• With slowing US demand and regulatory changes on the mainland, Hong Kong exports are projected to grow by a modest 6% in 2007, unchanged from our previous forecast.
  
  
• Product-wise, demand for digital products should sustain electronics sales, while a continued shift in US and EU orders back to the mainland is expected to facilitate clothing exports.
  
  
• In all, the world trade environment should stay largely constructive. Yet a few risks and challenges exist, especially further changes in the mainland's processing trade regulations.
  
  
• Hong Kong's export outlook is further clouded by the undercurrent of protectionism in overseas markets, as well as the possibility of a faster-than-expected downturn of the US economy.

As expected, Hong Kong exports, which grew by more than 9% last year, have slowed to a more modest pace in the course of 2007. Given an unassuming US demand, sales should further moderate over the medium term. On the brighter note, despite regulatory changes, the still strong external sector of the Chinese mainland should help, while relatively sustainable demand from the EU could also provide some buffer. For the whole of 2007, the expected value growth of Hong Kong exports is maintained at 6%.

Product-wise, despite the peaking of the global electronics cycle, sustained popularity of digital gadgets should presage a steady overseas appetite for a wide range of Hong Kong's electronics exports. As regards clothing, the mundane world demand will be somewhat offset by a continued shift in US and EU orders from other production bases back to Hong Kong and the mainland, as there have been no significant shortages of Chinese textile quotas for exporting to the EU and the US.

Although the world trade environment should remain generally favourable, certain risks and challenges exist. First, further changes in the mainland's processing trade regulations, covering VAT rebate adjustment, expansion of the prohibited category and tightening of environmental regulations, could have significant impact on Hong Kong manufacturers, probably in terms of mode of operations, use of technologies, sources of raw materials, manufacturing localities, production costs and, ultimately, overall profit margins.

Hong Kong's export outlook is further overshadowed by the undercurrent of protectionism in overseas markets. Particularly in the US, it is widely held that protectionism will intensify amid a Democrat-dominated Congress following the mid-term elections last year, as well as the presidential election coming next year. Now, with the imposition of countervailing (CV) duties on coated paper from China, US companies will be able to file both anti-dumping cases and CV cases against any imports from the mainland.

Apart from regulatory developments, the state of the US economy will also affect Hong Kong exports. In the case that further corrections of the housing market prove to have wider and deeper knock-on effects on other sectors, the US economy will slow sharply. Under such circumstances, there would be serious spillover effect on the global economy and trade, especially through a sell-off in the financial markets worldwide, and Hong Kong exports are unlikely to emerge unscathed from such developments.

Latest Developments

Summary of Hong Kong's External Trade

Source: Hong Kong Trade Statistics, HKSAR Census and Statistics Department

After growing by more than 9% last year, Hong Kong exports have slowed a tad in the course of 2007. This moderation in export growth, albeit largely anticipated, has been marked by a relatively drastic slowdown in the wake of the strong performance in January and February, which was boosted by advanced shipments ahead of Chinese New Year, triggered in part by rumoured reductions in various export tax rebates on the mainland, underscoring the repercussions of mainland's policy changes for Hong Kong exports. In any event, Hong Kong exports still recorded a sturdy 9% expansion during the first quarter of 2007. In particular, re-exports, which constituted 96% of total exports, surged by 12%, although domestic exports plunged by 33%.

This sturdy expansion of Hong Kong exports, in the main, has been buttressed by a broadly sanguine global trade environment. Despite financial market jitters in late February and early March, the world economy, albeit slowing somewhat, has remained basically strong. In the US, growth has been hampered by corrections in the housing market. But consumption has been propped up by further employment gain, a rising stock market and relatively subdued oil prices. In the EU, economic activity last year was the strongest in six years, and the growth momentum has largely continued into 2007, with falling joblessness and the strength of the European currencies boosting its import absorption power. In Japan, the weakness of the yen, though discouraging imports, has sustained its export expansion. More importantly, the export juggernaut of the Chinese mainland has continued to power ahead. So sales to the mainland, sharing 48% of Hong Kong's total exports, have been underpinned by its hearty appetite for industrial inputs for export production.

Product-wise, sales of electronics, following years of double-digit growth, have expanded moderately to account for 46% of Hong Kong's total exports, although value sales of electronics parts and components have been dragged by intensified price competition stemming from increasing production capacity and a build-up of inventories. More encouragingly, successive releases of electronics game consoles and the continued demand for electronics toys have bolstered toy exports. Stubbornly high prices of precious materials, stones and diamonds, on the other hand, have inflated jewellery exports in terms of dollar value, but volume sales were far less satisfactory. For their part, clothing exports, notwithstanding softer global demand, have benefited from the sustained shift of American and European buyers away from other Asian suppliers back to Hong Kong and the mainland, given the availability of Chinese quotas for selling to the US and the EU.

