HONG KONG ECONOMY FALLS INTO RECESSION; HKG

UNCLAS SECTION 01 OF 03 HONG KONG 002170

SENSITIVE
SIPDIS

STATE FOR EAP/CM AND EEB/IFD/OMA; TREASURY FOR DOHNER,
WINSHIP AND CUSHMAN

E.O. 12958: N/A
TAGS: ECON EFIN HK CH
SUBJECT: HONG KONG ECONOMY FALLS INTO RECESSION; HKG
LOOKING TO CHINA FOR HELP


1. (U) Summary: The Hong Kong government's third quarter
economic report, released November 21, confirmed that Hong
Kong has officially slipped into a recession, with seasonally
adjusted growth falling by 0.5 percent, after a drop of 1.4
percent in the second quarter of 2008. Private consumption
held up better than expected, but merchandise trade, tourism,
financial services, and private construction projects slowed
sharply. Economic activity plunged in September and October,
suggesting that the fourth quarter will bring an even more
pronounced contraction. The Hong Kong government will
increase minor government construction projects and speed up
plans for large infrastructure improvements to keep
construction workers busy. Officials have also announced
plans to support small and medium enterprises (SMEs) by
providing loan guarantees; additional SME-support proposals
are reportedly on the way. Hong Kong's government and
citizens increasingly are looking to China to lend a hand.
End Summary.


2. (SBU) Comment: The HKG is determined not to repeat the
mistakes of 2003, when the economy collapsed under the weight
of the SARS threat. At that time, the government responded
to falling revenues by cutting social spending and chopping
civil service salaries, moves that further inflamed a public
already angry with a slow response to the SARS crisis and its
handling of proposed national security legislation. This
time around, the government will use its accumulated fiscal
surplus to support current levels of spending, extend
subsidies, and introduce new support programs, in spite of
falling revenue projections. Hong Kong citizens and the
government seem increasingly willing to look to China for
creative economic support, instead of searching for their own
means to boost the competitiveness of Hong Kong firms. End
Comment.

=======================================
It's Official -- Hong Kong in Recession
=======================================


3. (U) The Office of the Financial Secretary released the
Hong Kong government's third quarter economic report on
November 21. As expected, the economy continued to slow
between July and September as weakening global demand hit
exports of both goods and services. Real GDP growth in Q3
was 1.7 percent year-on-year, but was down 0.5 percent on a
seasonally adjusted basis. This drop, on the heels of a 1.4
percent fall in Q2 (seasonally adjusted),means that Hong
Kong has officially fallen into a recession.


4. (U) Consumption spending in Hong Kong held up surprisingly
well in July and August, but dropped sharply in September.
Hong Kong Government Economist Helen Chan attributed the
sudden shift to the impact of bad financial news coming from
the U.S. The USG takeover of Fannie Mae and Freddie Mac, the
collapse of U.S. insurance giant AIG, the sale of Merrill
Lynch to Bank of America, the sale of Washington Mutual to
J.P. Morgan Chase and, most importantly for Hong Kong, the
failure of Lehman Bros., all within a few days, shocked Hong
Kong consumers and drove Hong Kong equity valuations down 15
percent in a week. Private consumption for the quarter was
up 0.2 percent year-on-year (yoy) from a high base in 2007;
government consumption increased by 2.3 percent. The
government's decision to waive two months of public housing
rent and subsidize electricity charges helped to boost
domestic demand, but early reports suggest October and
November consumption numbers are well down from even
September's lower mark.

========================================
Hong Kong Trade Growth Lowest Since 2002
========================================


5. (U) Hong Kong's trade account suffered in Q3 as
merchandise export growth fell to its lowest level since

2002. Goods exports to the U.S. have been falling since Q3
2007 and this trend accelerated in Q3 2008 with exports
contracting by 7.1 percent. Shipments to Japan, Korea,
Singapore and Taiwan were all down. Exports to Hong Kong's
largest trading partner, mainland China, grew only 3.9
percent in the quarter. This is a sharp slowdown from the
double-digit growth to which Hong Kong traders have become
accustomed. Service exports grew, but at a slower rate than
in the past as tourist arrivals fell to their lowest level
since SARS (in part due to visa restrictions imposed by PRC
authorities during the Olympics) and financial services
exports dropped. Citibank economist Joe Lo believes the drop
in both merchandise and service exports is not fully captured

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in the Q3 statistics and predicts Q4 results will be much
worse.


