Hongkong: The government says the economy grew a surprising 0.7% in the second quarter. But close analysis show the "growth" to be caused by a huge jump in the GDP deflator, exceeding the CPI fall. More statisical growth now means less later. 

Gambling centres live by putting a positive spin on negative
(for the punters) numbers. So it was appropriate that
Financial Secretary Donald Tsang was on a study tour of Las
Vegas when the latest Hongkong GDP figures were announced on
Tuesday. Second quarter GDP up 07%. Hurrah! Even better than
the surprise positive 0.5% preliminary figure given last
month. This further confounded the brokerage house economists
who almost to a man had forecast a negative number for the
first half and then hastily recast their full year estimates -
- without necessarily examining how the 0.5% was achieved in
the first place.

The devil as usual is in the detail. Last month one could only
surmise that the key detail was that pesky little number, the
"Implicit GDP price deflator" -- which adjusts actual money
GDP to supposedly real level after taking account of inflation
or (in this case) deflation. Now we know that "real GDP" has
been helped into positive territory by a dramatic leap in the
deflator to minus 5.4%, compared with a forecast for the whole
year of minus 2% issued as recently as May.

The nastier reality is that GDP in current prices -- actual
not statistical dollars -- fell 4.7%.

We all know that overall prices in Hongkong have fallen, in
some cases quite steeply. But it is a bit of a puzzle why the
GDP deflator now shows a markedly bigger negative number than
the Consumer Price Index. The CPI was 3.9% lower in the second
quarter and 1.8% in the first compared with deflator numbers
of 5.4% and 3.7% respectively.

A divergence between the two is quite normal, but this one
looks decidedly odd as it is hard to find specific numbers in
the data which point to a deflator higher than the CPI. For
instance, the important index of retained import prices fell
only 2% in the first half. Producer prices were just 2% lower
in the first quarter, and construction costs actually rose
marginally. Overall wages rates have been flat but not

Office rentals fell by 8% and tender prices for public sector
buildings by 7%. But otherwise it is hard to find steep falls.
Perhaps heavy weight has been given to falls in property
values, but if so this has been lagged as those have
stabilised this year.

Even in the "real" world it is hard to find sources of growth.
Retail volume fell 2%, goods exports by 3% and fixed capital
formation by a stunning 24%. Despite some pick-up in tourism,
increased non-retail consumption such as phones
and higher stockmarket turnover it is hard to find where the
actual growth came from apart from a big drop in the
merchandise trade deficit reflecting weak domestic demand. No
wonder the private forecasters got it all wrong -- though some
of them, and even the Asian Development Bank -- are sticking
with negative growth for the whole year.

Even the government seems a little wary of its own numbers and
has left unchanged its full year 0.5% forecast despite the
much better than expected second quarter. Logically it should
have raised it. Everyone knows the second half will be much
better than the first both because the economy is improving
quarter on quarter and because last year's second half was so

This is not to suggest the the government is cooking the books
to feed consumers and the stockmarket with a feel-good factor
now -- though after its manipulation of right of abode data
one cannot be sure. But the source of GDP growth is important.
Statistical joy now could easily lead to disappointment later.
For instance,  growth in current dollars is likely to return
by the end of the year. But it is quite likely that by then
the deflator will have reversed itself. In which case we could
be looking at minimal growth in 2,000.

Though the government talks confidently of deflation
continuing, a weak dollar, rising energy prices, the bottoming
out of manufactured goods prices, the end of one-off factors
such as the rates rebate and the dwindling impact of property
price declines suggest that the deflationary process has
peaked. The end of deflation should on balance be a plus for
Hongkong, but it will now be bad for the stastistical "real"

The economy is certainly picking up. The July export numbers
were excellent and judging from China's figures, and the
general revival of Asian import demand, real export growth
could well be close to double digits in the second half,
making the government's forecast of zero growth for the full
year look very conservative. 

But while the external sector is much brighter, the domestic
sector looks set to remain very sluggish despite stimulus from
the massive government deficit -- 3% of GDP. Unemployment is
stubborn despite the fact that the size of the workforce
has stagnated for four months even though mainland immigration
continues unabated. Money supply growth too has ground to a
halt. Retail sales will pick up but only very slowly because
grotesque property prices have left a legacy of household
debt. Interest rates will stay high till the US slumps,
holding back private investment recovery. Next year too the
government will have to think about reducing its deficit.

This is not to be pessimistic. The Asian recovery is for real.
Japan is at last picking up, China's deflation has probably
ended, Taiwan and Korea are doing splendidly. The dollar's
fall will reduce the burden of the peg. But a realistic
assessment of the future must start with a clear view of the
origins of "growth".




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