Madam President,

Introduction

              I move that the Appropriation Bill 2002 be read a second time.

 

2.        This is my maiden Budget.  I feel honoured, but also under some pressure.  Honoured because, under the leadership of the Chief Executive, I can serve the people of Hong Kong by working together with Members of this Council, the community and my colleagues in the civil service to map out the future economic development of the Hong Kong Special Administrative Region and manage its public finances.  I feel pressured because Hong Kong must overcome the difficulties spawned by the current economic downturn, and because I must address the structural problem of our public finances.

 

3.        Since I took office ten months ago, the views expressed by our citizens, along with surveys conducted by the media and academic institutions, have consistently indicated that the public are most concerned about how we are going to revive the economy and improve employment prospects.  The public expect me to identify the directions for economic development and to work with the community to sustain our prosperity.  They also expect the Government to introduce further relief measures in this time of economic difficulty.

 

4.        During this period, I also met with representatives of the local and international financial sectors.  All were most concerned about Hong Kong's fiscal deficit problem.  I am fully aware that, due to the externally-oriented nature of the Hong Kong economy and our linked-exchange-rate system, keeping public finances sustainable is of paramount importance.  The economic crisis in Argentina and the social unrest this has triggered are the results of overborrowing brought about by persistent fiscal deficits and price rigidity.  To safeguard Hong Kong against any such crisis, we must implement effective measures to restore fiscal balance within a reasonable period of time.

 

5.        As I prepared this Budget, I received many valuable suggestions from Members of this Council and the media.  I also met with members of the public and various sectors, including the financial sector, labour groups and academia.  My heartfelt thanks go to everyone.

 

Economic Performance and Prospects

 

Economic Performance

 

6.        I will begin my analysis with an overview of the economy.  Our economy underwent a downward adjustment in 2001 with a growth of only 0.1% in real terms, much lower than the 10.5% real growth in 2000.  Deflation continued, with the Composite Consumer Price Index falling by 1.6% last year.  In the quarter ended 31 January 2002, the seasonally-adjusted unemployment rate rose to 6.7%, its highest since the 1980s.


Chart 1

The Hong Kong economy underwent a downward adjustment in 2001

The Hong Kong economy underwent a downward in 2001


Chart 2

Unemployment increased

Unemployment increased


Chart 3

Deflation continued

Deflation continued


External Economic Environment

 

7.        The major economies of the world, including the United States (US), the European Union (EU) and Japan, are all experiencing economic slowdown.  It is the first time since the 1970s that a synchronized global economic downturn has occurred.  The US economy was already showing signs of slowing down by early 2001 and has worsened following the events of September 11.  The EU economy, though slightly better than that of the US, remains sluggish.  Japan has been mired in economic recession for ten successive years.  Under such conditions, Hong Kong's economy is inevitably affected.  Fortunately, the economy of the Mainland of China, the brightest spot in the global economy, has supported ours in this time of economic difficulty.

 

8.        Initial signs are that economic conditions in the US are improving.  However, the US and other major economies have accumulated massive excess capacity, which can scarcely all be absorbed over a period of a few quarters.  The global economy, in my view, will experience low inflation and low growth for some time to come.

 

 

Restructuring of the Hong Kong Economy

 

9.        In common with other places in Southeast Asia, Hong Kong experienced a bubble economy in the years up to and including 1997.  This was the result of various factors, including the restriction on land supply and the effect of negative real interest rates brought about, against the background of the linked-exchange-rate system, by low interest rates in the US and a high inflation rate in Hong Kong.  Following the outbreak of the Asian financial crisis, this bubble burst.

 

10.     Meanwhile, globalisation is leading to closer economic ties throughout the world. Increasing trade flows magnify comparative advantages among different areas and accelerate international division of labour.  For Hong Kong, globalisation in general, and integration with the Mainland economy in particular, have thrown down the gauntlet of economic restructuring.

 

11.     Since the opening up of the Mainland in the 1980s, Hong Kong enterprises, leveraging the low costs there, have expanded their scale of production and enhanced their competitiveness.  Our domestic economy has upgraded itself in tandem.  Support services for Hong Kong and the Mainland replaced manufacturing industries as the fastest-growing sector.  The South China region has now evolved into one of the world's most important production bases.  Since the mid-1990s, service industries on the Mainland have also been developing apace.  During this period, the bubble economy emerged in Hong Kong, giving rise to high operating costs here.  Some Hong Kong service industries started to move northwards as well.  Moreover, after reunification, Hong Kong residents, in increasing numbers, travel across the boundary to spend, affecting Hong Kong's domestic consumption.

 

12.     In the process of economic integration, the price differential between Hong Kong and the Mainland will inevitably narrow gradually.  In economics, this is called "factor price equalisation".  The price of tradable products adjusts swiftly due to relatively free trade between the two places.  The adjustment of non-tradable factors such as land and labour is slower. "Factor price equalisation”, however, does not mean that price levels between Hong Kong and the Mainland will be exactly the same, just as New York, London and Tokyo have relatively higher prices than their neighbouring areas.  We can foresee that prices in Hong Kong will generally remain higher than those in the Mainland.  The magnitude of this price differential will hinge largely on our ability to provide high-value services and goods.

 

13.     As the bursting of the bubble economy coincided with economic restructuring, Hong Kong has experienced heavy deflationary pressure.  Property prices have dropped from their peak by more than half.  Labour costs are being trimmed through pay reductions and layoffs.

 

14.    In the face of persistent deflation, there are some who have suggested abolition of the linked-exchange-rate system.  I must reiterate that the Government has no intention of making any change.