6. (U) Worsening consumer sentiment also impacted investment
spending during the quarter. Although spending on capital
equipment and machinery increased by 9.9 percent and public
construction investments increased, the fall in private
construction projects pushed investment growth down to just 3
percent. The slowing economy, combined with one-off
government measures and falling commodity prices, resulted in
an additional drop in the Consumer Price Index from 5.7
percent to 4.6 percent. Core inflation figures, which
exclude one-off government measures, also eased from 6.3 in
July to 6.1 percent in September. Unofficial figures show
additional easing in October to below 6 percent.
Unemployment rose slightly to 3.4 percent, but accelerating
layoffs across the economy are expected to push that number
up quickly in the months ahead.

=================================
HKG Throwing Money at the Problem
=================================


7. (U) Against this gloomy economic news, the government is
searching for policies to alleviate some of the more severe
effects of the slowdown on vulnerable groups. Senior
economist Helen Chan contrasted government policy moves
during Hong Kong's most recent economic slowdown from
1997-2003 with proposals for the current crisis. This time,
she said, the government has the resources to pursue
counter-cyclical fiscal policy. The government will not cut
spending, in spite of falling revenues. Current reserves
will allow the government to maintain spending levels for at
least two years, even if revenues slowed more than expected,
according to Chan.


8. (U) Citibank's Lo predicted that the government will do
little more than extend the current subsidies for government
housing rentals and for electricity, and may provide
additional support for lower income residents. Chief
Executive Donald Tsang recently backed away from
controversial means-testing proposals and announced modest
increases in old age subsidies (known locally as "fruit
money"). The government has already extended existing loan
guarantees for capital and trade financing to support local
SMEs.

====================================
Waiting for a Chinese Rescue Package
====================================


9. (U) Over the past 30 years, Hong Kong's liberal trade
policies and increasingly sophisticated financial services
market have linked the fortunes of the region's economy
closely to that of the United States. That link still
exists, but closer economic and political relations with
China have begun to erode Hong Kong's dependence on American
and European markets. As recently as 1997, China absorbed
just 17 percent of Hong Kong's goods exports; through the
first three quarters of 2008, that figure was 48.5 percent.
Together, the United States and Europe over the same period
accounted for just over 26 percent of Hong Kong's goods
exports.


10. (U) A recent survey by Hong Kong's Chinese University
showed that Hong Kong citizens are increasingly likely to
look to Beijing for support. Almost half agreed that the
government should ask Beijing to introduce additional
measures to help support Hong Kong's economy. Forty percent
said the central government was best placed to facilitate the
city's economic development and competitiveness, while 35
percent said the Hong Kong government and only 21 percent put
their confidence in the business sector.

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One from Column A...
====================


11. (U) Chinese support for Hong Kong's economy was
particularly helpful in the post-SARS period, when relaxed
travel permit requirements allowed many Chinese to come to
Hong Kong for tourism and shopping for the first time.
Chinese President Hu Jintao and Premier Wen Jiabao have both
promised support for Hong Kong's economy, including further
expanding the individual visitor scheme to cover more Chinese
cities. At a recent meeting on the margins of the APEC
Leaders Summit in Peru, CE Tsang reportedly presented

HONG KONG 00002170 003 OF 003


President Hu with a list of more than 100 suggestions of ways
Beijing could help Hong Kong's economy, including speeding up
approvals for cross-border infrastructure projects,
increasing tax concessions for Hong Kong firms operating in
the mainland and expanding market access for Hong Kong
service providers. One news report quoted an unnamed
government source as saying, "it will be a great help to Hong
Kong, even if only half of these are accepted." While these
statements and requests have been prominently reported in
local media, concrete support from the PRC has yet to
materialize.


12. (U) HKMA Chief Joseph Yam has also been busily advocating
for increased access for Hong Kong banks and additional RMB
business in Hong Kong, including allowing RMB trade
settlement in the SAR. Citibank's Lo repeated anecdotal
reports that the provincial government has relaxed
enforcement of recently introduced labor and environmental
regulations in Guangdong, but discounted Yam's drive for
additional RMB facilities in Hong Kong as unrealistic.
International banks have lost too much credibility in China,
said Lo. Chinese media has been warning that a Lehman
Bros.'-type scandal could easily happen in China if
regulations are prematurely loosened. Lo predicted that the
Chinese authorities would be very cautious in approving any
liberalization proposal that could reduce their control of
RMB flows.
DONOVAN