Introduction

The Hong Kong economy went through an eventful year in
1997. First and foremost was the historic reunification of
Hong Kong with the mainland of China (the Mainland) in July.
Growing confidence in the run-up to the reunification provided
a significant boost to economic activity. The Gross Domestic
Product (GDP) registered accelerated growth, to 6 per cent in
the first quarter and further to 6.8 per cent in the second
quarter. The growth momentum was sustained into the third
quarter, albeit at a somewhat slower rate of 5.7 per cent.

Domestic demand was highly intensive up to the early part of
October. Overall investment spending on machinery and
equipment grew strongly, as did building and construction by
the private sector. Consumer spending also thrived, amid
sustained growth in population, a steady rise in household
income, and buoyancy in both the stock and property markets.

Sentiment then began to turn, as the regional financial turmoil
that first broke out in Thailand in July swept through the
economies of the Association of South-East Asian Nations.
The turmoil intensified and then extended to economies in
North-East Asia. Hong Kong as a global financial centre could
not remain immune. The contagion induced a major
speculative attack on the Hong Kong dollar in late October.
Local interest rates came under much upward pressure.
Marked corrections occurred in both the stock and property
markets, giving rise to severe knock-on effect on domestic
demand.

A crude initial estimate suggests an abrupt setback in
economic growth to around 2 per cent in the fourth quarter.
Yet given the strong performance in the first three quarters,
GDP for 1997 as a whole still grew by about 5.2 per cent,
slightly higher than the 5 per cent growth in 1996.
Consumption demand grew by about 7 per cent, and
investment demand as represented by gross domestic fixed
capital formation was almost 13 per cent higher. Both were
private sector-driven, and provided the major impetus to
economic growth in 1997.

In the external sector, total exports of goods grew by 6 per
cent in 1997, slightly faster than the 5 per cent increase in
1996. Performance was better in the second half of 1997 than
in the first half. This was particularly so for domestic exports.
Notwithstanding a relatively strong Hong Kong dollar in line
with the US dollar, the real effective exchange rate (reckoned
against export prices which were on a decline in Hong Kong
dollar terms) remained generally stable. This was mainly due
to increased investment in machinery and equipment, thereby
raising productivity, as well as streamlining of production
processes and relocation to lower-cost production centres.
Thus Hong Kong was able to maintain growth in exports
against reduced price competitiveness vis-a-vis the
neighbouring economies and slackened import demand in
some of the major markets abroad.

The substantial currency depreciation in East Asia from the
middle of the year did not materially affect Hong Kong's
overall export performance in the latter part, as the combined
share of the economies concerned in Hong Kong's overall
exports was not particularly large. Moreover, the product mix
of Hong Kong's exports was more diversified and was not
entirely comparable to those of the East Asian economies
concerned. The austerity programmes being implemented in
most of these economies also constrained their output
capacity.

Exports of services however slackened to virtually zero
growth, having risen by 6 per cent in 1996. This was mainly
attributable to the poor performance of inbound tourism.
Affected at least in part by the regional financial turmoil, there
were considerably fewer visitors from Japan and other parts
of East Asia in the second half of the year. Nevertheless,
exports of various professional services such as legal,
accounting and advertising services continued to increase.
Exports of trade-related services such as transportation
services also rose further, as reflected by the strong growth in
air cargo flows and the faster increase in seaborne cargo
flows, including transshipment flows.

Imports of goods grew by 7 per cent in 1997, faster than the
4 per cent increase in 1996. This was mainly due to a marked
revival in retained imports, which was broad-based for both
production and consumption purposes. Imports of services
also showed accelerated growth, by about 5 per cent in 1997
following a 2 per cent growth in 1996.

Putting the exports and imports together, the visible trade
account recorded a deficit of $159 billion in 1997, equivalent
to 9.9 per cent of the value of imports. This was nevertheless
on a narrowing trend over the course of the year, falling from
a peak of 13.3 per cent against the value of imports in the first
quarter to 7.5 per cent in the fourth quarter. On the other
hand, the invisible trade account continued to register a
substantial surplus of around $113 billion in 1997, thereby
offsetting a large part of the deficit on the visible trade
account.

The labour market was relatively tight during most of 1997.
Reflecting this, the unemployment rate fell steadily to a low of
2.2 per cent in the third quarter, before rising to 2.5 per cent
in the fourth quarter, as it was at the beginning of the year.
The easing in employment conditions towards the end of the
year was concentrated mainly in the manufacturing, transport,
construction, and consumption and tourist-related sectors.
Nevertheless, in the first three quarters of 1997 taken together,
earnings in all of the major sectors surveyed showed
considerable increases in money terms, and in some sectors,
also notably in real terms over a year earlier, reflecting the
tighter labour market conditions for most of the year. Wages
in most major sectors surveyed also accelerated in growth.
However, the increases in earnings and wages could have
turned more moderate towards the year end as the labour
market tended to ease.

The residential property market consolidated in the second half
of 1997, following buoyant trading and sharp escalation in flat
prices in the first half. In the third quarter, market activity
began to taper, in face of the government's policy commitment
to stabilise the market and to increase flat supply substantially
in the longer term. The market underwent a distinct downturn
from late October as the effect of the regional financial turmoil
spread to the local economy. This notwithstanding, flat prices
at end-1997 were still higher than a year earlier. The markets
for office space and shopping premises also went from
buoyancy to consolidation in the latter part of 1997. The
markets for conventional flatted factory space and
multi-purpose industrial premises remained generally slack
during the year.

Consumer price inflation moderated further in 1997. The
Composite Consumer Price Index rose by 5.8 per cent and the
Consumer Price Index (A) by 5.7 per cent in 1997, the lowest
for 10 years. There was little price pressure from imported
sources, owing to the sustained strength of the US dollar,
generally soft world commodity prices and low inflation in the
major supplier economies. Domestically generated inflationary
pressures were largely contained even amid the buoyancy in
the early part of the year. In general, the increases in labour
wages and property rentals were not particularly rapid. In the
latter part of the year, the economic slow-down further
relieved inflationary pressures. Meanwhile, the GDP deflator,
as a broad measure of overall inflation in the economy, rose by
5.9 per cent in 1997, somewhat faster than the 5.4 per cent
increase in 1996.