 

Hong Kong's Competitive Advantages and Challenges

 

15.     As we undergo economic restructuring, we must consider what are our strengths and play to the best of them.

 

16.    Our strengths lie in the following four areas -

  • first, our geographic location. Hong Kong is at the centre of Asia. Our hinterland, the Mainland, is the fastest-growing economy in the world.  Other cities cannot claim this advantage;

  • second, our institutional strengths.  These include "One Country, Two Systems", the rule of law, a level playing field, clean government, the free flow of information, a simple and low tax regime, and an efficient and effective market-regulatory system. These institutional strengths, developed over many years, have deep roots;

  • third, our talent.  Hong Kong is rich in talent in fields such as business, management, and professional services, as well as some aspects of scientific research and education.  These individuals are biliterate and trilingual, and familiar with both Chinese and Western cultures, management, business operations, mindset and practices; and

  • fourth, our strong business base.  Over the years, many leading enterprises have built up a strong presence in Hong Kong.  They complement and support each other, and create a clustering effect that helps attract more high-value-added business activities to Hong Kong.

 

17.    But several challenges also confront our economy -
  • first, our costs are relatively high so we need to develop high-value-added businesses;

  • second, we need to upgrade the quality of our manpower further and increase the number of talented individuals, to meet the needs of our changing economy; and

  • third, we need to enhance economic ties with our neighbouring region, particularly the Mainland, to maintain Hong Kong's status as a regional financial and commercial centre.

 

Moving up the Value Chain

 

18.     Since our costs are higher than those of our neighbours, low-skilled and labour-intensive industries are no longer competitive.  Hong Kong cannot rely on them to provide the impetus for economic development.  We need to focus on high-value-added economic activities.  High added value is not the same as high technology.  High-value-added activities exist in every sector.  Of the many economic sectors in Hong Kong, I believe four are of particular importance, as they can foster the development of other sectors, give impetus to our economy, and create employment.  These four areas are financial services, logistics, tourism and producer and professional services.

 

Financial Services

 

19.     As an international financial centre, Hong Kong has a considerable edge.  We are renowned for our business in foreign exchange, securities and banking.  To develop further, our financial market needs to concentrate on two important areas.

 

20.     The first is to increase liquidity.  The Government will work together with the Hong Kong Monetary Authority, the Securities and Futures Commission, Hong Kong Exchanges and Clearing Limited and the financial services sector to attract more financial product issuers to Hong Kong, as well as capital and investors from the Mainland and overseas.  We are now streamlining procedures and lowering associated costs for the issuance of financial products, so as to facilitate market development and the introduction of new products.  For example, we are simplifying procedures for retail bond issues, and reviewing issuance and listing fees for derivatives.

 

21.     Second, we need to enhance our market system further.  We will continue to modernise our financial system and make it more user-friendly for investors, issuers and intermediaries through regular reviews.  We will ensure efficient and effective regulation in line with international standards in order to maintain our edge in the region.  The Securities and Futures Bill, which is in its final legislative stage, will introduce a series of measures to streamline the licensing system for intermediaries, increase market transparency, maintain a level playing field and facilitate product innovation.  When preparing the associated subsidiary legislation, we will continue to consult the public and the industry to ensure that such legislation is user-friendly.

 

Logistics

 

22.     Hong Kong's logistics industry enjoys many advantages.  We have the world's busiest container port, which handled nearly 18 million TEUs (twenty-foot-equivalent units of containers) last year.  The volume of international freight handled at Hong Kong International Airport was also the highest in the world, last year amounting to nearly 2.1 million tonnes.  The further development of our logistics industry depends on increase in speed and efficiency, as users often value these attributes more than cost.  In this respect, thanks to the efforts of the freight transport sector, the Airport and the government departments concerned, the transshipment time through Hong Kong of cargo shipped from the rest of the world to the Pearl River Delta has been reduced from two days to less than 24 hours.  Moreover, Phase 2 extension works at Lok Ma Chau Control Point are in full swing.  The Shenzhen Western Corridor, targeted for completion in 2005, is also under active planning, and upon completion will increase the capacity for vehicular cross-boundary trips by 44 000 a day.  Apart from enhancing infrastructure, the Government is re-engineering the customs process to speed up clearance, for instance by introducing "one-stop"  arrangements on a trial basis for trucks crossing via Lok Ma Chau Control Point.  The Logistics Development Council is studying the use of information technology to establish a common platform to facilitate data exchange among participants in the logistics industry, including consignors, transport companies, the Customs and Excise Department, banks and container terminal operators.

 

23.     To foster the further development of our logistics industry, we have to expand Hong Kong's cargo catchment area and we will encourage logistics services providers to do so.  We also need to develop high-value-added logistics parks in order to attract enterprises to use Hong Kong to support low or even zero-inventory modes of production in the region.

 

 

Tourism

 

24.     Last year, over 13.7 million visitors came to Hong Kong, with those from the Mainland registering strong growth of over 17%.  With the rebound of tourism in Asia, Hong Kong will remain the first choice for many.  To promote tourism, we must develop more attractions and improve our facilities.  We must also develop different types of tourism, such as business tourism linked with exhibitions and conferences, and family, ecological and cultural tourism.

 

25.     In addition to our existing first-class convention and exhibition facilities, we plan to build a new international exhibition centre at the Airport.  Upon its completion, this new facility will attract many more business visitors to Hong Kong.  Meanwhile, Ocean Park is introducing new attractions, and the construction of Hong Kong Disneyland is progressing well.  These theme parks, as well as the proposed Tung Chung cable car project on Lantau Island, will help cater for family tourism.  Hong Kong is endowed with scenic country parks, hiking trails and nature conservation areas.  They provide a good foundation for the development of ecotourism.  We are also well-equipped to promote cultural tourism.  As the city where East meets West, Hong Kong has attractions as diverse as Temple Street and Lan Kwai Fong, or Wong Tai Sin Temple and Murray House, which form strong and colourful contrasts.  The concept plan for an exciting new cultural zone in West Kowloon has been selected through international competition.  We will soon start detailed planning for its early construction, to provide new attractions for local residents and tourists alike.  Alongside these, we have one of the greatest attractions of all: our fine cuisine.  China has a venerable culinary tradition and Hong Kong enjoys a reputation as a gourmet paradise.  We need to make every effort to retain that accolade.

