• Given a US-led global slowdown and rising overseas protectionism, Hong Kong's total merchandise exports are projected to expand by 7% in 2008, with electronics remaining the growth leader.
  
  
• Led by the Chinese mainland, the dynamic growth of developing Asia will largely remain unscathed from the global slowdown. Intra-regional trade, especially demand from the mainland, will provide the main stimulus to Hong Kong exports.
  
  
• However, changes in processing trade policies on the mainland, along with surging production and raw material costs, will pose big challenges for Hong Kong exporters and manufacturers.
  
  
• In response, they should strive to better manage their supply chains to maintain their competitiveness, not least shifting from simple processing and assembly to high value-added activities and high technology sectors.
  
  
• They are also advised to monitor regulatory developments in overseas markets, covering environmental laws and safety measures too, and diversify into selected emerging markets, especially oil exporters and countries with sustainable domestic demand.
  
  
• Services exports should moderate slightly in tandem with the slower growth of merchandise exports, though the prospect of exporting trade-related services and travel services should stay largely constructive.
  
  
• While the mega-sized IPOs seen in 2006 in Hong Kong are not repeated this year, listing of mainland enterprises of reasonably large size will remain frequent next year.

A US-led Setback in Traditional Markets

In 2008, the global economy, albeit remaining fairly decent, will witness the continued transition of advanced economies to a slower lane of growth. In the US, growth is expected to decelerate markedly, because of further housing corrections and the sub-prime fallout. This US slowdown will likely constrain growth in the EU and Japan, although the expansion of both economies should remain relatively strong by their own standards, and a steady demand from the EU and, to a lesser extent from Japan, will provide some buffer against the uninspiring demand from the US. At any rate, consumption in both Europe and Japan will be largely tepid, despite helpful currency movements. Oil prices are a wildcard. Stubbornly high crude prices may not only drag consumption, but also stir up inflationary pressures, making it difficult to adopt a relaxed monetary stance if needed.

Hong Kong exports will be further affected by potential protectionism in traditional markets. Especially in the US, it is widely held that protectionism would intensify amid the presidential elections in 2008. Calls for a tougher stance against the mainland have already grown, and the US government has taken a number of policy actions accordingly. Across the Atlantic, the EU will probably exert a tougher stance on trade issues with the mainland, bringing its position more in line with the US. While the initiation of anti-dumping actions against mainland products has subsided for some time, new investigations are expected to gain momentum, and rigorous use of other trade defense measures cannot be ruled out. On both sides of the Atlantic, recalls of mainland-origin products, especially toys, pose another challenge for Hong Kong exporters.

Mainland as a Cushion against World Moderation

For Hong Kong exporters, a more cheerful development is expected to be the sustained growth of developing economies. In particular, developing Asia, powered by the Chinese mainland, will continue to be the most vibrant region on the global economic scene. To some extent, sustained intra-regional trade, primarily driven by continued demand from the Chinese mainland, should be able to cushion some of the negative impact engendered by the slowing world economy in general and a dwindling US demand in particular. Sound economic fundamentals, including solid external positions, large exchange reserves and high domestic savings, should indeed help the region weather the global slowdown, whereas stronger currencies should mitigate the negative consequences of high crude prices.

Evidently, Hong Kong is set to further benefit from the sustained expansion in intra-regional trade, especially sales to the mainland, where economic growth will remain at a double-digit rate in 2008, despite further policy curbs in response to signs of overheating. Notwithstanding successive interest rate rises and a reduction in the tax on deposit interest, retail sales were up 15.9% in the first three quarters of 2007, vis-à-vis 13.7% in 2006. Consumption growth is expected to stay strong next year, as the prevailing positive wealth effect deriving from rising wages and the stock market should remain largely in place, while the government also seeks to rely more on consumer spending, rather than investment and exports, as the driver of economic growth.

