Deflation a challenge of maturing economy
When the current cycle of falling consumer prices began in November 1998, it was the first time this had happened in 23 years. If the phenomenon was unknown to the people of Hong Kong then, it is certainly familiar now, after five full years of deflation.
The biggest impact of this month-by-month drop in the consumer price index has been the blow it has dealt to confidence. Many people simply do not spend, on the expectation that prices will keep falling. It is a self-fulfilling prophecy and the spiral proves difficult to stop once it gets under way. This deflation has gone hand in hand with a persistently sluggish property sector. Real estate values, once a major driver of the city's economic growth - and rising prices - are still struggling to recover to their previous levels.
Now, it seems, we are seeing the beginning of the end of deflation. Price drops have slowed and economists are predicting a return to rising prices within the next 18 months. We owe the end of deflation in large part to the fact that Hong Kong has an open economy and a currency tied to the US dollar. With the combination of a weak dollar and rising global commodity prices, import costs are set to rise. And with a return to growth in key world economies - as well as greater investment flows into the local stock market - Hong Kong should benefit from rising confidence and overall growth. Property is starting to recover and retailing is showing signs of life - rental of spaces in prime shopping areas is picking up and luxury goods retailers are once again looking seriously at expanding in Hong Kong.
Policy-wise, there is very little the government needs to do to hasten the end of deflation, aside from measures it has already announced. The rates rebates announced at the height of the Sars outbreaks were one-off and their expected end should help boost the price index. As for market stimulus and job creation, the temporary job programmes already announced should help ease unemployment in the short term. However, creation of more permanent jobs should be left to the private sector, which is the best judge of where they are needed. Indeed, with the return of tourist arrivals to pre-Sars levels, we have already seen a drop in unemployment in the services sector.
Promoting the recovery in general should involve pushing ahead with long-delayed measures to ensure the city's macroeconomic health. These include addressing the structural issues behind the budget deficit, improving regulation of the stock markets and looking more seriously at steps to curb the power of cartels in the domestic economy. Coupled with advantages such as the rule of law and large fiscal reserves, such reforms should bolster Hong Kong's attractiveness to both local and overseas investors.
There is no denying that Hong Kong finds itself in a much more sober mood now than it did five years ago. The falling prices and property values have been coupled with the rise of competition from several other cities in the region. Hong Kong's predominance in any of the areas where it leads - finance, shipping, trade and services - can no longer be taken for granted. Continually rising prices, wages and asset values, as well as uninterrupted economic growth, have also been proven to be phenomena of the past.
In many ways, these changes can be attributed to a change in the nature of the economy, from developing to developed. The problems of high unemployment and growth cycles that include recession and deflation are essentially problems of mature economies. Economies that have managed these cycles well have done so by finding new sources of growth, focusing on prudent fiscal policy and promoting investment through transparent markets. Hong Kong should be preparing now to take its economy to the next stage.