 

26.     Together we must welcome our visitors with hospitality, courtesy and sincerity.  I am pleased to note that improvements are taking place.  Every citizen, shop and restaurant is a Tourism Ambassador for Hong Kong.  We must give our guests a value-for-money experience so that they will all want to come back again, and tell their relatives and friends that Hong Kong is a uniquely vibrant and charming destination.

 

27.     Promoting inbound tourism does not merely bring economic benefits: it also helps us to rediscover Hong Kong's attractiveness.  Tourism enriches the flavour of Hong Kong, and encourages us to cherish our heritage and develop our cultural traditions.

 

Producer and Professional Services

 

28.     Another force driving economic development is producer and professional services.  As the Mainland, our hinterland, opened up, this permitted our industries to expand their production base and increase their competitiveness.  In this process, our industries have moved up the value chain, from a low-value-added and labour-intensive production mode to a high-value-added and technologically-based one.  That is why we have, in recent years, witnessed rapid expansion in producer services such as import and export, transportation and warehousing, trade financing, insurance, accreditation and testing, research and development, product design and market research and promotion.  In addition, Hong Kong has a steadily-growing professional services sector, including legal, accounting, engineering, advertising, consultancy, public relations and design services, which provide services to clients in Hong Kong, the Mainland, and throughout the world.

 

29.     To advance further up the value chain, enterprises in Hong Kong need to devote more resources to research and development, become more innovative and make wider use of technology, especially information technology, to add value to their services.  Such research and development work includes helping the manufacturing industry to introduce more sophisticated and efficient production techniques to enhance productivity and competitiveness.  One way is by accelerating the evolution of the production mode from Original Equipment Manufacturing to Original Design Manufacturing and thence Original Brand Manufacturing by means of design and product innovations and use of new materials.  Such activities can generate many other high-value-added industries and businesses, for example the design of integrated circuits.

 

30.     We have set up steering committees to promote development in each of these four important economic sectors.  I have been overseeing their work personally and will see to it that good progress is made.  In Hong Kong, there are many other industries with good potential, such as applied technology, Chinese medicine, film, music, publishing, fashion and construction.  Their concerted efforts will give further impetus to our economy.

 

 

Local Community Economy

 

31.     Apart from the more externally-oriented economic sectors that I have just mentioned, economic activities in the local community closely linked to our daily life are also important.  This local community economy covers a wide range of activity, including cultural, recreational, sports, social and personal services; and there are many different types of players, such as small traders, local domestic helpers and fitness instructors.  Development of the local community economy can promote domestic consumption, create employment opportunities and highlight Hong Kong's unique characteristics.  I will chair an inter-bureau working group to promote the development of the local community economy.

 

 

Quality, Speed and Creativity

 

32.     Everyone in Hong Kong, whatever his or her particular walk in life, must seek to excel.  Being ahead of the game helps to improve economic efficiency and increase market share.  It also assists us to overcome our higher costs, and allows us to maintain and enhance our standard of living.  We already command a leading position in the region in fields such as financial services, logistics, tourism and pop culture.  We have to keep up this good work to stay ahead of the competition.  In other areas where we enjoy competitive advantages but have not yet taken a lead, we must work harder to reach that goal.

 

33.     The key to success in business is either a competitive price or product differentiation.  With our cost, we have to use the latter.  This calls for market-driven, customer-oriented services and products delivered or made with quality, speed and creativity.  Such attributes are essential for both high- and low-technology industries.  Let me cite a few examples by way of illustration.  Our restaurants enjoy worldwide renown for their quality and creativity: Hong Kong cuisine is now a synonym for fine dining.  Our pop music and movies are now in demand throughout Asia, another example of success through creativity.  Our garment industry is distinguished by speed and quality.  I believe all of us, irrespective of age, occupation or academic qualifications, and all our businesses, regardless of scope or scale, can harness these attributes of quality, speed and creativity.

 

Nurturing and Attracting Talent

 

34.     Hong Kong has good human resources, but we still need to train and attract more talent.  That is the second challenge we have to overcome.

 

35.     We are now taking action on two fronts.  The first is to improve the quality of our basic education, enhance higher education and promote lifelong learning in the community.  We need more talented individuals who are biliterate and trilingual, innovative, adaptable and have the ability to think critically and communicate.  Indeed, most people in Hong Kong strive to improve themselves and enhance their personal worth.  The Government will continue to invest heavily in education and training and help those in financial difficulties to pursue further studies through subsidies and loans.  Nevertheless, it is also reasonable for those who can afford it, to pay their own expenses in the pursuit of lifelong learning.

 

36.     The second important task is to attract to Hong Kong individuals with the right knowledge and skills or who have entrepreneurial spirit.  Some believe that the admission of outside talent would deprive local people of employment.  The reality is quite the opposite.  Outside talent gives impetus to our economic development and this in turn creates more jobs.  The keen competition among the developed economies in America and Europe for talent from all over the world is a testament to this.

 

37.     Whether such talent is prepared to come to Hong Kong depends on many factors, including the living environment, town planning, potential for self-fulfillment and cultural diversity.  But the crucial element is the Government's admissions policy.  Last October, the Chief Executive announced in his Policy Address that the Government was reviewing its immigration policy with a view to relaxing restrictions on the entry of overseas investors.  He has recently suggested the need to conduct a comprehensive study of Hong Kong's admissions policy.  These initiatives are intended to facilitate the steady economic restructuring of Hong Kong.

 

 

Fostering Economic Flows between Hong Kong and its Hinterland

 

38.     As a regional financial and commercial centre, Hong Kong must maintain a smooth flow in both directions of economic activity with its neighbouring areas, in particular the Mainland.  Our interaction with other economies generally does proceed smoothly.  With the Mainland, however, the flows, in particular those of people, goods, capital, information and services, still need improvement.  This is the third challenge we face.

 

39.     As regards the flow of people, the quota system for the Hong Kong Group Tour Scheme was abolished on 1 January this year, following discussions between the Government of the Hong Kong Special Administrative Region and the Central People's Government.  There are now 67 Mainland travel agencies organising tours to Hong Kong, as against four in the past.  The Central People's Government has also simplified the procedures for Mainland visitors to come to Hong Kong on business.

