Budget promises made to be broken The impact of Sars on economic growth means the government is unlikely to balance the books by 2007, write Kelvin Chan and Ambrose Leung.

(From South China Morning Post)

When Financial Secretary Antony Leung Kam-chung stood before the cameras in Legco on March 5 to announce the 2003-04 budget, he had no idea that in less than two weeks a deadly virus would come along and throw all his best laid plans for balancing the books into disarray. Up until that point, Hong Kong had been on a bit of a rebound after weathering a rough 2002. Economic growth had been slower than average at 2.3 per cent, but had picked up in the second half thanks to strong growth in exports and tourism. The deficit, which was forecast to top out at $70 billion last year, ended up at $61.7 billion - or about 4.8 per cent of gross domestic product. But Mr Leung set out a plan to fix that by cutting spending and raising revenue. A forecast of 3 per cent economic growth a year also would help lower the deficit until it reached a surplus of $8.1 billion in 2006-07.

So as Mr Leung read his budget, he was confident the government would be able to stick to a promise he had made a year earlier to balance the books by then. Then along came Sars. It wreaked massive, if temporary, devastation on the economy, most notably in tourism and retailing. By most estimates it probably will result in the economy shrinking by 2 to 3 per cent in the second quarter. Economists predict Mr Leung will eventually fulfil his promise, but it may take him a bit longer to do so. In his speech, he estimated that between now and 2006-07 economic growth will rake in about $30 billion extra for the government, while raising revenue and cutting spending will raise a further $20 billion each. But since Sars, the predicted growth rate has been revised to 1.5 per cent and the government will probably overshoot its $67.9 billion deficit forecast for this year. The long-term goal of balancing the budget has been thrown into doubt. For one, it has been pointed out that 2006-7 is an arbitrary deadline.

"There is no red line that gets crossed if the budget doesn't get balanced by 2006-07 {hellip} [But] it's important that the government is taking steps to reassure the market," said Michael Kurtz, regional strategist at Bear Stearns. In fact, there is no overriding economic or financial reason for the target of 2006-7. Instead, it's a political goal tied to Chief Executive Tung Chee-hwa's successor. The financial secretary's office has even said as much. "We feel it is only responsible for this government to resolve the structural deficit problem before the next government comes into term. It ties into the current term," said Raymond Tam, Mr Leung's press secretary. When asked whether the government would be changing its target, Mr Tam said: "We are still committed to achieving the fiscal target by 2006-07."

Stephen Cheung Yan-leung, chair professor of the economics and finance department at City University, agrees the government does not have to be so rigid in setting the date for balancing the budget. "The government should take a flexible approach," he said. "If I were them, maybe Sars would be a good excuse to push the problem a little further, another year or another two years. Everybody understands that Sars has had a significant impact on the economy." Most importantly, the international credit rating agencies are keeping a close eye on the deficit. Moody's and Standard & Poor's both say the government does not need to stick to any concrete target as long as it takes steps to eliminate the deficit, as promised. "The government set itself this balanced budget target based on its own assessment of economic growth prospects, tax elasticity and other discretionary measures," said Ping Chew, director of Asia-Pacific sovereign ratings at Standard & Poor's. If the target was not met it would only reflect badly on ...