VZCZCXRO3500
RR RUEHCN RUEHGH RUEHVC
DE RUEHHK #2170/01 3370319
ZNR UUUUU ZZH
R 020319Z DEC 08
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC 6350
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC

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 
 
HONG KONG 00002170  002 OF 003 
 
 
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. 
 
==================== 
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