 

40.     I have already touched upon the subject of goods and capital flows earlier in my speech.  In the field of information, Hong Kong is the telecommunications and broadcasting centre for the region.  We have readily-available information on economic developments in the Mainland. We are the natural base for analysts and investors interested in China.  This creates a clustering effect.  We need to reinforce our advantage in the field of information through upgrading both hardware and software.

 

41.     As for services, the Government will continue to promote closer connections between these industries in both places.  Our professional services, such as accounting and banking, have gained a foothold in the Mainland.  I am now holding discussions with officials of the Central People's Government on a Closer Economic Partnership Arrangement with the Mainland.  Such an arrangement will greatly enhance the flow of goods and services between the two places.

 

Economic Role of the Government

 

42.     Let me now turn to the Government's role in the economy.  I am a firm believer in market economy.  I believe the market can allocate and utilise resources more effectively and has greater capacity to foster creativity, provide economic impetus and create employment opportunities.  Some may have the impression that, to maintain Hong Kong's economic freedom, the Government should be passive and distance itself from the economy.  I disagree.  I am of the view that the Government should have a clear vision of the direction of economic development and be a proactive market enabler.  This role includes -

  • first, maintaining an institutional framework conducive to market development, including reinforcing our institutional strengths, such as the rule of law, the low and simple tax regime, the level playing field, law and order and the business-friendly environment.  The Government should review the regulatory and supervisory framework at regular intervals to ensure that it remains user-friendly, effective and up-to-date;

  • second, providing that infrastructure in which the private sector will not invest;

  • third, providing an appropriate environment and the resources required to raise the quality of our human capital.  That includes investing in education and attracting outside talent to Hong Kong;

  • fourth, securing more favourable market access for our local enterprises through multilateral and bilateral economic and trade negotiations and participation in relevant economic and trade organisations.  The Government in conjunction with the appropriate organisations should also assist local enterprises to promote their products outside Hong Kong; and

  • fifth, considering the need to take appropriate measures to secure projects beneficial to our economy as a whole when the private sector is not ready to invest in them.

 

43.     Apart from the foregoing, the Government should also provide a "safety net" for the community.  While economic activities are the lifeline of society, a caring community based on mutual concern and support is equally important.  The Government will continue to take care of the basic needs of those who are disadvantaged or in hardship.  Their well-being will not be neglected.

 

 

Economic Prospects for 2002 and
the Medium Term

 

44.     I now turn to the economic forecast for 2002 and our medium-term (from 2002 to 2006) prospects.  I believe that the EU and US economies will recover in the foreseeable future and that the Mainland will maintain its high economic growth.  In the light of the more favourable external factors and our sustained efforts to move up the value chain, the outlook for Hong Kong is bright in the medium and long term.

 

45.     I am forecasting a GDP growth of 1% in real terms for 2002, and real trend growth of 3% over the medium term.  As the excess capacity within the global economy has yet to be digested and local deflationary pressure will remain, I forecast a fall of 1.5% in the GDP deflator for 2002 and 0.4% trend growth over the medium term.

 

46.     While the medium- and long-term outlook is promising, it will take time for our economy to recover.  Economic restructuring will continue for some time.  In the light of these factors, coupled with the pressure of deflation, I expect that, in the short term, the unemployment rate will increase further.

 

 

Public Finances

 

47.     As in the past, the Government will continue to follow the guiding principle of prudent management of public finances.  Article 107 of the Basic Law stipulates that the Hong Kong Special Administrative Region shall follow the principle of keeping expenditure within the limits of revenues in drawing up its budget, and strive to achieve a fiscal balance, avoid deficits and keep the budget commensurate with the growth rate of its gross domestic product.

 

48.     Two weeks ago, the Task Force on Review of Public Finances published its findings.  The Task Force concluded that our public finances are confronted with structural problems.  On the revenue side, consolidation in the property market has resulted in a structural diminution in revenue from land premiums, profits tax from the banking and property sectors, and stamp duty on property transactions.  The investment income from our fiscal reserves will also suffer a structural reduction, as successive years of fiscal deficits result in a rundown of the reserves, and as the anticipated rate of return on investment income is likely to drop alongside low inflation in the years ahead.

 

49.     On the expenditure front, the Task Force pinpointed price rigidity in government expenditure, which is particularly severe in times of deflation.  Over the past three years, the general price level of the economy1 has fallen by 12%, whereas the price of government expenditure2 has remained basically unchanged.  Furthermore, our ageing population will increase the demand for social security payments.  In the recent years of economic downturn, the Government has also consciously embraced counter-cyclical fiscal policies.  As the economy recovers, measures to redress these will have to be taken.  Otherwise, our fiscal policies would be out of line with the economy, and this would exacerbate the structural problem in our finances.

1             Price changes in the economy refer to the GDP deflator.

2             Price changes in government expenditure refer to the Government Consumption Expenditure deflator.

 

50.     The Task Force was of the view that, were the prevailing revenue and expenditure policies to continue, the Government would face ongoing and persistent fiscal deficits.  It estimated that the fiscal reserves would be depleted by 2008-09.  Obviously, this scenario is unacceptable.

 

51.     Later on, I will propose measures to restore fiscal balance.  Let me first discuss four issues concerning the management of public finances, namely public expenditure as a share of the economy, basis for comparison of growth in expenditure and the economy, consolidated and operating balances, and purpose and level of fiscal reserves.

 

 

Share of Public Expenditure in the Economy

 

52.     The share of public expenditure3 in the economy4 averaged around 16% in the mid-1980s, about 17% in the mid-1990s, but rose to 22% in 2001-02.  This is due to the fact that, in the face of economic downturn since 1998, the Government has consciously adopted a counter-cyclical fiscal policy, by keeping expenditure growth above the trend growth of the economy.  In addition, due to rigidity in the prices of public expenditure, they have continued to rise despite deflation in the economy.

