Public Finances

Hongkongers have been warned by Financial Secretary Paul Chan Mo-po to expect a much bigger budget deficit in the current financial year than previously forecast.

Following some comments he made last month, newspaper reports have said the shortfall “could be nearly twice that of earlier estimates and exceed $100 billion”. In fact, the underlying situation is even more challenging than reported and I would not be surprised by a real deficit close to $200 billion. The final deficit for 2022-23 was $205.8 billion, though the cashflow position was helped by bond sales of $66 billion leaving a net shortfall of $139.8 billion.

In his 2023 budget for the current fiscal year, Chan said that taking into account the proceeds from issuance of government bonds of about $65 billion he was forecasting a deficit of $54.4 billion for 2023-24. This means the actual shortfall would be around $119 billion.

At the halfway point in this financial year, the government reported cumulative revenue of $131.3 billion and expenditure of $355.6 leaving a deficit of $224.3 billion. Bond sales of $46.6 billion reduced the shortfall to $177.7 billion. It would be too simplistic to just double those numbers to derive a full year forecast as much revenue from profits and salaries taxes comes in the second half. Nonetheless we already know from public comment and reporting that revenue from companies and individuals is soft, and both the property and stock market are weak which reduces stamp duty. Another prominent sale site in Tung Chung has just been pulled from the market so expected land revenue is also suffering.

Bond sales are useful to bolster cash flow and reassure the public that the government still has money in the bank. But the downside of presenting the figures on a net basis in this way is that it can obscure the underlying situation and create a false impression among ordinary citizens – and perhaps some ministers -- that there is plenty of money to fund new and improved services without raising more revenue. The real world does not work in this way. As I have pointed out before, the proceeds of bond sales are not revenue in the conventional sense. Rather, they are loans that have to be repaid.

Some may think that by putting a negative spin on the numbers I am suddenly talking Hong Kong down after a lifetime of talking it up. Such an assessment would be naïve. We are an international financial centre with thousands of top financial analysts looking at the same numbers and drawing their own conclusions. We would only be fooling ourselves if we thought these experts would not be able to see what was really happening. It is surely more effective to tell ourselves the truth so that sound decisions can be made about revenue and expenditure.

The policy address by chief executive John Lee Ka-chiu last month contained many worthy new proposals, in particular those improving assistance for the elderly and the disabled. The challenge now is for Chan to show in the 2024 budget how they can all be funded.

Hong Kong has an excellent reputation for fiscal prudence, built up over many decades of careful budgeting. That is how we have been able to amass extensive reserves, unlike governments in many other economies which have outstanding debts equal to or even greater than GDP. When the pandemic struck, our administration was able to help citizens ride out the storm by drawing on those reserves without having to go into debt. Now that normal times have returned, it is time for normal budget practices to resume also. A good reputation takes a long time to build up but can disappear quickly.

One aspect that we need to be particularly wary of is the rising cost of borrowing. Our recent bond sales have been pitched at an interest rate of about five per cent. That is probably as much as we really want to pay. After all, government debt should be regarded in the market as virtually risk free. Coincidentally that is the same rate currently applied to US Treasury 10-year paper.

Traditionally Hong Kong has divided both revenue and expenditure into two separate streams: recurrent for money the government expects to receive and pay out on an ongoing basis every year such as income from taxes on salaries and profits, and spending on welfare payments and civil service salaries; and capital, where the revenue tends to be “lumpy” such as land premium from sale of a prominent site, and major capital works projects where the spending flow is also uneven.

When revenue on capital account is weak, as it is at the moment, then alternatives have to be considered. One simple option, of course, would be for the government to cover any shortfall by running a surplus on the recurrent side, but that would impose a severe squeeze on spending. Allowing a bigger role for the private sector is another possibility and seems likely to apply to development of the northern metropolis where there are many private landowners who might be interested in participating. This option would not of course apply to the proposed artificial islands at Kau Sai Chau, because they do not yet exist.

Many governments fund capital works by issuing bonds, which is reasonable as the assets thus secured have a lifespan of many years so it is fair to spread the cost in this way. But then the cost of annual interest payments and redeeming the bonds has to be recouped somehow, usually (elsewhere) by user charges.

Whichever way you look at it, Chan has a real challenge ahead in preparing his next budget.