Hong Kong faces a downgrade of its credit rating unless the Government can find ways to increase taxation income to plug the budget deficit, Standard & Poor's has warned. The international credit rating agency said the Government had to do more to address the deficit problem in the next few years. If the rating is downgraded, government and businesses face the prospect of paying more for funds they want to raise. Banks and institutional investors closely watch credit ratings before deciding what interest to charge on loans. Hong Kong has a local long-term currency rating of AA minus with a stable outlook - one of the highest in Asia. S&P associate director Chew Ping said the agency had no immediate plan to cut the rating as the SAR had strong reserves to support the budget deficit. However, Mr Chew warned a downgrade was possible if the Government could not solve the deficit problem in the long term. For the year to March 31, the budget deficit was HK$65.6 billion, in the wake of lower income from land sales and a fall in salary tax income due to rising unemployment. Companies also paid less tax as a result of lower earnings due to the economic downturn. The Government expected the deficit would be HK$45.66 billion this year and a balanced budget is expected only in 2006-2007. Meanwhile, there has been much debate over whether Hong Kong is facing a structural deficit problem. 'No country would see its credit rating unaffected if it had suffered structural budget deficit problems for years,' Mr Chew said. He said S&P's decision to downgrade Japan's rating to AA minus from AA with a negative outlook, was partly because the Government had delayed introducing reforms to address budget deficit problems and other economic concerns. 'The SAR Government has already taken some steps to address the [deficit] problem, but it needs to do more to make sure it has enough revenue to plug the gap,' Mr Chew said. A government spokesman said Financial Secretary Antony Leung Kam-chung has set a target of reducing public expenditure's share of gross domestic product by 3 per cent and it was a very powerful weapon in fiscal management. However, Mr Chew said that although the Government had set the target it had not provided details on how this would be achieved. He said the Government must give details of its plans to increase income, such as whether it would proceed with a goods and services tax. 'A goods and services tax has been introduced in many countries and it has proven to be able to widen the tax base,' Mr Chew said. This appeared to be what was needed in Hong Kong, where only one in three of the working population was paying salary tax. He agreed that the new tax should not be implemented immediately amid the economic downturn, but said this was the right time to study if it was needed. Mr Chew said the Government should seek ways to restructure the economy to ensure it benefited from the opening up of China's markets. He said Japan's situation was somewhat different from Hong Kong's in that Japan had more serious problems with its banking system. As a result, Mr Chew said the outlook for Hong Kong's economy remained stable, provided the Government could bring in reforms to solve the deficit problem before it used up its reserves.