3             Public expenditure comprises government expenditure and expenditure by the Trading Funds, the Housing Authority and payments from the Lotteries Fund.  Government expenditure accounts for the majority of public expenditure. In 2001-02, for example, government expenditure accounts for about 88% of public expenditure.

4             The share of public expenditure in the economy is expressed as a percentage of GDP.

 

53.     The growing share of public expenditure in the economy consumes scarce resources that could otherwise be used by the private sector more efficiently.  To maintain Hong Kong's competitiveness, we must contain public expenditure as a percentage of GDP.  My target is to reduce this share to 20% of GDP or below by 2006-07.

 

 

Basis for Comparison of Growth in Expenditure and the Economy

 

54.       Government expenditure and economic growth can be measured in both real and money (or nominal) terms.  In a nutshell, our recurrent revenue and expenditure are accounted for in money terms, whereas "real" is an economic concept, referring to value after discounting price movement.

 

55.     Price movement in government expenditure does not follow that of the economy.  This is mainly attributable to the higher wage content of government expenditure.  Wages tend to increase faster than the general price level in the economy, which means that the price of government expenditure grows faster than the general price level.  Government expenditure also includes pension and social security payments, and these have not adjusted downwards with the general price level in times of deflation.  The differential between the government expenditure price level and the general price level thus widens further.  Over the past decade, the government expenditure price level has risen by 72% but the general price level only by 29%.  As a result, although in real terms the growth in government expenditure has been broadly in line with GDP growth, it has overshot in money terms.  From 1998-99 to 2001-02, government expenditure recorded a cumulative growth of 17% in money terms, while GDP registered a cumulative fall of 5%.

 

56.    As both government revenue and expenditure are accounted for in money terms, I shall strive to control the growth of government expenditure in money terms, in addition to controlling it in real terms.

 

 

Consolidated and Operating Balances

 

57.     Government revenue and expenditure can be measured on two levels.  One is the Consolidated Account, which comprises all revenue and expenditure, including recurrent and capital revenue and expenditure.  The other is the Operating Account, which, put simply, includes only recurrent revenue and expenditure.  It is important to achieve a balance in both accounts, but for investors and international rating agencies, the operating balance sometimes is even more important.

 

58.     Investment income from the fiscal reserves has been a major source of revenue for the Operating Account, contributing on average 13% in each of the past four years.  This income source is expected to decrease as a result of the declining fiscal reserves and the lower return on their investment.  Accordingly, we should focus not only on the deficit or surplus after taking investment income into account, but also on that before its inclusion.  Let me illustrate this point with reference to daily family financial management.  The recurrent revenue of the Government can be compared to the wage income of a family, the fiscal reserves to a bank deposit, and investment income to interest earnings.  Generally speaking, a family's operating account is balanced when the wage income is adequate to cover its daily expenses.  If a family has to draw on interest earnings to meet its daily expenses, then it has to be very much on the alert because interest earnings, being susceptible to interest rate movements, are not stable.  If its income is insufficient to cover daily expenses and the family has to draw on the principal of the deposit, I am afraid that it will have to survive on debt once the deposit is depleted.

 

59.     In seven out of the past ten years, the Government has run a capital account deficit.  Capital expenditure is mainly on infrastructural projects, and is principally funded by land premiums.  As Hong Kong's property sector undergoes consolidation, land premiums in future will likely be inadequate to meet capital expenditure.  Although the Government can sell some of its assets, this cannot provide a stable source of revenue in the long term.  Therefore, to ensure consolidated balance, we need to achieve surpluses in the Operating Account over the longer term to finance a part of capital expenditure.

 

60.     We have had operating deficits for four consecutive years since 1998-99.  In three of the past five years, the Consolidated Account has also recorded a deficit.  This cannot go on forever.  My target is to achieve consolidated and operating balances by 2006-07.


Chart 4

Four consecutive years of operating deficits

Four consecutive years of operating deficit


Chart 5

Consolidated deficits in three of the past five years 

Consolidated deficits in three of the past five years


Fiscal Reserves

 

61.     During my Budget consultations, I heard suggestions for the Government to revise the target level of fiscal reserves in the light of the prevailing conditions of the economy and public finances.

 

62.     In the wake of the Asian financial crisis, the Hong Kong Monetary Authority has implemented a series of measures to reinforce the stability of the Hong Kong Dollar exchange rate.  In addition, the accumulated surplus of the Exchange Fund has now reached $300 billion.  These developments have greatly enhanced the Exchange Fund's ability to maintain exchange rate stability.  I see no further need to link the level of fiscal reserves to money supply.  In my view, it should be sufficient to have fiscal reserves equivalent to around 12 months of government expenditure to meet operating and contingency requirements.  Although it is no longer necessary to link the level of fiscal reserves to money supply, the Government's fiscal reserves will continue to be placed with the Exchange Fund, thereby providing even more resources for the Exchange Fund to maintain the stability of the Hong Kong Dollar and our monetary system.

 

 

Medium Range Forecast: Restoring Fiscal Balance

 

2001-02 Outturn

 

63.     Let me now elaborate on the Government's plan to solve the deficit problem in the medium term.  First, I forecast a consolidated deficit of $65.6 billion for 2001-02 (equivalent to 5.2% of GDP), far larger than the original estimate of $3 billion.  This is due mainly to revenue from land premiums and investment income from our fiscal reserves falling far short of our original forecasts.  Furthermore, the secondary offering of Mass Transit Railway shares originally planned for this financial year has been postponed to the next because of changes in investment market conditions.  I estimate the fiscal reserves to be $369.8 billion by 31 March this year, roughly equivalent to 19 months of government expenditure.

 

Restoring Fiscal Balance Step by Step

 

64.   Earlier, I set three targets for our public finances in 2006-07 -
  • first, restore balance in the Consolidated Account;

  • second, attain a balanced Operating Account; and

  • third, reduce public expenditure to 20% of GDP or below.

I aim to achieve these targets step by step through reducing the growth of government expenditure and modestly raising revenue.  I believe this is a practical strategy commensurate with our economic condition.

