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But the outcome of Legco elections may curtail spending reforms, says S&P

International credit rating agency Standard & Poor's may raise its ratings outlook for Hong Kong this year if the economy continues to improve and the government carries through on promises to cut spending and fix structural problems.

But S&P also warned yesterday that the Legislative Council elections were also a big question mark and if more pro-democracy candidates were elected, the government could have more difficulty pushing through spending reforms.

'We're seeing some windfall gains as the stock market and the economy bounce back' in Hong Kong, said Paul Coughlin, the agency's managing director of Asia-Pacific corporate and government ratings.

But with the budget deficit expected to hit $78 billion this year, he said the government still had to cut spending.

'We'll be looking for implementation of policy and biting the bullet and taking difficult decisions to restrain expenditure growth' in the upcoming March budget, Mr Coughlin said.

'If that occurs, I think the prospects of going from negative to stable are quite reasonable.'

S&P rates Hong Kong's long-term local currency debt at AA-minus, the fourth highest of 10 investment grades, with a negative outlook, which means the rating is more likely to be downgraded. It rates the city's foreign currency debt at A-plus, the fifth-highest rating, with a stable outlook.

The comments highlight the growing influence of political factors on how the government manages its finances, as parties take advantage of the growing desire for reform to win seats. They are also indicative of the broader view among analysts who say that while Hong Kong's economy is reviving strongly, making the deficit less of a problem, the government still needs to fix structural problems.

The biggest problem is the narrow tax base. Only about 1.24 million of Hong Kong's working population of 3.2 million pay  taxes.

At the same time, the government's main source of revenue - land income - has disappeared amid the slumping property market. That has prompted calls for a general sales tax and cuts in spending, particularly on the civil service. But that might be difficult, depending on how the elections turned out, Mr Coughlin said.

'One would assume that if the district council elections are anything to go by, presumably they [opposition parties] will be increasing their representation in Legco' in the September elections, he  said.

'The democratic parties have been sometimes less than positive in terms of responsible budgeting. The question is if they do have greater representation in Legco, what will be their position in budgeting? Will they be taking the long-term responsible view or a short-term opportunistic view?'

At Fitch Ratings, Brian Coulton, senior director of Asia sovereign ratings, was also cautiously optimistic.

'We certainly recognise that the picture is improving quite sharply,' Mr Coulton said.

'It seems to have gone past a post-Sars rebound, but because of our view on deflation as still not being out of the way, and also because we're still concerned about the fiscal deficit, we maintain a negative outlook.'  Fitch has an AA-minus rating on Hong Kong's long-term debt.

A better credit ratings means governments and companies can borrow money more cheaply.



Improving economy may boost HK's rating