On the external front, mainland exports will moderate somewhat, as foreign demand, not least US demand, is forecast to slow. In all likelihood, however, such impact will not be substantial. According to the World Bank, if US consumption contracts by the equivalent of 1% of GDP, China's economic growth is estimated to be lowered only by 0.2-0.5 percentage point. Indeed, China, the world's third largest exporter in 2006, has overtaken the US as the second largest since the beginning of 2007, and is expected to surpass Germany as the largest in the near future. Hong Kong should therefore further benefit from the mainland's healthy appetite for materials and semi-manufactures for export production. In addition, the mainland's continued industrial upgrade will generate huge opportunities for Hong Kong as a technology marketplace, especially for machinery and equipment for advanced production and green manufacturing.

A Challenging Production Environment

An unceasing demand from the mainland will surely bring glad tidings. But changes in processing trade policies will pose a challenge for Hong Kong exporters and manufacturers. Now that promoting the transformation and upgrade of the processing trade and restricting the development of high energy-consumption, heavily polluting and resource-intensive industries are the mainland's long-term development objectives, it will continue to make adjustments to processing trade polices. Such policy changes, covering VAT rebate adjustment, expansion of the restricted/prohibited category and access threshold for processing trade enterprises, could have significant impact on Hong Kong manufacturers, perhaps in terms of mode of operations, use of technologies, sources of raw materials, manufacturing localities as well as production costs.

However, rising labour costs present the greatest challenge to Hong Kong manufacturers. In the PRD, labour costs that comprise wages, social security contributions and other welfare benefits have increased by some 25% over the past two years, while the new Labour Contract Law, which will come into effect from January 2008, may have additional cost implications. Meanwhile, the RMB exchange rate has been appreciating. It is estimated that a 10% appreciation of the RMB would translate into a 2-4.5% rise in production costs. So if labour costs account for 15-30% of the total production costs, just the rise in wages and RMB appreciation in the past two years alone has already resulted in an estimated increase of 6-12% in the total production costs. To compound problems, the recent product recalls, dominated by toys, will also increase safety compliance costs, whereas soaring commodity prices will jack up input costs, especially for precious metals and stones, as well as plastic raw materials due to high oil prices.

Likely Performance of Selected Hong Kong Exports

Given a stable demand due mainly to the continued popularity of digital products in overseas markets and sustained demand for parts and components from the mainland, Hong Kong's electronics exports, which account for over half of Hong Kong's total overseas sales, will stay as the growth leader. For clothing, a continued shift in US and EU orders from other production bases back to Hong Kong and the mainland, amid low levels of US quota utilisation and the removal of EU textile quotas next year, should partly offset the moderation in foreign demand. For toys, sales will be clouded by the recent recalls, although the impact should not be substantial, given Hong Kong's ability in safety compliance. As regards jewellery, sales in value terms will be particularly inflated by lofty raw material costs, while exports of watches and clocks are expected to be steady, with higher priced timepieces likely to perform better.

Supply Chain Management: Tenet for Exporters and Manufacturers

Hong Kong exporters and manufacturers must take note of the likely developments not only in the global market environment, but also the production environment on the mainland. In view of changing processing trade policies and rising production costs, they should strive to better manage their supply chains in order to maintain their competitiveness. First, to cope with the expanding range of prohibited commodities of the processing trade, enterprises processing with supplied materials should consider converting to foreign invested enterprises. Second, to avoid high labour costs in the PRD, Hong Kong companies could shift part of their manufacturing activities beyond the PRD and further into other provinces. They could even consider maintaining a diversified production base rather than just concentrating on the mainland, not least setting up a presence in emerging production bases like Vietnam and Cambodia.

More importantly, they should upgrade their product structure, and shift from simple processing and assembly to high value-added activities and high technology sectors. This move might involve a wide spectrum of activities, probably including developing own designs and brands, introducing innovative and high-tech products, adopting new materials and technologies, embarking on automated production, implementing a green manufacturing system, tightening financial control, strengthening inventory management, as well as enhancing logistic arrangements. Prompted by the urgency of transformation and upgrade, alongside the substantial adverse effect of rising production costs, Hong Kong exporters and manufacturers should no longer adopt a wait-and-see attitude, and be ready to step out of their comfort zone to avoid being crowed out.

