VZCZCXRO5562
PP RUEHCN RUEHGH
DE RUEHHK #2166/01 1441027
ZNR UUUUU ZZH
P 241027Z MAY 06
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC PRIORITY 6880
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 02 HONG KONG 002166 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EAP/CM AND EB 
TREASURY FOR OASIA GKOEPKE 
STATE PASS USTR 
USDOC FOR 4420 
 
E.O. 12958: N/A 
TAGS: ECON PGOV HK CH
SUBJECT: ECONOMIC COOLING SEEN AS CHINA TIGHTENS, CONCERNS 
MOUNT ABOUT U.S. INTEREST RATES, AND STOCKS TUMBLE 
 
(U) THIS DOCUMENT IS SENSITIVE BUT UNCLASSIFIED.  PLEASE 
PROTECT ACCORDINGLY.  NOT FOR RELEASE OUTSIDE U.S. GOVERNMENT 
CHANNELS.  NOT FOR INTERNET PUBLICATION. 
 
SUMMARY/COMMENT 
--------------- 
 
¶1. (SBU) Hong Kong's 8.2 percent first quarter GDP growth 
caps off two years of impressive and above-trend economic 
performance, but this is likely to change quickly.  The boost 
to Hong Kong's economy from China's growth appears set to 
wane amid determined moves in the mainland to slow loan 
growth and avoid overheating in specific sectors.  Meanwhile, 
there is widespread concern here that U.S. interest rates 
will continue to rise.  Since the Hong Kong dollar is pegged 
to the U.S. dollar, this implies further local hikes as well 
which would cut into the all-important property market as 
well as the disposable incomes of the many Hong Kongers who 
have adjustable mortgages.  Finally, the stock market here 
has fallen nearly 9 percent since its recent May 8 peak, and 
any sustained correction could have a negative wealth effect 
that would dampen consumer sentiment.  END SUMMARY/COMMENT 
 
ANOTHER UPSIDE SURPRISE 
----------------------- 
 
¶2. The HKG announced May 23 that Hong Kong's first-quarter 
year-on-year GDP growth was 8.2 percent, significantly 
outpacing analysts' forecasts.  Below are key year-on-year 
economic figures from the first quarter economic report 
released by the HKG; we have provided selected trend 
commentary: 
 
(percent) 
                              1Q06    4Q05    2005 
 
-- GDP GROWTH                  8.2     7.5    7.3 
 
o Official HKG forecast for 2006 is now 4-5 percent. 
 
-- UNEMPLOYMENT                5.2      5.3  6.1(1Q) 
 
o Unemployment is at a 4 1/2 year low. 
 
-- INFLATION                   1.6      1.3    1.0 
 
-- MERCHANDISE EXPORT GROWTH  14.4    11.4    11.2 
-- MERCHANDISE IMPORT GROWTH  14.0    12.0     8.6 
 
o Most Hong Kong trade activity is re-exports involving the 
mainland. 
o It is significant that exports continue to grow at a 
double-digit rate against what was already a strong base. 
 
-- SERVICE EXPORT GROWTH       8.9      8.2     8.7 
-- SERVICE IMPORT GROWTH       4.8      2.3     2.9 
 
o Service exports include revenues from tourism, an area 
where growth had recently flattened but is now coming back. 
Business-related services are also expanding. 
 
-- PRIVATE CONSUMPTION GROWTH  4.5      3.4     3.4 
 
o Reflects sustained optimism, at least until recently, in 
the face of higher interest rates and energy prices. 
 
-- INVESTMENT SPENDING GROWTH  8.5      8.4     4.1 
 
o Business capital spending is up significantly but 
construction was down 8.7 percent for the quarter. 
 
LIKELY END OF IMPRESSIVE GROWTH FIGURES 
--------------------------------------- 
 
¶3. (U) Since recovering from the SARS outbreak in 2003, Hong 
Kong's economy has consistently registered growth rates above 
7 percent.  Several analysts whose views we follow agree that 
a significant slowdown is inevitable, if only because it is 
difficult for an advanced economy like Hong Kong's to keep 
building upon such an impressive expansion.  In step with 
this view, the HKG declined to raise its overall 2006 
forecast from its current prediction of 4 to 5 percent, 
implying that we could see a fall from 8.2 percent in the 
 
HONG KONG 00002166  002 OF 002 
 
 
first quarter to a run-rate of around 3 percent for the rest 
of the year. 
 
¶4. (SBU) Three events that have occurred since the first 
quarter ended are likely to contribute further to Hong Kong 
slowing down.  First, the stock market has tumbled 
dramatically, with the Hang Seng Index falling nearly 9 
percent since May 8, a correction that many saw coming and 
believe will have a negative effect on consumer sentiment. 
Second, China recently raised interest rates, imposed 
administrative controls on lending, and signaled a 
determination to take further measures as needed to check 
overheating in sectors like steel and cement.  Finally, there 
is a growing concern here that U.S. Federal Reserve interest 
rate hikes may not pause as many anticipate, with even the 
head of the monetary authority recently warning the 
legislature that "it does not look like a peak is forming 
yet."  This is significant for consumer sentiment in Hong 
Kong because local rates generally rise and fall in line with 
U.S. rates as a result of the currency peg.  Since many Hong 
Kongers have adjustable mortgages on their already expensive 
properties, any hint of rising interest rates generates 
significant anxiety here. 
 
KEY FINANCE AND TRADE SECTORS VULNERABLE 
---------------------------------------- 
 
¶5. (SBU) Standard Chartered China Economist Tai Hui believes 
that mainland tightening could have a significant effect on 
Hong Kong's financial markets, particularly as individual 
firms are hit by specific austerity measures.  Citibank 
Senior Economist Joe Lo shared with us his more broad-based 
and gloomy assessment, focusing on how Hong Kong's most 
important sectors are trade facilitation and finance and 
observing that U.S.- and China-related trends are the primary 
factors in determining future growth in these areas. 
Anticipating a slowdown in the U.S. and persistence by China 
in avoiding economic overheating, Lo predicted that Hong Kong 
would see significant impacts in trans-shipments and in 
financial market turnover, both of which are important to the 
business volumes of many locally-based companies. 
Cunningham