 

Controlling Expenditure Growth in Real Terms

 

65.     Having regard to the current state of our economy, I have decided to allow government expenditure in 2002-03 to grow by 2% in real terms over the original estimate for 2001-02, or 7.7% over the revised estimate, higher than the forecast economic growth of 1% in real terms for 2002.

 

66.     From 2003-04 to 2006-07, I will reduce the real growth in government expenditure to an average of 1.5% each year, lower than the forecast economic growth rate.  I believe Hong Kong's economy should have picked up by then and such a reduction will be necessary to restore fiscal balance in the medium term.

 

Civil Service Pay

 

67.     I have mentioned earlier that it is necessary to control the growth of government expenditure in money terms.  Personnel-related expenses account for 70% of government operating expenditure.  Given our serious fiscal position, I have assumed in the Medium Range Forecast, for financial planning purposes, that civil service pay will be cut by 4.75% and the salary-related portions of subventions to the various organisations will also be reduced by the same rate.  This assumed 4.75% pay cut has taken into account the respective cumulative pay rises for civil servants of different ranks since July 1997.

 

68.     Under the existing mechanism, the Government will consider, among other things, the results of the private sector pay trend survey and its own budgetary position before deciding on an annual civil service pay adjustment.  We will continue to adopt this mechanism and make a final decision after the outcome of this year's survey is known in May.  Any decision on a civil service pay cut needs to go through the legislative process before it can be implemented.  Assuming that the pay cut takes effect from 1 October this year and that the level of reduction is 4.75%, the Government will achieve savings of about $3 billion in 2002-03 and about $6 billion in a full year.

 

69.     Last month, I met with representatives of the civil service central consultative councils and a number of civil service staff unions.  I appreciate their position.  I believe many colleagues in the civil service and the subvented organisations understand that we are facing a serious fiscal situation and that persistent fiscal deficits will adversely affect Hong Kong as a whole.  In fact, many colleagues told me that they were willing to stand by the rest of the community in this time of difficulty and share the burden.

 

 

Doing More with Less

 

70.     In addition, we will stringently contain the growth of the civil service in all ranks.  Last year, the Government proposed to reduce the civil service establishment to around 181 000.  Thanks to the efforts of all departments and grades, we will achieve this target as scheduled in 2002-03.

 

71.     We will also review the demand for services and our priorities for the deployment of resources.  Departments will streamline procedures, simplify structures and economise on manpower in order to release resources to meet additional needs.  Furthermore, we will make use of market forces and strengthen our co-operation with the private sector to provide better and more efficient services to the public through various means.

 

 

Controlling Expenditure Growth in Money Terms

 

72.     Assuming that civil service pay is cut from 1 October this year, government expenditure in 2002-03 will increase in money terms by 0.6% over the original estimate, or 6.2% over the revised estimate, for 2001-02.  Average annual growth of government expenditure from 2003-04 to 2006-07 will be 1% in money terms.  With the foregoing measures for controlling expenditure, I am confident that public expenditure will fall to 20% of GDP in 2006-07.

 


 

Chart 6

Public/Government expenditure as a percentage of GDP

Public/Government expenditure as a percentage of GDP


Revenue Proposals for 2002-03

 

73.     Nevertheless, in order to restore fiscal balance in the medium term, we need to increase revenue in addition to controlling the growth of government expenditure.

 

74.     Under present economic conditions, I consider it inappropriate to make any major changes on the revenue front in 2002-03.  My only tax increase proposal is a modest increase in the duty rate on wine.  I also propose to reduce the quantities of duty-free tobacco and still wine that local residents may bring back to Hong Kong.  These two proposals have no bearing on livelihood and will not hinder economic recovery.

 

Duty on Wine

 

75.     I propose to increase the duty rate on wine from 60% to 80%.  I estimate that this will generate additional revenue of $70 million in a full year.  This proposal will have only a mild effect on the retail prices of wine, as the level of duty is determined on the basis of ex-factory prices.  The new duty rate became effective at 2:30 p.m. today in accordance with a Public Revenue Protection Order signed by the Chief Executive and published in the Gazette.  We will introduce the related legislation into this Council as soon as possible.

 

Quantities of Duty-free Tobacco and Still Wine

 

76.     I propose to cut by 40% the quantities of duty-free tobacco that Hong Kong residents may bring back.  The new duty-free quantities will be 60 cigarettes or 15 cigars or 75 grammes of tobacco.  For duty-free still wine, the quantities that Hong Kong residents may bring back will be cut by 25%, from one litre to 750 millilitres, the standard size of a bottle of wine.  I estimate that this proposal will generate additional revenue of about $330 million in a full year.

 

 

The Shortfall

 

77.     With the foregoing measures to control expenditure and increase revenue and the assumed 4.75% civil service pay reduction, we would not yet be able to restore balance in the Operating Account in 2006-07.  We still need to increase recurrent revenue or reduce recurrent expenditure by $2 billion from 2003-04 onwards, with another $3.5 billion required from 2004-05 onwards and a further $3.5 billion from 2005-06 onwards.

 

78.     To achieve overall fiscal balance in 2006-07, we also need to increase capital revenue (e.g. by the sale of government assets) or reduce capital expenditure by $20 billion over the medium term.


Chart 7

The Shortfall

The Shortfall

Boundary Facilities Improvement Tax

 

79.     Having considered the views of various sectors of the community, I propose to introduce a Boundary Facilities Improvement Tax.  Many Members of this Council and citizens agree that it is in principle justifiable to impose a tax at a modest level on passengers departing from Hong Kong through land crossings.  At present, passengers departing through Hong Kong International Airport or people leaving by sea for the Mainland and Macau through our marine ferry terminals are required to pay a flat-rate tax or fixed fee to the Government.  As our economic links with the Mainland strengthen, we will allocate substantial resources to improve our land crossing facilities to remove constraints on the flows of people and trade between the two places.  The collection of a Boundary Facilities Improvement Tax at a reasonable rate will help finance the improvement of boundary facilities.