On the market front, as protectionism is likely to intensify, while consciousness on environmental protection and product safety will become more popular, what Hong Kong exporters should do is to keep a close eye on regulatory developments and respond accordingly, covering quotas and anti-dumping/countervailing actions on the one hand, and environmental laws and related green manufacturing requirements, plus product safety measures and standards, on the other hand. Given the limited growth prospects of traditional markets, Hong Kong exporters are further advised to look for other fledgling markets, spanning from Southeast Asia, South Asia and the Middle East to Central and Eastern Europe and Latin America, particularly the oil and commodity-rich countries, and economies more insulated from the global slowdown. But despite abundant emerging opportunities, obvious pitfalls await the unwary. Hong Kong exporters should be prepared for, among others, market volatility, red tape, inadequate infrastructure, retail fragmentation and affordability problems in the emerging world.

Development of Hong Kong's Services Exports

Consistent with the moderating growth expected in merchandise exports, the growth in services exports should slow a tad in 2008. Although the trade prospects for the Greater PRD region next year should remain promising on the whole, direct shipment or cargo diversion will continue to take its toll on Hong Kong's transportation service receipts. The healthy state of inbound tourism expected for next year, which would help the passenger of transportation service exports, may not offer too much of an offset in light of the sector's downtrend in growth over the past four years. Although cargo diversion would negatively impact transportation receipts, Hong Kong still derives very substantial income from the export of trade-related services, which are primarily offshore trade transactions, that should hold up well next year.

Cargo diversion notwithstanding, the increased transhipment of PRD cargo by barge to Kwai Chung has become a brighter spot in the activities of Hong Kong Port lately. For its part, the Hong Kong government has recently tendered out a waterfront plot of four hectares off Container Terminal 7 for improving barging operations. Apart from measures to improve efficiency and reduce the cost of cross-boundary trucking, Guangdong and Hong Kong are also discussing the need for additional boundary crossing points to enhance land connectivity between the two places. Nevertheless, Hong Kong's seacargo sector is facing intensifying challenges from neighbouring ports in Southern China, which are fast catching up in terms of the number of shipping lines, overseas destinations, efficiency and capacity. The first two berths of Dachan Bay will come into operation by the end of this year, with port expansion projects in Yantian and Shekou steaming ahead.

In comparison with seafreight, Hong Kong's airfreight sector should perform somewhat better in 2008. Against the background of the continued relocation of electronics production capacity to Asia, now an increasingly integrated production region, airfreight prospects next year should be helped by higher electronics-related sales and sustained intra-regional trade. On the other hand, to reinforce Hong Kong's position as an international and regional aviation hub, progressive steps have been taken to expand Hong Kong's air transport network and capacity. Hong Kong International Airport (HKIA) is now working on an enhancement project to increase the capacity of the existing runways, while carrying out a feasibility study of adding a third runway. The Airport Authority has also decided to consult cargo facility operators regarding the need for establishing Hong Kong's third aircargo terminal.

The performance of Hong Kong's travel and tourist sector looks promising next year, thanks to the US dollar's substantial cumulative depreciation against major currencies, which raises the purchasing power in Hong Kong of tourists from many long-haul markets. Hong Kong's themed promotion of its being a host city of the Olympics Games, expansion of the individual travel scheme for mainland visitors to cover currently 49 cities (including all provincial capitals of Pan-PRD), plus a strengthening RMB, should attract more mainland tourists to the city.

Financial services, which constitute about 10% of Hong Kong's total services exports, have grown annually at around 30% for the past couple of years. While the mega-sized IPOs seen in 2006 in Hong Kong were not repeated this year, listings of mainland enterprises of reasonably large size will remain frequent next year. In addition to a significant number of IPOs related to mainland enterprises, listing hopefuls from other places can also be expected in 2008, with the Hong Kong bourse starting to reap the fruit of its active promotion of Hong Kong's listing platform in many emerging markets.

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