The Budget 2005-2006: My Views Stephen Yan-Leung Cheung Prof. (Chair) of Finance City University of Hong Kong

Content Hong Kong Economy How can we position ourselves? Opportunities in China Market Uncertainties

Government Deficit (I) Year 2004-05 ($billion) 2005-06 ($billion) 2006-07 ($billion) 2007-08 ($billion) 2008-09 ($billion) Operating revenue 165.6 170.7 177.7 184.9 194.8 Operating expenditure 212.2 210.6 207.1 203.5 200.0 Operating surplus/ (deficit) (46.6) (39.9) (29.4) (18.6) (5.2) Capital revenue 37.9 56.8 44.5 56.0 49.3 Capital spending (including payments from the Capital Investment Fund) 53.4 52.3 45.9 39.6 37.1 Capital financing surplus/ (deficit) (15.5) 4.5 (1.4) 16.4 12.2 Government bond issuance - Proceeds - Interest expense 20.0 0.5 - 1.0 Capital financing surplus/ (deficit) after bond issuance 4.0 3.5 (2.4) 15.4 11.2

Government Deficit (II) Year 2004-05 ($billion) 2005-06 ($billion) 2006-07 ($billion) 2007-08 ($billion) 2008-09 ($billion) Consolidated surplus/ (deficit) before bond issuance - as a percentage of GDP (62.1) 4.9% (35.4) 2.7% (30.8) 2.2% (2.2) 0.2% 7.0 0.5% after bond issuance (42.6) 3.4% (36.4) (31.8) 2.3% (3.2) 6.0 0.4% Fiscal reserves after bond issuance - as number of months of Government expenditure 223.8 10 187.4 9 155.6 7 152.4 8 158.4 Public expenditure 286.0 22.5% 277.7 20.8% 270.2 19.3% 264.3 18.0% 259.3 16.9% Source: The Budget 2004-05

Observations (I) Operating revenue cannot cover operating expenditure Operating deficit will last until 2008/09 Consolidated deficit will last until 2007/08

Observations (II) The consolidated surplus/ (deficit) is boosted by the 20 billion bond issue Interestingly, Mr. Tang’s speech did not mention about the payment Issuing bond is a source of financing not income

Operating Expenditure Forecast (in $billion) Target Forecast Source: The Budget 2004-05

Operating Revenue Forecast (in $billion) Target Forecast Source: The Budget 2004-05

Surplus/Deficit Forecast (in $billion) Source: The Budget 2004-05

Observations (III) Operating expenditure drops from 218 billion in 03/04 to 200 billion in 08/09 → 8% decrease Operating revenue increases from 155 billion in 03/04 to 200 billion in 08/09 → 29% increase Question is how to boost up government revenue

Facts Hong Kong has a narrow tax-base No room to increase direct tax rate Salary tax Profit tax Depend too much on direct tax 40:60 (indirect tax: direct tax) Only 40% working population pay salary tax For those who pay the standard tax rate (less than 1%) are responsible for more than 20% of the salary tax revenue Government becomes serious on GST

Economic Situation Hong Kong GDP in Q3 increased to 7.2% Close to the GDP in 2000 Q1, which was 13.6% (IT bubble) The total exports in Q4 2004 increased around 13% Tourism, individual travel scheme CEPA

Property Market Recovery Recovery in 2003 Q4 and 2004 Q1 Number of transactions increased by 22% in the first half of 2004 over the second half of 2003 Average property price dropped slightly recently but prices went up by 26% relatively to mid-2003 Affordability ratio improves substantially

Prices for Residential Property

Tourism Number of tourists arriving at Hong Kong increased substantially from China, and from other destinations Number of tourists arriving at Hong Kong in June 2004 exceeded the pre-SARS level In July 2004, number of tourists reached 1.99 million

Visitor Arrivals

Consumption Private consumption expenditure had an average growth of 7% in real term in Q1-3 2004 The volume of total retail sales increased by 6.8% in Dec 2004 Reflection of strong rebound of local consumers and tourists

Private Consumption Expenditure

Hong Kong’s Price Movement

Market Forecast Hong Kong’s Economic Growth Government 7.5 BOC HK 7.6 HSBC 7.8 DBS Merrill Lynch 8.0 Citibank 6.5 INC Sources: Census and Statistics Department, Reuters, and BOCHK Research

Hong Kong Economic Situation (I) Two Problems Deflation A period of 5 years & 8 months CPI increased by 0.2% in Dec 04 but fell by 0.5% in Jan 05 Declined in prices were recorded in Jan 2005 for housing (-3.1% in the Composite CPI), durable goods (-2.0% in the Composite CPI), miscellaneous services which cover package tours (-1.6% in the Composite CPI), and transport (-0.1% in the Composite CPI)

Hong Kong Economic Situation (II) Unemployment Unemployment rate at 6.4% in Nov 04 - Jan 05 Structural problem Possible to drop to 5 - 6% The age group of 15 -19 has high unemployment rate How to improve the education level of population? How?

Uncertainties Oil price US$50/barrel US economic figures good/bad? US interest rate increase

China Economy Macro-economic adjustment started to work? Fixed asset investment slowed 2004 Q1-3 GDP increased 9.5% Inflation is 1.9% in Jan of 2005 Prices of food items increased by 4.0% Prices of non-food items increased by 0.8% China economy further down may affect the external trade of Hong Kong

Budget 2005-2006 Recurrent revenue and non-recurrent revenue will increase Budget deficit will decrease substantially Structural deficit? How to match recurrent expenditure with recurrent revenue?

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