 

80.     The Government will look into the details of implementation, including appropriate exemption arrangements, for the Boundary Facilities Improvement Tax.  We aim to introduce a bill into the Legislative Council in 2002-03 so that this tax can come into effect in 2003-04.  Assuming that the Boundary Facilities Improvement Tax is set at $18, it can generate an estimated additional revenue of approximately $1 billion a year.

 

Making Up the Shortfall: the Way Forward

 

81.    Apart from the Boundary Facilities Improvement Tax, the Government has to consider other options for raising additional revenue or reducing expenditure to make up the shortfall that I mentioned earlier.

 

82.     As regards increasing revenue, the Advisory Committee on New Broad-based Taxes has recently released its report.  I would like to express my sincere thanks to Mr Moses Cheng, Chairman of the Advisory Committee, and all its members for their work.  The report's recommendations include the introduction of a Goods and Services Tax and a Land and Sea Departure Tax (akin to the Boundary Facilities Improvement Tax), an increase in rates, and a reduction in personal allowances under salaries tax.  Apart from these recommendations, the Government will consider other options for raising additional revenue.  The Government is considering how to tackle illegal soccer betting more effectively, including options that may bring additional revenue to the Treasury.

 

83.     I understand the community's concern about the recommendation for a Goods and Services Tax.  The Chief Executive and I have stated clearly that the Government will not introduce such a tax while there is a downswing in the economy.  Nevertheless, the Government will continue to study the details of a Goods and Services Tax for implementation as and when necessary.

 

2002-03 Expenditure Estimates

 

84.     Let me now focus on the expenditure estimates for 2002-03.  These estimates have taken into account the assumed 4.75% civil service pay reduction and the corresponding reduction in subventions for salary-related expenses to subvented organisations.

 

85.     I have earmarked adequate resources to implement the Chief Executive's vision for Hong Kong, including the policies and performance pledges announced in his Policy Address last October.

 

86.     In 2002-03, total recurrent government expenditure will amount to $204.9 billion, an increase of 5% in real terms over the revised estimate for 2001-02.  Recurrent expenditure for Education is estimated to be $49.3 billion, an increase of 8%; for Health $32.4 billion, an increase of 4%; for Social Welfare $32.1 billion, an increase of 9%; for Support $28.4 billion, a decrease of 2%; for Security $24.8 billion, an increase of 2%; for Infrastructure $11.8 billion, an increase of 4%; for Environment and Food $9.0 billion, an increase of 10%; for Economic $8.8 billion, an increase of 12%; for Community and External Affairs $7.6 billion, an increase of 3%; and for Housing $0.6 billion, a decrease of 1%.

 

87.     Government capital expenditure in 2002-03 is estimated to be $49.4 billion, representing an increase of 21% in real terms over the revised estimate for 2001-02.  This is due mainly to provisions for setting up the Continuing Education Fund, support for small and medium enterprises and increased spending on capital works.  Expenditure on capital works is estimated to be $28.5 billion, an increase of 15% in real terms over the revised estimate for 2001-02.  From 2003-04 to 2006-07, expenditure on capital works will be in the range of $25 to $30 billion per year, depending on progress of individual projects.

 

 

Helping the Community Ride Out the Storm

 

88.     In the course of Budget consultations, Members of this Council and many citizens expressed the hope that the Government would show concern over the community's hardship in this time of economic difficulty.  The Chief Executive and I both agree that, the Government's overall financial position permitting, we will provide some one-off concessions related to people's livelihood.

 

Reducing Rates Payments

 

89.     In his Policy Address last October, the Chief Executive decided to ease the burden on all ratepayers by reducing the amount of rates payable in 2002.  The maximum amount to be waived for each rateable tenement is $2,000.  To provide further relief to our citizens, especially middle-income earners, I have decided to raise the maximum amount to $5,000.  The previous concession of $2,000 reduced the load on ratepayers by $5 billion.  With an increase in the concession to $5,000, their burden will be reduced by another $2.6 billion.

 

Reducing Water and Sewage Charges and Trade Effluent Surcharge

 

90.     I propose to waive water and sewage charges for domestic households for one year, subject to maximum amounts set at $800 and $200 respectively.  As for non-domestic consumers, I also propose to waive their water and sewage charges for one year, subject to maximum amounts set at $3,200 and $800 respectively, so as to help reduce the operating cost of the industrial and commercial sectors.  As some premises still use fresh water for flushing, I also propose to waive such flushing charges for one year, subject to a maximum amount set at $800.  Currently, operators in 30 specified trades are required to pay a trade effluent surcharge.  I propose to reduce this surcharge by a flat rate of 30% for one year.  The foregoing concessions will cost about $1.3 billion.

 

Waiving Business Registration Fee

 

91.     To help further reduce the operating cost of businesses, I propose to waive the business registration fee for one year.  This proposal will cost about $1.3 billion.

 

Extending Duty Concession for Ultra Low Sulphur Diesel

 

92.     The duty concession for ultra low sulphur diesel is due to expire on 31 March this year.  In view of the operating difficulties of the transportation industry, I propose to extend this concession, for the third time, for another year to 31 March 2003, maintaining the duty rate of ultra low sulphur diesel at $1.11 per litre.  This proposal will cost $1.2 billion.

 

Freezing Government Fees and Charges

 

93.     To avoid adding to the burden of the community, I have decided to freeze government fees and charges up to the end of March next year.  However, this measure will not apply to fees and charges levied by trading funds, nor to services provided at full cost to certain public entities.  Nor will it apply to any new fees that are in the pipeline.

 

Summary of Concessions 

 

94.    With the implementation of the above concessions -

  • about 85% or more than 2.3 million ratepayers will pay no rates for one year;

  • about 80% of households and business consumers will pay no water and sewage charges for one year;

  • each of the 15 000 or so businesses currently required to pay the trade effluent surcharge will on average pay $4,000 less;

  • over 600 000 business operators will be exempted from the business registration fee for one year; and

  • the transportation industry will continue to benefit from the duty concession for ultra low sulphur diesel.

