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Last Updated: Wednesday, 9 July, 2003, 11:34 GMT 12:34 UK
HK political crisis may dent economy

By James Arnold
BBC News Online business reporter

Hong Kong demonstration
We're not here to discuss fiscal policy
For Tung Chee-hwa, Hong Kong's beleaguered chief executive, the past weeks' protests against his anti-subversion bill have had one compensation: at least they have stopped people grousing about the economy.

For investors in the territory, meanwhile, the timing could hardly have been worse.

The protests have distracted attention from the need to slash away at Hong Kong's ballooning budget - cuts long delayed, but seen as crucial to soothe market nerves.

Worse still, by torpedoing what little credibility Hong Kong's government had left, the protests may leave Mr Tung powerless to push through anything but the feeblest of reforms.

Bad timing

Frustratingly, Hong Kong's economy was just starting to regain its swagger.

Hong Kong growth
Although the Sars virus took a chunk out of the territory's economy, that chunk now seems rather small - and certainly not enough to derail the longer-term recovery.

Economic output, which fell sharply last year, has stabilised, and all-important exports are growing at almost 18% a year.

Unemployment, now close to 8%, has admittedly climbed in the past couple of years, and wages for most workers remain stagnant.

But lively predicted growth this year - some 5% was talked about at one point - looked likely to provide compensation.

Home-made problems

Now, those calculations are having to be revised.

Part of Hong Kong's problem is the reluctant global economy, to which it, as a small, trade-oriented nation, is unusually sensitive.

Tung Chee-hwa
Mr Tung may not be smiling for long
But the real difficulties lie at home, and especially in the government's failure to control its own finances.

From a more-or-less reliable surplus in the 1990s, Hong Kong has slumped into the red: the 2003-04 budget forecasts a record deficit of close to 70bn Hong Kong dollars (5.5bn; $9bn).

State revenue, some HK$220bn as recently as 1999, falls below HK$150bn in the 2003/04 budget, battered by plunging property taxes, an diminishing taxable population and a weak global economy.

Spending up

At the same time, state spending has become vastly more ambitious.

Under Mr Tung, Hong Kong has moved from laissez-faire frugality to the full expensive panoply of state services.

Hong Kong state expenditure
Over the past decade, the proportion of national income spent on government services such as education and welfare has doubled, and state expenditure has grown twice as fast as the overall economy.

Mr Tung has acknowledged that something needs to be done: in March, he raised taxes for the first time in 20 years, and has repeatedly warned that austerity measures will have to get more serious.

And while its critics point to waste, mismanagement and largesse in all aspects of state expenditure, the government pins the blame on Hong Kong's 175,000 civil servants, whose pay and benefits have remained largely immune to the general downturn.

High hopes

At the beginning of this year, Mr Tung ordained that the civil service should shrink to 160,000 by 2006/07, and that remaining employees should swallow a package of pay cuts.

Hong Kong budget
Civil-service reform, Mr Tung hopes, will be the headline item in a package of spending cuts that will save HK$20bn, and could get the state budget back in the black in three years.

Mr Tung needs to do something, if only to avoid some of the tempting but reckless suggestions being bandied around by Hong Kong politicians - decoupling the Hong Kong dollar's currency peg, for example, or banning land sales in an attempt to raise property prices.

But analysts are starting to question whether Mr Tung - once seen as universally competent - now has the clout to do anything but cling cravenly onto power.

Playing it safe

He has already dodged some tricky decisions, shrugging off advisers' calls for a universal sales tax, and doing little to widen the revenue base to the 60% of the population who pay no tax.

Paul Cavey
Tung is running out of friends, says Paul Cavey
He has compensated by raising the levels of some existing taxes, and proposing some harmless new levies - a boundary facilities improvement tax, for example, and a charge on football betting - but without a civil service deal, his austerity plan has little hope.

And that deal is looking trickier than ever.

"People here had no faith in the ability of the government even before the protests," says Paul Cavey of the Economist Intelligence Unit in Hong Kong.

"Now, things have - if possible - got worse.

"What constituencies can he rely on for support now? Not the civil service any more, that's certain."

Rescue hopes fade

The global economy may yet come to Hong Kong's rescue.

Growth among key trading partners has underperformed expectations so far, but a more sustained upturn in Europe and the US is likely later this year - and Hong Kong's nimble exporters should feel the benefit pretty quickly.

And mainland China, on which Hong Kong's economy leans more each year, continues to exceed expectations.

But even a rapid economic bounce will not be enough to dig Mr Tung out of his fiscal hole.

The Hong Kong budget depends heavily on the property sector, which accounts for 15% of the territory's economic output.

Property prices have fallen by 70% since 1997, and the current oversupply - especially of office space - is so severe that it would take many years of economic boom to clear it.

Unless Mr Tung, or his replacement, finds the muscle to strong-arm the budget, the current political crisis may well become a financial one.

Fresh HK protests expected
09 Jul 03  |  Asia-Pacific
HK delays anti-subversion bill
07 Jul 03  |  Asia-Pacific
HK leader under fire over bill
07 Jul 03  |  Asia-Pacific
Tung Chee-hwa: Beijing's favoured son
07 Jul 03  |  Asia-Pacific
Q&A: HK's anti-subversion law
01 Jul 03  |  Asia-Pacific
Protesters fear for HK freedom
01 Jul 03  |  Asia-Pacific
HK unveils anti-subversion law plan
24 Sep 02  |  Asia-Pacific

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