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Joshua Eisenman

But the IMF, in its annual report, says the city faces short-term challenges

The Hong Kong government should reduce spending and introduce a consumption tax in order to deal with challenges to the economy including Sars, deflation and the budget deficit, the International Monetary Fund said yesterday.

In its annual health check on the Hong Kong economy, known as an Article IV report, the IMF also said it expected the city's gross domestic product to grow 2.2 per cent this year.

The report, released after an IMF mission visited Hong Kong in February, comes at a crucial time for the city's economy, which has been battered by the Sars outbreak. While the government is fighting to revive the economy, it is also attempting to rein in a mushrooming deficit.

The report said Hong Kong's financial system was in good shape but faced short-term challenges, such as the 'possible persistence of the adverse effects of Sars' and longer-term challenges including the need to integrate with the mainland.

The IMF said it backed the government's $11.8 billion short-term relief package to help the economy recover from the outbreak.

One of the IMF's main concerns is the budget deficit, which ballooned to $61.7 billion  last year. As traditional sources of revenue for the government such as land income have become less dependable, the IMF repeated a call it made last year to introduce a 'low-rate, broad-based goods and services tax'. Preparations for such a tax would be time-consuming so planning 'should begin soon', the report said.

But such a tax did not need to be introduced right away.

The IMF said it supported the government's method of taking a cautious approach and only introducing the tax 'when the economic situation permits'.

Financial Secretary Antony Leung Kam-chung has previously signalled his intention to introduce a sales tax, announcing in his  budget in March that the government's long-term goal was to introduce a goods and services tax 'to broaden the tax base and ensure a stable source of revenue', without giving a specific date.

Chief Executive Tung Chee-hwa has also said that a sales tax would not be introduced in Hong Kong during the short term.

Regarding spending, the IMF said a significant cut was needed to make a  credible dent in the deficit. At the same time, it applauded the government's moves taken so far to cut civil service staff levels and salaries.

But it also urged the government to separate the pay system for civil servants from those for employees at government-funded agencies such as the Equal Opportunities Commission and Legal Aid Services Council in order to make wages more flexible.

Prices will continue to fall for a fifth year  this year, with deflation of about 2 per cent in the composite consumer price index, the IMF said. Its directors were concerned that deflation 'appeared to have grown more entrenched'.

'The appropriate policy response to deflation would be to intensify reforms to bolster the Hong Kong Special Administrative Region's competitiveness and long-term growth prospects,' such as promoting higher-value-added services and enhancing its attractiveness as an international financial centre, it said.

Sound macroeconomic policies and structural reforms to raise productivity were needed to back up Hong Kong's traditional strengths that include a flexible labour market and good legal system.

Mr Leung  last night welcomed the IMF's report, calling it 'fair and balanced', and highlighted its  'support for the government's measures to tackle the negative economic impact of Sars'.

'We expect the negative impact of Sars to be one-off and short-term. It should not affect our ability and determination to achieve the fiscal target by financial year 2006-07,' he said.



HK financial system 'in good shape'