 

95.     These extensive concessions will benefit the general public and the business community alike.  The total cost of these concessions will amount to $6.4 billion.

 

96.     Implementation of the proposed concessions on water and sewage charges, the trade effluent surcharge, the business registration fee and the duty on ultra low sulphur diesel is subject to the passage of subsidiary legislation.  We will introduce the subsidiary legislation into this Council as soon as possible.  I hope that Members will support these proposals.

 

Rates Revaluation

 

97.     Apart from my proposal to raise the maximum amount of rates to be waived to $5,000 for each rateable tenement in 2002, the recently-completed revaluation exercise has also indicated that average rateable values fell by 6% last October compared with a year earlier.  The burden of rates payments on citizens has thus been further alleviated.

 

Youth Work Experience and Training Scheme

 

98.     In this time of high unemployment, the lack of jobs for young people aged between 15 and 24 is of particular concern to us.  When the economy is sluggish, as such people generally have little or no working experience, it is difficult for them to secure employment.

 

99.     To assist them to raise their employment prospects, I have decided to allocate a one-off sum of $400 million for the implementation of a two-year scheme to provide on-the-job training for about 10 000 young people.  Training periods will range from six to 12 months, depending on the needs of individual industries.  During this time, the trainees will acquire knowledge and skills relating to their chosen industry.  Upon completion of their training, they will receive a certificate which will enable them to continue their studies or find employment.  For the period of training, we will provide a monthly subsidy to employers who will be required to pay the trainees’ wages.  We will work out details of the programme with the relevant industries and training institutions.  I urge the business sector to participate actively in the scheme.

 

Estimates of Revenue and Expenditure

 

100.     Total expenditure for 2002-03, including the expenditure initiatives which I have announced today and assuming that civil service pay is reduced by 4.75% and subventions to the various organisations are reduced correspondingly, will amount to $259.8 billion.  I estimate that, after implementation of my revenue proposals, total revenue will be $214.6 billion.  The consolidated deficit will be $45.2 billion, equivalent to 3.6% of GDP. The operating deficit will be $62.0 billion before, and $49.3 billion after, inclusion of investment income from the fiscal reserves.  At 31 March 2003, the fiscal reserves are forecast to be $325.6 billion, equivalent to 15 months of government expenditure.

 

101.     When all the foregoing expenditure-control and revenue-raising measures are implemented and when we have taken further measures to make up the shortfall as targeted, the Government's fiscal position5 will be as follows -

 

 

2002-03

2003-04

2004-05

2005-06

2006-07

Operating surplus/(deficit) before investment income from fiscal reserves

$ billion

 

 

(62.0)

$ billion

 

 

(42.5)

$ billion

 

 

(32.2)

$ billion

 

 

(19.0)

$ billion

 

 

(10.8)

Operating surplus/(deficit) after investment income from fiscal reserves

(49.3)

(26.9)

(18.0)

(5.3)

2.8

Consolidated surplus/(deficit)

(45.2)

(38.7)

(15.9)

0.1

0.1

Consolidated surplus/(deficit) as % of GDP

3.6%

3.0%

1.2%

0.0%

0.0%

5               Please refer to Appendix A for the assumptions and details of the forecast.

 

 

102.     The Government will achieve operating and consolidated balances in 2006-07, at which time the fiscal reserves are forecast to be $271.2 billion, equivalent to 12 months of government expenditure.

Chart 8

Forecast of consolidated and operating surplus/deficit

Forecast of consolidation/and operating surplus/deficit



Chart 9

Forecast of Fiscal Reserves Balance

Forecast of Fiscal Reserves Balance


 

Concluding Remarks

 

103.     It has been my great honour to lead the preparation of this Budget.  Over the past 30 years, I have often travelled on business.  Whenever I was away, however, I longed to return to Hong Kong, my home town.  In Hong Kong we have the wonton noodle, "daipaidong" tea, and noisy but lively tea houses. Also, the night scenes that surround our harbour are so colourful, dazzling and enchanting and can be found in no other place in the world.  So many lights.  I see each light as a symbol of the energy and brilliance of this great city.

 

104.     We have all grown up in Hong Kong.  Many of you may still remember the days of water rationing, when we had to queue up in the street, bucket in hand, waiting for our turn, and the times when the whole family had to assemble plastic flowers or put stickers on toys to make ends meet.  We have moved on past all those times now.

 

105.     Hong Kong is a vibrant and dynamic place.  With determination and hard work, we can achieve our goals.  The Hong Kong that we treasure is caring, full of mutual respect, very free and a great believer in diversity.  Today we are in the rough.  It is high time for all of us to pitch in.  I believe that this is the wish of Members, my government colleagues, the media and citizens outside this Chamber.  In these difficult times, I see many people rising to the challenge, working harder and holding their heads up high.  I am confident that we will scale new heights.

 

106.     Compared with so many other places, Hong Kong has a promising future.  This is founded on the strength and prosperity of our hinterland.  Since reunification in 1997, we are no longer separated from our motherland by an accident of history.  With the implementation of "One Country, Two Systems", Hong Kong has returned to her embrace.  We will continue to help build our nation.  Hong Kong has always been an energetic, free, liberal and enterprising city.  History made us the pearl of the convergence between East and West.  As we forge ahead, we have a special role to play at the vanguard of our motherland's integration with the rest of the world.

 

107.     I look forward to working with Members of this Council, my government colleagues and the whole community, to revitalise our economy and to contribute to Hong Kong and our nation.

 

108.                   In closing, I would like to share with you the following lyrics6 -

Of one mind in pursuit of our dream

All discord set aside

With one heart on the same bright quest

Fearless and valiant inside

 

Hand in hand to the ends of the earth

Rough terrain no respite

Side by side we overcome ills

As the Hong Kong story we write.


 

 6        The lyrics are extracted from the theme song of "Under the Lion Rock" which is in Chinese.  The English translation is for the purpose of this Speech.

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