running. It is true that structural changes in our economy, involving the migration of our manufacturing sector into the Mainland, have meant that the benefits of an export-led economic recovery in Hong Kong now take more time than before to spread to the community. But eventually they will. The improvements that we have been waiting for in employment and the public finances will come through with economic recovery. We will, I hope, be able to see this happening on a significant scale in 2004.

There are also good prospects for deflationary pressures to ease further. Five years of deflation has been unsettling for the community, although we have to accept that at least a substantial part of it represents a necessary evil brought on by the increasing economic integration with the Mainland. I believe that the end of that structural change, and therefore structural deflation, is in sight. Although this varies between different sectors of the economy and the cross-border mobility of both the products and the factors of production in each sector, the Hong Kong price premium over the Mainland has generally been narrowing. This process has also been helped by inflation on the Mainland. For particular sectors, the narrowing of the price premium may have even overshot such that it now appears small, having regard to what seems intuitively justifiable under "one country, two systems". Furthermore, continued reform and liberalisation in the Mainland will hasten the reduction of the asymmetry in the mobility of money and people (consumers and investors) between the Mainland and the rest of the world. Hong Kong stands to benefit, I hope, to a much greater extent than others, from this inevitable process, because we are well positioned and we have positioned ourselves well. It is difficult to see why Hong Kong would not benefit more fully from the rapid economic development in the Mainland after our structural adjustment is completed.

To the extent that deflation has been a cyclical phenomenon, the economic recovery should, in time, help to eliminate it. This hopefully will not take too long. The recovery in consumer spending, and the upturn in the prices of financial assets and residential property provide scope for optimism. The accommodative stance of monetary policy in the United States, which on current indications is expected to be maintained for a considerable period, enabling a continuation of low interest rates in Hong Kong, will help further. So should the weakness in the US dollar. It does look like deflation will be over soon. Indeed, some internal work at the HKMA suggests that it is not impossible that deflation will be over by the end of 2004.

The financial markets have certainly been feeling rather excited about the better economic prospects. But I am sure readers can remember the never-failing behaviour of financial markets in overshooting. This is particularly so with globalisation. The HKMA is not against globalisation, or market gyration, as long as they do not lead to systemic problems or disrupt the important function of financial intermediation that is so essential to economic growth and development. But there is always a need for investors (and regulators) to recognise and prudently manage risks. And the risks in 2004, as I see them, and in general terms, are:

  • economic optimism becoming not justifiable or supported by fundamentals leading to sudden and large market corrections
  • less than benign exchange rate adjustments brought on by heightened concerns about external imbalances, particularly in the United States
  • greater than expected inflationary pressure developing to the extent of requiring upward interest rate adjustments that are larger and sooner than expected
  • unexpected escalation of geo-political tension.

I could go on, and it is the duty of central bankers to be worried about these issues. But I obviously do not wish to sour the mood as we all move with renewed optimism into 2004.

Let us then welcome the year and hope that it will turn out to be much better than our expectations, in every respect.

 

Joseph Yam

1 January 2004

 

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