1 Impacts of the Financial Tsunami on the Hong Kong Economy Government Economist 3 November 2008

2 Economy already slowing before global financial crisis

3 Global financial crisis adding significant downside risks to HK economy Global financial crisis mutated into synchronised downturn Financial markets under exceptional stress credit conditions unusually tight Key risk facing advanced economies is downward spiral between asset prices and real economy, leading to prolonged slump Increasing impact on Asia in coming quarters

4 Transmission mechanisms – how it impacts on HK Trade Asset markets Credit market tightness impacting on SMEs Consumption and investment Unemployment, with feedback on domestic sector

5 Impact on trade

6 Exports slackening fast as global downturn increasingly set in

7 Hong Kong’s total exports of goods by market (year-on-year rate of change in real terms) Q12008 Q22008 Q3* US-2.5%-5.8%-7.4%-6.9% EU3.8%4.6%1.6%2.3% Asia excl. Japan and Mainland China 10.4%19.0%10.7%2.4% Mainland China12.9%12.2%8.6%3.9% Japan-0.8%-3.2%-4.1%-1.3% Overall8.3%9.1%5.4%2.2% Note : (*) Crude estimates.

8 World GDP growth in current and previous downturns 1998 AFC 2001 global downturn 2009 global downturn # World GDP2.5%2.2%3.0% Of which: US4.2%0.8%0.1% EU2.9%2.0%0.6% Japan-2.0%0.2%0.5% Mainland7.8%8.3%9.3% Singapore-1.4%-2.4%3.5% South Korea-6.9%3.8%3.5% Thailand-10.5%2.2%4.5% Taiwan4.5%-2.2%2.5% Indonesia-13.1%3.6%5.5% Note: (#) IMF’s Forecast in the World Economic Outlook.

9 Current US$ strength will not bode well for HK’s exports

10 Guangdong’s export growth slower than the national total

11 Impact on asset markets and domestic demand

12 Stock market saw a significant correction

13 Property market also down across the board

14 Property market transactions down to level close to 2003 average

15 Asset price corrections in the current and previous downturns so far Hang Seng Index (trough/peak) -60.1% 7 Aug 97: Aug 98: % 28 Mar 00: Sep 01: % 30 Oct 07: Oct 08: Residential flat prices-32.5% Dec 98/Dec % Dec 01/Dec % Sep 08/Dec 07

16 Negative wealth effect can be profound

17 Slowdown in income will also impact on consumption

18 Impact on Businesses

19 Bankruptcy cases still low, but likely to rise

20 Business confidence worsened markedly (Results of latest Quarterly Business Tendency Survey)

21 Results of latest Business Tendency Survey (Large firms)

22 Impact on SMEs also severe Figures on SMEs: (As in June 2008)No. of SMEsEmployment (‘000) I/E trade Wholesale & retail trades, restaurants and hotels Financing, insurance, real estate & business services Community, social & personal services Transport, storage & communications Manufacturing and others Total (about 98% of all business units) 1219 (about 1/3 of total employment)

23 Business investment set to slow

24 Impact on labour market

25 Employment conditions to worsen as economy slows

26 Unemployment expected to rise further

27 Employment impacts in previous downturns 1998 AFC 2001 global downturn 2003 SARS GDP growth in the economy’s trough -8.1% (98 Q3) -1.7% (01 Q4) -0.9% (03 Q2) Employment (year-on-year % change) -3.3% (98 Q4) -2.1% (02 Q2) -1.8% (03 Q3) Unemployment rate 5.9% (98 Q4) 7.5% (01 Q2) 8.5% (03 Q2) Swing in underlying CPI inflation from preceding year -2.7% (1998 over 1997) -0.8% (2002 over 2001) -1.1% (2003 over 2002)

28 Sectors expected to be harder hit(1) Financial services Trading and logistics Tourism and consumption-related Real estate and construction

29 Sectors expected to be harder hit(2) Direct contribution to GDP in 2006 (%) Employment in 2007 (‘000) Share in total employment (%) Financial services Trading and logistics Trading Logistics * * Tourism & consumption- related sectors (Retail; restaurants & hotels) Real estate & construction (*) 2006 position.

30 Wide range of uncertainties ahead

31 HK’s economic slowdown will be more severe if: Global financial market meltdown Global downturn degenerated into prolonged and severe slump; and Asia moving into recession US$ continues to strengthen China's exports slow markedly Property market suffers continued fall-off

32 Factors that may cushion HK against a severe slowdown : Global concerted efforts to prevent systemic crisis from spreading further Global financial markets stabilise CPG’s support for Hong Kong: Premier Wen’s recent remarks China maintains reasonably strong momentum, especially in trade Interest rates hold stable or move down US$ to reverse trend Infrastructure projects can speed up

33 Short-term economic outlook GDP growth likely to slow down further in Q4; earlier forecast of 4-5% for 2008 difficult to attain Economic conditions will worsen further in early 2009; prospect of turnaround in H still highly uncertain Unemployment rate looks set to rise further, more visibly in 2009 Inflation likely to ease as pressures from local and external sources recede significantly

34 Overall Global financial crisis will inflict major shocks on HK economy via various channels HK's strong fundamentals mean speedy recovery once global situation turns for better But short term outlook inevitably much dimmer; risk of recession in 2009 now higher Remain alert to risk of potentially more damaging impact from global crisis Need to get prepared for difficult period ahead

35 END