'Slower GDP growth seen as healthy' SCMP, May 19 I didn't see much sign of the word 'slower' in the government's official announcement on the first-quarter gross domestic product figures. There it was all phrases like 'continued to show broad-based expansion' and 'GDP growing solidly' and '14th consecutive quarter of distinctly above-trend growth'. The fact of the matter, however, is that a first-quarter GDP growth rate of 5.6 per cent year over year was less than most people had expected; less than the 7.3 per cent achieved the previous quarter and less than the 8.1 per cent achieved in the first quarter last year. Time, therefore, to haul out the public relations paint. What gloss shall we put on this? Ahah, got it, we shall use the word 'healthy'. We wouldn't want GDP to grow too fast now, would we? That wouldn't be good, would it? Well, I agree, but because there is something else happening here, something very healthy indeed although not necessarily conducive to producing high figures for real GDP growth. I emphasise 'real' GDP growth because it is the key. GDP figures come in two forms - nominal GDP, which gives you the straight dollar of the day figures for economic performance without adjustments for inflation, and real GDP, which has these adjustments for inflation and which we refer to when we talk of GDP growth. The strange thing about these first-quarter figures is that while real GDP growth fell to 5.6 per cent from 7.3 per cent the previous quarter, a difference of 1.7 per cent, nominal GDP growth fell by a much lesser extent to 6.6 per cent from 6.9 per cent, a difference of only 0.3 percentage point. The explanation for this is apparent from the first chart. The inflation rate for the entire economy, the GDP deflator, which covers much more than the consumer price index (CPI), suddenly shot up in the first quarter. It was about time this happened. For years there had been a distinct anomaly in the deflator figures. They consistently indicated greater price declines or lesser price increases than the CPI did. There was a reason for this. International merchandise trade is one of the components of the GDP deflator but is not represented in the CPI. And in merchandise trade, Hong Kong for a number of years has seen export prices dropping and import prices rising. The combination of these two trends has had a hugely deflationary impact on the overall GDP figures. The second chart shows you the evidence of the deflation. Terms of trade is the ratio of the average price of an economy's exports to the average price of its imports. Our terms of trade index has slumped ever since the US dollar (and our linked Hong Kong dollar) started weakening in 2002. But, as the chart also shows, that decline seems to have ended at last. Inflation in import prices dropped quite suddenly in the first quarter while export prices continued to rise strongly. The result was a sudden spike upwards in the deflator. I call that good news. Endless deterioration in terms of trade is not good news for any economy. It is strong evidence that the economy's competitiveness is deteriorating. In our case we can plead that it was due to external factors but that just gives us an excuse, not restored competitiveness. Thus ignore the talk about how the growth rate was down in the first quarter because investment in machinery was down. This item was indeed down but it has no impact on GDP growth. Almost all of that machinery is imported, which means that there is an offsetting plus number in net trade for every minus number in machinery investment. GDP growth was down because of a price recovery in merchandise trade and this is quite rightly to be seen as something healthy for the economy.