Next Hong Kong leader's acute task: how to revamp creaky economy

[HONG KONG] Hong Kong's next chief executive - to be selected on Sunday - will inherit an economy vulnerable to China's growing pains on one side and volatile global capital flows on the other.

Having weathered war, revolution, handover, crises, epidemics and much else over its turbulent history, the gateway to China has repeatedly overcome challenges. It now boasts a wealthy population and an economy that's ranked as the world's freest place to do business.

But its traditional four pillars are being buffeted once more.

Financial services face competition as China develops other hubs. Its position as the world's seventh-largest exporter of merchandise trade is at risk as companies use alternative ports along China's coast.

Tourism and retail sales have been dented by a corruption crackdown on the mainland. And rising borrowing costs tied to Federal Reserve policy cast a shadow over record-high property prices that continue to defy government attempts to cool them.

Such economic strains are blamed in part for fueling political deadlock that's hindering economic development. Tensions have risen - most notably when pro-democracy protesters occupied key parts of the city in 2014 - amid complaints Beijing isn't observing its promise for a "high degree of autonomy" when it took over the former British colony in 1997.

"Hong Kong's economy is almost solely dependent on the financial markets and real estate, and that's a risk," said Willy Lam, an adjunct professor at the Chinese University of Hong Kong. Neither of the two leading candidates have "mentioned productive ways to create some new growth areas," he said.

The incoming chief executive will be chosen by a 1,194-member committee of Hong Kong's political and business elite, including nine billionaires whose combined wealth exceeds US$100 billion and 87 local representatives of China's national legislature. The three candidates are former Chief Secretary Carrie Lam former Finance Secretary John Tsang and retired judge Woo Kwok-Hing.

While opinion polls show Mr Tsang is the most popular among Hong Kong residents, Ms Lam is tipped to win after receiving the most nominations from the city's electoral committee. In an interview last month, Ms Lam acknowledged that perceptions of Beijing's endorsement had dented her image, even as she continued to canvas for support among the city's elite.

Tepid Growth

While living standards for the well heeled are high, income inequality remains stark and Hong Kong is routinely listed among the world's most expensive cities to live in.

The city's richest man, Li Ka-Shing, last year called for higher corporate taxes to tackle inequality and urged the government to help younger residents in a city where one-in-seven residents live in a household earning less than US$2,100 a month. In a press conference Wednesday accompanying his company's results, the octogenarian billionaire was emotional as he discussed Hong Kong's economy growing at a slower pace than previous years and said it will need to work hard to catch up.

"I want Hong Kong to continue to prosper," he said.

Economic growth expanded 1.9 per cent last year, compared with 2.4 per cent a year earlier, and is forecast by the government to grow between 2 and 3 per cent this year.

The incoming leader faces the dual challenge of breathing fresh life into old growth drivers while finding new ones to provide opportunities for its educated workforce. Options include incentives for financial services technology firms and bolstering Hong Kong's role as a key gateway for capital into and out of China.

There are reasons for optimism. Premier Li Keqiang said this month that investors will be allowed to buy mainland bonds in Hong Kong this year, building on earlier connections with the Shanghai and Shenzhen stock exchanges. That suggests Beijing still sees a role for its special administrative region in the south, which boasts some degree of independence and legal protections for western businesses that are not available on the mainland.

Healthy fiscal and current account surpluses also provide buffers. There's also signs that the worst of the recent slowdown may have passed as China's economy stabilises and global growth perks up.

"It was very bad last year, but we are seeing signs of improvement," said Kwon Young Sun, a Hong Kong-based economist at Nomura Holdings Inc.

"Hong Kong has proven itself to be quite resilient."

Yet much of Hong Kong's economic destiny is out of its hands. Because Hong Kong's currency is tied to the US dollar, it effectively imports US monetary policy. That means when the Federal Reserve lifts interest rates, it flows through to borrowers in Hong Kong.

"A key risk is that the market is too complacent about the amount of Fed tightening that is likely over the next two years," said Mole Hau, a Hong Kong-based economist at BNP Paribas SA.

Then there's Donald Trump. Heightened trade tensions between the US and China risk spilling over to Hong Kong, piling further pressure on the government and likely stretching the city's economic model.

"There are several headwinds," said Kevin Lai, chief economist for Asia excluding Japan at Daiwa Capital Markets in Hong Kong.

"We are at a critical juncture."

BLOOMBERG