How infrastructure borrowing can benefit Hong Kong for decades to come

Debt financing is more efficient and equitable, with cutting spending and raising taxes unpalatable given the city’s current sluggish growth
The government should also put in place a framework to ensure debt sustainability and boost financial transparency for the projects involved

Donald Low

Published: 10:00am, 24 Feb 2024

Why you can trust SCMP

Faced with a deficit of more than HK$100 billion (US$12.8 billion) this financial year, the Hong Kong government has proposed issuing bonds to finance large-scale infrastructure projects that could include the Northern Metropolis and land reclamation on Lantau Island.

This proposal makes sense. Hong Kong’s public debt to gross domestic product ratio is extremely low by international standards; the government therefore has the space and creditworthiness to borrow more – even though interest rates today are higher. There is also a strong economic case to rely on debt financing for infrastructure projects which incur costs today but generate benefits for the next few decades.

Nonetheless, there are concerns among some that such borrowing only deepens the government’s financial hole, burdens future generations, and masks the precarity of government finances. Rather than dismiss these concerns as invalid or ignorant, the government should engage seriously with them and, in so doing, build society’s trust in its ability to manage Hong Kong’s finances well. This is also an opportunity to educate the public on why borrowing for infrastructure is not only necessary, but may even be desirable in the current macroeconomic context.

A construction site for public housing on Hong Kong’s Lantau Island in 2020. Photo: Sam Tsang

Necessary and desirable

The first principle of public financial management that the Treasury should convey is that all deficits have to be financed eventually. In this, the government has to choose between three unpalatable options: raising taxes, cutting spending, or borrowing. Raising taxes – particularly the introduction of a Goods and Services Tax (GST) – is probably something that Hong Kong must do eventually.

But mainland China’s slow recovery, higher interest rates and a strong Hong Kong dollar (the result of the Hong Kong dollar’s peg to the US dollar) have contributed to the city’s current sluggish economic growth and in such an environment, authorities can ill afford to raise taxes that would reduce disposable incomes or consumer spending.

Cutting public spending in other areas is even less realistic than raising taxes. As long as growth remains weak (as is likely the case for 2024), the demand for publicly financed or subsidised services will increase. In the longer term, an ageing population will increase social spending as a share of GDP. While there is merit in reducing some health and welfare subsidies, the fact is that public provision of these services in Hong Kong is already very lean by the standards of developed economies. This also means the savings that can be squeezed in these areas are likely to be very small compared to the expenditure demands of an ageing society. Unless Hongkongers are willing to accept a significantly lower standard of health and welfare provision, there is little chance of public spending decreasing in the coming years.

An elderly man in a park at Cheung Sha Wan. In the longer term, an ageing population will increase social spending as a share of GDP, says academic Donald Low. Photo: Jelly Tse

That leaves increased public sector borrowing as the least bad option to finance Hong Kong’s infrastructure plans.

The second idea that the Treasury should convey is that borrowing is the more efficient and equitable way of financing infrastructure. It is more efficient because the benefits of infrastructure development accrue over many years – even decades – and so it makes sense to finance that development over a similar time frame. Just as households make costly capital purchases (such as a property) by taking a 30-year loan rather than pay for it entirely with cash, it is also more efficient for the government to finance infrastructure projects (which generate a stream of benefits over many years) using debt.

Debt financing is also more equitable because future generations are the major beneficiaries of these infrastructure projects. Future generations are likely to be richer than current generations, so it is only fair that future generations pay at least part of the costs. Meanwhile, paying for these projects with cash upfront represents a large subsidy from past and current generations of Hongkongers to future, richer generations. This is highly regressive. Unless one is extremely pessimistic about Hong Kong’s future – and believes that future Hongkongers would be poorer than today’s Hongkongers – debt financing is much fairer in terms of intergenerational equity.

An electronic ticker at the Exchange Square Complex, which houses the Hong Kong stock exchange, in January. The Hong Kong government should set up rules to ensure debt sustainability and build public trust. Photo: Bloomberg

A debt sustainability framework

While increased borrowing is a better way to finance infrastructure development, this does not mean the government should be allowed to borrow as much as it wants or to spend however it likes. To build public trust, the Treasury should put in place, and articulate, a set of principles to ensure debt sustainability. Such a framework would also assuage concerns that the Hong Kong government is becoming a less prudent or capable steward of public funds.

The first principle is that debt financing should be used only for infrastructure projects in which assets that can be valued are created. This is critical because debt financing creates liabilities for future generations of Hongkongers. Good financial management requires that these liabilities be matched with corresponding, long-term assets. This rule also means the government should borrow only for capital, not operating, expenditures.

Second, alongside the budget (that shows the government’s income and expenditure of the coming financial year), the Treasury should also present a debt sustainability report which shows the government’s outstanding liabilities and the estimated value of the assets. This need not be done for all the state’s assets and liabilities, only for those that result from its borrowing. The first two principles would address concerns that issuing debt boosts the government’s revenue for the year but masks (future) debt repayment obligations.

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Third, to the extent possible, the bonds the government issues should be linked to specific projects rather than be used for unspecified capital expenditure. While public funds are fungible (movable across various uses), this practice would require the government to make a strong case for the projects that it is borrowing for, and not rely only on its overall creditworthiness, to borrow at lower interest rates. This practice would also improve financial transparency and support the market’s scrutiny of the government’s development projects. Done well, this would establish Hong Kong as an issuer of high-quality government bonds, helping the city attract more capital through its bond market.

This principle does not mean the government would be barred from issuing bonds not linked to specific projects. But if it does so, it should have to explain why. Without this principle, governments always prefer more discretion over rules that constrain their flexibility or freedom of manoeuvre.

Finally, there should be a rule that sets a cap on the total stock of debt that the Hong Kong government owes, as well as a rule that limits (as a percentage of GDP) the amount of debt the government can issue in any one financial year. This would assure the public and financial markets that the government is still a disciplined steward of public funds.

Donald Low is Senior Lecturer and Professor of Practice, and Director of Leadership and Public Policy Executive Education, at the Hong Kong University of Science and Technology. He was formerly Director of Fiscal Policy at the Ministry of Finance in Singapore.