Hong Kong, China WT/TPR/S/173/Rev.1 
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I. ECONOMIC ENVIRONMENT 
(1) INTRODUCTION  
1. The economic performance and outlook for H ong Kong, China has greatly improved since 
mid 2003, following a period of prolonged weakness in  economic activity, persistent deflation, rising 
unemployment (especially among relatively low-skilled labour), and increasing fiscal deficits.  
Annual growth in real GDP jumped from 3.2% in 2003 to 8.6% in 2004, before dropping back to 7.3% in 2005.  After six consecutive years of deflation, the Composite Consumer Price Index (Composite CPI) rose by 1.0% in 2005.  After p eaking at 7.9% in 2003, the annual unemployment 
rate fell to 5.6 % in 2005.  At the same time, r eal GDP per capita has risen steadily to an estimated 
US$30,032.8 (2005).
1  The Hong Kong Special Administrative Region (HKSAR) has retained its high 
ranking in the UN Human Development Index.2 
2. This recovery is due in part to the conti nued openness of the HKSAR economy to trade and 
foreign investment during the period under review (2002-06).  The HKSAR remains one of the most 
open economies in the world, with trade in goods and non-factor services continuing to rise, reaching 
383% of GDP in 2005.  With the signing of the bi lateral free-trade agreement, the Closer Economic 
Partnership Arrangement (CEPA), with Main land China, the HKSAR economy has become 
increasingly integrated with the Mainland, which im plies that economic fluctuations in the Mainland 
could have significant spill-over effects on the HKSAR.3  The structural transformation of the 
HKSAR from a manufacturing-based to a service-based  economy has continued, with manufacturing 
and some low-end service jobs moving to the Mainland. 
3. With the maintenance of the pegged (linked) exchange rate system (LERS), albeit further 
refined in 2005 to address, inter alia,  uncertainty about exchange rate expectations, the brunt of the 
adjustment has continued to fall on prices in domes tic product, factor, and asset markets.  While the 
budget has recently been brought from deficit to surplu s, the Government is still heavily dependent on 
rather volatile non-tax sources of revenue (notably  land-related transactions, such as the sale of 
government land, modification of lease conditions, pr emiums collected from the granting of land by 
way of private treaty, etc., and investment income ).  Tax revenue as a percentage of GDP is only 
about 10.9% (average for the period 2001/02-2005/06), one of the lowest in the world.  Consequently, 
the authorities are considering the introduction of a goods and services tax (GST) in order to broaden 
the tax base.   
4. In order to tackle the problem of unemploymen t in the already flexible labour market, a key 
factor in the economy's resilience to external shoc ks, the authorities intend to  continue retraining and 
skills-upgrading programmes and to reform the edu cation system.  The HKSAR continues to eschew a 
comprehensive competition law aimed at addressing possible anti-competitive practices by powerful conglomerates that could hinder competition from dom estic and foreign enterprises, preferring instead 
a sector-specific approach;  nevertheless, the HKSAR's stance may be changing as a result of 
recommendations in the July 2006 Competition Policy Review Committee report, which could lead to 
public consultations on this matter.  The regulat ory framework against money-laundering has been 
improved and the adoption of anti-corrupti on regulation is under consideration.   
                                                     
 
1 IMF (2005b). 
2 No income poverty indicators (population living below income poverty line of US$1) are available on 
the HKSAR in UNDP (2005). 
3 A sharp slowdown in growth on the Mainland could affect HKSAR’s economy through a variety of 
channels including trade links, Mainland tourism and investment earnings (IMF, 2005c). WT/TPR/S/173/Rev.1 Trade Policy Review 
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5. While there were no major changes in the HKSAR 's trade and investment patterns during the 
review period, the Mainland's shares of its trade as well as inbound and outbound investment have risen;  this may be expected to continue in th e future as the economies of the HKSAR and Mainland 
China become increasingly integrated.  Owing to the Mainland's robust trading activities in recent 
years and the rapid development of transport infr astructure on the Mainland, some goods managed by 
HKSAR traders are exported to overseas buyers di rectly from the Mainland without being imported 
into and re-exported from HKSAR.  As a result, th e importance of offshore trade in total external 
trade managed by HKSAR residents has been increasing.   
