Hot Spots: Hong Kong. (International Insight).

China's Special Administrative Region (SAR) has ended a problematic year and is facing another one in the backwash of the global economic slump. It is well equipped to overcome the difficulties, however. The Hong Kong dollar, pegged to the USD, will not suffer the fate of the Argentine peso, at least not for some time to come.

The economy did better than widely anticipated in the third quarter of last year, with a real GDP decline of only 0.3 percent compared to the like span of 2000. Measured quarter-to-quarter, gross domestic product actually gained by 0.6 percent, so that the SAR managed to skate past the technical definition of a recession. But this is as far as the good news goes. Results for the fourth quarter will be nothing much to write home about, and for all practical purposes, Hong Kong is in recession.

The government, which prior to September 11th had still hoped for real growth of at least 1 percent in 2001 as a whole, revised this down to zero in late November, This spells a rather drastic comedown from the 10.5 percent advance clocked in 2000. The main source of the problem is the weakness of the U.S. economy, the territory's second most important trading partner, but business conditions have worsened in Europe and in many parts of Asia as well, and lately even the support that commerce with China has given HK's external accounts has started to wear away.

With unemployment at an 18-month high of 5.5 percent and virtually certain to climb further, and with property prices still under pressure, consumer demand cannot be counted on to make up for the lagging of exports. Property, a key source of wealth for many in Hong Kong, has lost close to 60 percent of its value since the bubble of 1997. Many homeowners now have a negative net worth (meaning that their remaining mortgage debt exceeds the value of their house). Consumer prices fell by around 1.6 percent in 2001, and a turnaround of the three-year-old deflation trend is not in sight.

Hong Kong's Monetary Authority, the de facto Central Bank, has been following the U.S. Federal Reserve in cutting interest rates, but while the most recent reduction, in mid-December, was by the same 50 basis points as that implemented by the Fed, commercial banks trimmed their rates by just 12.5 basis points, leaving the prime rate at 5.125 percent and the deposit rate at 0.125 percent. Total loans for use in Hong Kong last October were 4.9 percent lower than a year earlier. For a while, the banks, boasting ample liquidity against the backdrop of a sluggish property market, sought to increase business by pushing consumer lending and giving away credit cards. They are now, however, becoming more cautious in the face of a surge in personal bankruptcies. In the first 11 months of last year, there were 8,070 such insolvencies, up from 4,606 in all of 2000 and 3,071 in 1999. This still gives Hong Kong a relatively good ratio, with one in 1,000 going bankrupt compared to six or seven per thousand in the United Sta tes, but the recent upspurt has been alarming. As banks tighten their credit requirements, they cannot help but hurt the economy further.

All in all, real GDP growth will probably not bounce back until the second semester of this year, and will only be about 2 percent-3 percent for 2002 as a whole. Between the growing weakness of domestic demand, declining import prices and increasing integration with the lower-cost PRC, the deflationary trend is likely to persist. Exports have ...