High 2010 economic growth pushed 2010-2011 surplus estimate to $140.5bn

The surplus is over six times the government's original estimate of 0.8 percent.

According to HSBC, today’s was a surprisingly expansionary budget given that inflation’s clearly on the rise: Chinese and global food prices are inching higher, liquidity conditions extremely loose, wages on the rise, domestic demand vigorous, and residential property activity robust.

Despite clearly rising inflationary pressures, the government’s spending plans will see its consolidated fiscal budget drop sharply from a revised 4.1% in 2010-2011, to 0.2% in 2011-2012. Consolidated expenditures are set to rise 22% this year, with consolidated revenue growth is expected to hold steady. Two factors may help to explain this seemingly large fiscal surplus descent.

First, last year’s exceptionally high budget surplus was not typical, nor was it expected. The government had originally penciled in a surplus of 0.8% for 2010-2011. But with growth shooting well over the government’s anticipated range of 4-5% last year and incomes rising in tandem, revenues from profits tax and salaries took off to push the new 2010-2011 estimate to a newly upgraded HKD140.5bn (over six times the government’s original estimate). At the same time, continued low interest rates and a spillover effect from Mainland visitors helped to fuel both Hong Kong’s stock and property market activity, pushing 2010-2011’s stamp duty revenues up to an equally heady new estimate of HKD51bn (more than double the original estimate).

Second, part of the fiscal spending this year was applied to measures specifically designed to protect the welfare of the poor. One off relief measures including a two-month public housing rental waiver (worth 0.1% of GDP) and residential electricity subsidy (worth 0.3% of GDP) were introduced to buffer the impact of higher housing and energy costs, while more creative solutions including a one-off injection of HKD24bn into the Mandatory Provident Fund (a compulsory workers pension scheme) were introduced to minimize the erosion of household savings by inflation. Hong Kong’s first inflation linked government bond was also unveiled (sized around HKD5-10bn, to be issued via the Government retail bond program and targeting retail investors), presumably designed to provide some relief to the real estate market as they offer savers an alternative, inflation-hedged investment.

Amounting to less than 0.5% of Hong Kong’s total savings deposit base, the reach of the first iBond issuance will be limited. But there may be further future issuances, and as a means to managing public inflationary expectations, and for developing Hong Kong’s nascent government bond market, there are clearly benefits.

Property measures tilted towards supply

As the government acknowledged in its budget speech, “there are signs of a pick up in the turnover of residential flats lately” and that private flat prices have recouped most of their losses since the government’s last set of property cooling measures, rose 2-3% in the first month. Based on preliminary numbers for January, although flat prices fell 0.9% in December, they more than recouped losses in January by rising 2-3%.

All property measures undertaken in the 2011-2012 budget focused on boosting the supply of residential units in both the primary and secondary markets.

But real estate supply-side measures always have a construction delivery time lag – and the first fruits of past supply side property measures won’t materialize until 2012 at the earliest. Plans to identify public housing rental sites to ensure that the 3-year average waiting time for general PRH applications is not extended were also tabled. New PRH flat production for the five-year period starting 2011-2012 and 2012-12013 is now forecasted at around 11,200 and 16,700 units respectively (2010-2011: 75,000).

Less relevant for the private residential market perhaps but of note was the first ever explicit allocation of land available for sale to commercial/business use (600,000 square metres in 2011-2012). This move can be seen as an attempt to pre-empt any material spill-over of inflationary pressures from private residential markets into Hong Kong’s commercial property markets at a later stage.

Hong Kong’s fiscal dilemma

Putting the lack of effective monetary tools aside, fiscal restraint can be considered an attractive tool for Hong Kong’s fight against inflation for two reasons. First, it avoids adding to excessively loose liquidity conditions and further stoking demand-side inflationary pressures. Second, it would also help build up reserves to cushion the territory’s financial capital markets in the event the property market has a sharp price correction similar to that post the 1997-1998 Asian financial crisis when the US finally starts hiking rates.

But fiscal restraint doesn’t necessarily rule out fiscal sweeteners. What matters is on what it is spent, with goods or services that have seen less emerging inflationary pressures being the most ideal. In this regard, the biggest “sweetener item” flagged in today’s budget appears to fit the bill. Over half of the HKD242bn (USD31bn) recurring expenditure budget will be spent on education, healthcare, and social services – the first two categories of which contributed on average only 6% to headline inflation through 2010.