Hong Kong's nominal gross domestic product will plunge 7 per cent next year and unemployment will reach a record 7.5 per cent, according to CLSA Emerging Markets. In a 200-page report due to be released today, the brokerage delivers a bleak assessment of the SAR's near-term economic prospects. The report, 'Hong Kong's Future - Tough Choices to Stay Afloat', says the SAR is facing structural deflation from its integration into the mainland that will weaken any cyclical recovery. 'For the next six to nine months, the cyclical downturn will be exacerbated by structural issues: unemployment rising to 7.5 per cent as employment moves to cheaper centres and deflation as consumer spending ebbs,' the report says. Unemployment peaked at 6.4 per cent during the Asian crisis in late 1998 and was 5.3 per cent between July and September this year. The figure for August to last month will be released today. 'September is basically the first quarter where we are going into the recession [and] we are pretty close to the unemployment peak of the Asian crisis now,' said the report's lead author, Amar Gill. Evidence of structural change comes from nominal GDP, which remains below the peak of 1997 before the Asian crisis despite a cyclical recovery two years later. In previous economic cycles, nominal GDP has attained a new high in each cycle, according to the report. GDP growth is usually reported in real terms, which adjusts for price changes. The Asian Development Bank forecasts that Hong Kong's real GDP will shrink by 0.4 per cent next year. HSBC, in a report last month, forecast growth of 1.8 per cent. Consumer prices have been falling in Hong Kong for three years and were down 1.2 per cent year on year in September. 'One quick way of adjusting relative costs is devaluation [of the Hong Kong dollar], but this would by no means be painless,' the report says. However, the peg to the US dollar has served Hong Kong well and devaluation has been ruled out by the Government, it says. Falling property prices will have a large fiscal impact, as 24 per cent of government revenue is derived from the property sector. Lower property prices mean less revenue from tax on property deals. As Hong Kong integrates further with the mainland, more people and businesses may relocate across the border, which will also cause the tax base to fall. Both effects are expected to force the Government to find new ways of raising more revenue, according to the report. 'The integration of Hong Kong's economy into the mainland is incompatible with how its Government is financed,' the report says. 'To survive as part of mainland China, Hong Kong needs new taxes.' Despite the problems, integration with the Pearl River Delta is necessary to enable Hong Kong to grow by providing more high-value services to the region in areas such as finance. Such integration should be encouraged by the Government with measures such as easier border access and liberalised immigration procedures for mainland professionals, according to the report. 'Integration with the Pearl River Delta is the nettle that Hong Kong has yet to grasp,' the report says. 'What is needed is an enabling framework that pushes Hong Kong up the value chain.' In the difficult economic environment ahead, CLSA recommend investors to seek companies that have international revenue streams they can build upon over the medium-term.