Down but not out must be the take on Hong Kong's third quarter economic performance. Commentary has reached apocalyptic proportions in recent weeks with senior government officials adding to the brew of gloom. In reality this downturn looks a controlled affair that may yet get worse but has not reached 1998 levels of seriousness. Hong Kong's economic performance is certainly weak with retail sales, exports and property prices all registering declines compared with a year ago. Firms are again running down stock inventories having aggressively built them up over the past year and unemployment continues to creep higher. Yet by official measures Hong Kong has avoided entering recession. Gross domestic product fell by 0.3 per cent in the third quarter compared with the same period last year but rose 0.4 per cent compared with the previous quarter. Significantly the latest figures beat analysts' consensus forecasts. Government spending is propping up demand with a 6.2 per cent increase compared with a year ago. The pressure is being felt in public coffers with a $63 billion deficit in the first seven months of the year. That points to a full-year deficit of about $45 billion, which although unhealthy has been widely anticipated for at least three months. The worry must be that these relatively benign figures do not tell the full story. Consumption increased 1.4 per cent in the third quarter compared with last year but must be prone to a fall should unemployment keep rising. A robust 3.7 per cent increase in overall investment over the period includes one-off aircraft purchases by Cathay Pacific, while other activity such as construction and machinery purchases showed weakness. In short, Hong Kong looks to be a recessionary economy if not one formally in recession. Being reliant on trade and financial services, things could easily worsen given grim international conditions. Much depends on the perilously perched United States economy, and Chief Secretary Donald Tsang Yam-kuen's prediction that Hong Kong will rebound the quarter after the US recovers seems plausible. The violent recession of 1998 was triggered by the Asian financial crisis but had the unwinding of a property bubble at its core. Companies and consumers' expectations were radically altered. Huge wealth destruction from collapsing property prices caused a dramatic reduction in personal consumption and reduced investment and inventories held by firms. An outflow of capital and speculative attacks on the currency pushed interest rates to dangerous levels and effectively seized the economy's vital organs. Such conditions could return, with potential trigger events being an Argentinian financial meltdown or a Japanese banking panic; the SAR, with its fixed currency regime, would be in the firing line. The difference this time is that Hong Kong has already made radical price adjustments dictated by its currency board discipline. Indeed its economic performance - measured in US dollars - has been remarkably strong compared with regional competitors. Should external conditions improve there is good reason to believe a rapid snap back is possible. Such reasoning will be cold comfort to swelling ranks of the unemployed and struggling businesses who increasingly look to the Government for direct assistance. And here lies the danger as a dysfunctional and transitional political system seeks to manage these demands for help. Given these handicaps what is needed is extreme clarity of policy. Chief Executive Tung Chee-hwa needs to sell to the public the underlying strengths of the SAR economy rather than preparing everyone for the worst. He and his senior officials need to come out fighting. There are no quick fixes for Hong Kong. As a small open economy it is dependent on external conditions. Pointless infrastructure spending and unjustified handouts are not the answer. Sensible economic engagement with the mainland as recently proposed represents a positive move. The onus is on the SAR leadership to argue that message in tough times.