Executive Summary

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Strong Performer
Growth in Hong Kong surprised on the upside in Q406, as domestic demand remained robust and exports defied expectations of a more significant slowdown on the back of easing external demand. In seasonally adjusted quarter-on-quarter (q-o-q) terms, the economy expanded by 1.3% in Q406, above expectations, although slowing from a revised 2.6% q-o-q in Q306 due to easing growth in net exports. The breakdown of Hong Kong’s Q4 growth shows a further strengthening in private consumption, which rose by 5.8% year-on-year (y-o-y), up from 4.4% in Q3, contributing 3.0 percentage points (pp) to overall expansion, compared with 2.2% in Q3. Investment growth also remained strong, coming in at 9.5% y-o-y and adding 2.1pp to overall growth. Meanwhile, growth in net exports, while remaining in double figures, slowed to 10.7% from 16.4% in July-September, contributing 2.1pp to overall growth, down from 3.1pp in Q3. The government is targeting growth of 4.5-5.5% in 2007, with the anticipated slowdown attributed to a further moderation in external sector growth. While this is in line with our own expectations of a slowdown, we retain our more optimistic forecast of 6.2% expansion in 2007.

Concerning the external sector, Hong Kong’s export growth remained robust through to the end of 2006, despite expectations of a slowdown on the back of moderating growth in the US, and bucking the trend of a regional slowdown. Crucially, Hong Kong continues to benefit from still rapid growth in mainland China. As such, we expect this year’s easing of export growth to only be moderate. We could, however, see a deterioration of the trade balance this year, as export growth falls off and imports of goods and services are bolstered by strong domestic demand. The key downside risks to the outlook are a sharper than anticipated slowdown in the US or Chinese economies, which would have a greater impact on Hong Kong’s trade performance.

Over the medium term, Hong Kong must continue working towards cementing its role as a regional financial services and supply chain hub. Closer economic integration with the mainland remains essential, particularly as China’s ongoing development will boost demand for Hong Kong’s financial services. In addition, the Hong Kong stock exchange raised more from initial public offerings (IPOs) last year than any other exchange, due to listing by firms in mainland China. The government is forecasting an annual trend growth rate of 4.5% during 2008-2011.

Hong Kong’s real GDP growth accelerated to 7.0% y-o-y in Q406 from a revised 6.7% in Q3, putting full-year growth at an impressive 6.8%. The economy continued to be supported by strong domestic demand, while export growth remained resilient in the face of a slowing US economy. While we expect export growth to moderate over the coming months, as external demand softens with the slowing global economy, Hong Kong should continue to post strong growth figures in 2007. Ongoing improvements in an already vibrant labour market underpin the largely positive domestic outlook. Furthermore, Hong Kong will continue to benefit from China’s red-hot economy, which has spurred investment, supported trade and boosted tourism through relaxing restrictions on travel to the territory. BMI is forecasting real GDP growth of 6.2% in 2007.

Press Reports
The Standard has reported on the willingness of Hong Kong’s banks to incorporate in mainland China, despite the cost of conforming to the stringent regulatory requirements of the banking regulator on the mainland. Despite those requirements, it does represent an opportunity for expansion in the region. In a related article, the Asia Insurance Review reported on a recent Standard & Poor’s (S&P) publication that pointed out the strong growth potential in Hong Kong banks expanding into the Chinese markets, even though such expansion would lead to increased exposure. The S&P report also highlighted the strong position of most of Hong Kong’s domestic banks, and despite the management problems expected to arise from the mainland’s regulatory framework, it expected the credit profiles of most of Hong Kong’s domestic banks to remain stable. The International Herald Tribune followed up the story of Hong Kong’s expansion into mainland China by reporting how the Bank of East Asia was one of nine foreign banks granted permission by the Chinese regulator to incorporate on the mainland.

This growing trend is not one-way, however, as SinoCast China Business Daily News reported that mainland Chinese banks expect to hold 40% of the Hong Kong market by 2010. As things stand now, the mainland banks hold 25% of the Hong Kong market, with Hong Kong banks holding 7% of the mainland market.