While the global economic environment has remained generally favourable, Hong Kong exporters are confronted with a host of operating difficulties. First, the mainland's policy changes in relation to processing trade, covering VAT rebate adjustment, expansion of the prohibited category and tightening of environmental regulations, coupled with Guangdong's industry relocation measures, have far-reaching implications for Hong Kong manufacturers, probably in terms of mode of operations, use of technologies, sources of raw materials, manufacturing localities, production costs and, ultimately, the overall profit margins. Nevertheless, rising labour costs in the PRD present the toughest challenge to Hong Kong manufacturers, making exports more expensive and less competitive. So far this year, wages in the PRD have grown by some 20% year-on-year and, in tandem with pay rises, workers have further looked for fringe benefits. Despite considerable wage increases and improvements in fringe benefits, however, labour shortages have remained critical.

Making matters worse, continued revaluation of the RMB inevitably has a bearing on Hong Kong exports. Following the initial 2.1% appreciation of the RMB resulting from the exchange rate reform in July 2005, the Chinese currency has continued to strengthen against the US dollar. Compared with the pre-reform level, the RMB has so far appreciated by more than 7%. This stronger RMB, however, has appeared to exert only modest impact on production costs, especially for products with lower local content like jewellery. Separately, stubbornly high prices of crude oil and certain other commodities like metals and precious materials, in spite of recent slackening, have translated into more expensive prices of raw materials and semi-manufactures, while price volatility has remained an uncertain element for Hong Kong exporters.

In another development, the continued popularity of direct shipments from the mainland to overseas markets has served to depress Hong Kong's re-export growth, despite the narrowing cost differentials between Hong Kong and Shenzhen. During January-March 2007, the total container throughput of Hong Kong port edged up by 2.3%. In contrast, Shenzhen's container throughput grew by 15%, with Yantian, Shekou and Chiwan showing increases of 12%, 6% and 24% respectively. According to a recent TDC survey, although re-exports have remained the leading shipping mode for products produced on the mainland, their relative share declined from 52% in 2003 to 44% in 2006. Quite the opposite, the share of transhipments expanded from 10% to 12% during the same period, while that of direct shipments rose from 38% to almost 44%, just losing to re-exports by a narrow margin. Yet taken together, the contribution of offshore trade, comprising of both transhipments and direct shipments, has already outpaced that of re-exports.

Global Economic Outlook

Total Exports by Main Destination

Source: Hong Kong Trade Statistics, HKSAR Census and Statistics Department

Over the medium term, the world economy will likely expand at a still healthy pace. Global economic activity is set to slow further. But the outlook for 2007 and 2008 should remain decent. In its latest forecast, the IMF expects world growth to be 4.9% in both years, after a commendable 5.4% increase in 2006. While world growth is expected to moderate, expansion among developed economies should become more balanced. Despite a pronounced slowdown in the US, growth in the EU and Japan will likely stay strong by recent standards, thus providing the much-needed impetus to world growth. Meanwhile, the developing economies, which are expected to outperform the advanced economies by a wide margin, should also slip a gear, although the Chinese mainland, an increasingly important driver of world expansion, is expected to maintain its growth inertia. In this context, world trade should rise at a more modest but steady pace, and Hong Kong exports are poised to show a similar growth pattern in the rest of 2007 and in 2008.

The US economy should keep on course its transition to a slower rate of expansion, thanks to further corrections of the housing market. To be sure, the lingering impact of interest rate hikes over the past years remains a damper on the housing market, particularly leading to rapidly rising delinquency and default rates in the sub-prime sector. As the consolidation has yet to come to an end, the lacklustre housing market will increasingly weigh on consumer spending. Entrenchment of the household sector will also hinder business investment, regardless of solid corporate balance sheets, the need to enhance productivity, as well as sustained demand from overseas markets. That said, the consequence should not be none too uninspiring for Hong Kong exports. For one thing, impact of the sub-prime sector, which accounts for only around 12% of the mortgage market, has been quite contained. For another, rising consumer cautiousness will translate into a penchant for value-for-money, in which Hong Kong exports excel.

If anything, the EU could give some buffer to softer demand from the US, as it is on a moderate and sustainable expansion path. In the euro zone, growth should decelerate mildly, a reflection of monetary tightening, slowing overseas demand and a stronger euro. Still the rate of growth should be above the trend in recent years. Germany is leading the way, spurred by the less-than-anticipated impact of the VAT increase on consumer spending. Outside the euro zone, the UK economy, on the back of rising house prices, remains on a fast growth trajectory. However, an appreciating pound and slower growth in overseas markets will tend to hinder exports, while rising interest rates are not conducive to consumption. In all, EU consumers will continue to look for quality products at competitive prices, and the prospects for Hong Kong exports should remain steady, especially with the strengthening of the European currencies, which serves to enhance the price competitiveness of Hong Kong products.

Likewise in Japan, there are indications that the economy is heading for a steady and sustainable recovery. The stimulus to growth will derive mainly from the still solid foreign trade sector, facilitated by the weak yen, as well as related expansion of business investment. While the good showing of the external sector has yet to fully feed through to the domestic front, a sustainable improvement in the labour market and the ensuing wage increases, in tandem with a mild recovery of the property market, should set the stage for a further pick-up of household spending. But many Japanese consumers will remain conservative following years of economic hardship, although competitively priced Hong Kong exports are expected to benefit from th