Hong Kong’s Financial Secretary, John Tsang, made ‘competitiveness’ the theme of his 2014 budget speech. There will be no major tax hikes, but the budget surplus should shrink as capital expenditure and social welfare spending increase.
The budget surplus will fall to HKD12 billion (USD1.55 billion) for 2013/14 according to Mr Tsang, down from HKD65 billion in 2012/13, and should further fall to HKD9.1 billion in 2014/15. Government total revenue in 2014/15 is expected to fall by 4.0 per cent with total expenditure falling faster, by 5.7 per cent. However, a repayment of bonds and notes means the surplus will be lower.
But the main highlight of this year’s budget was a report on long-term fiscal planning that presented different scenarios for the budget balance using different assumptions. For instance, assuming 3 per cent growth in government spending on services such as education, social welfare and healthcare, state expenditure would grow by 7.5 per cent annually, meaning Hong Kong will run a structural deficit by 2021.
Part of the reason for the deficit is slowing growth over the long run
Part of the reason for the deficit is slowing growth over the long run. GDP grew by 2.9 per cent in 2013 compared with 1.5 per cent for 2012 and we forecast 3.7 per cent growth for 2014. The main positive contributions came from household consumption and government spending, but net exports have now been a drag on annual GDP growth for 11 consecutive quarters.
However, the ageing population and shrinking labour force are likely to slow annual trend growth to 2.8 per cent in the next 20 to 30 years, significantly below the 4.6 per cent average of the past three decades.
To align government revenue and expenditure, public spending will be held at roughly 20 per cent of GDP, said Mr Tsang, while the Inland Revenue will clamp down on tax evasion and avoidance. But over the long run, productivity growth is the only way to keep the economy growing fast enough to prevent spending outpacing revenues in our view.
A number of measures to boost longer-term competitiveness were announced, including education and training with school programmes aimed at supporting the IT industry, while financial services will be helped by a waiver of stamp duty on trading exchange-traded funds and the issue of up to HKD10 billion of inflation-linked three-year bonds.
Indeed, although the budget surplus is expected to decline in the next few years, the operating surplus is actually increasing. But offsetting that is increasing deficits on the capital balance caused by higher capital expenditure. However, properly planned capital-works expenditure can help Hong Kong’s long-term potential growth.
We think even more investment should be encouraged, either through direct government investment or through tax incentives for private investment. Hong Kong has the budget surpluses and access to cheap funding to finance this and the markets can be sympathetic to countries running fiscal deficits for the right reasons.
Given that it is unlikely much can be done to stop the labour force from shrinking because of the ageing population, it is even more important to invest in productivity-boosting measures in our view. The 2014 budget was a good start, but future budgets should continue to focus on increasing potential growth.
This research was first published on 26 February 2014.