(2) R
ECENT ECONOMIC DEVELOPMENTS  
(i) Growth, incomes, and employment 
6. The economy of Hong Kong, China rebounded in 2004 and has since grown steadily 
(Table I.1).  This owes much to the favourable external environment, judicious macroeconomic 
policies, continued structural reforms, strong gr owth on the Mainland, and the confidence-building 
effects of the Closer Economic Partne rship Arrangement (CEPA) (Chapter II).4  Riding on the three-
pronged development, in external trade,5 local spending6, and investment, HKSAR's economy is 
experiencing a balanced and solid expansion, en abling it to rise to various challenges from the 
external environment, such as oil price hikes, incr eased interest rates in the United States, changes to 
the Renminbi exchange system (section (3)(i) and Chapter IV) and the Sino-US textile negotiations 
(section 6).7   
Table I.1 
Selected macroeconom ic indicators, 2000-06  
  2000 2001 2002 2003 2004 2005 2006a 
National accounts (Percentage change)  
Real GDP (production based) 10.0  0.6  1.8  3.2  8.6  7.3  ..  
Consumption 5.5  2.6  -0.5  -0.5  6.3  2.5  ..  
Private consumption 6.0  2.1  -1.0  -0.9  7.3  3.4   ..  
Government consumption 2.1  6.0  2.5  1.9  0.7  -3.1  ..  
Gross capital formationb 20.3  -2.8  -1.3  1.9  2.1  0.5  ..  
Gross fixed capital formation 11.0  2.6  -4.5  0.9  3.0  4.1  ..  
Exports of goods and non-factor services 16.4  -1.7  9.1  13.1  15.8  10.7  ..  
Imports of goods and non-factor services 16.8  -1.5  7.5  11.5  14.2  8.1  ..  
XGS/GDP (%) (at current market price) 143.6  138.7  149.6  171.1  190.2  197.9  ..  
MGS/GDP (%) (at current market price) 139.1  134.2  141.3  161.9  181.3  185.4  ..  
Unemployment rate (%) 4.9  5.1  7.3  7.9  6.8  5.6  ..  
Labour force participation (%) 61.4  61.4  61.8  61.4  61.3  60.9  ..  
Table I.1 (cont'd)  
                                                      
4 IMF (2005a). 
5 Economic expansion was largely trade-led in 2005, marking the third consecutive year that exports of 
goods and services attained double-digit growth. 
6 Private consumption in 2004 benefited from the property market rebound, stronger household balance 
sheets, and rising employment (ADB, 2005). 
7 Hong Kong Trade Development Council (2005a);  Government of the HKSAR (2006c);  and IMF 
(2005a). Hong Kong, China WT/TPR/S/173/Rev.1 
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  2000 2001 2002 2003 2004 2005 2006a 
Productivity (Percentage change)  
Labour productivity 5.3  -0.6  1.7  4.1  4.8  5.1  ..  
Capital productivity ..  ..  ..  ..  ..  ..  ..  
Total factor productivity ..  ..  ..  ..  ..  ..  ..  
Prices and interest rates (Per cent)  
Inflation (composite CPI, percentage change) -3.8  -1.6  -3.0  -2.6  -0.4  1.0  ..  
Best lending rate  (period average) 9.22  7.00  5.11  5.00  5.02  6.12  ..  
Saving deposits rate  (period average) 4.47  2.16  0.14  0.03  0.02  0.97  ..  
Money credit (end period) (Percentage change)  
Money supply (M2) 7.8  -2.7  -0.9  8.4  9.3  5.0  ..  
Credit to private sector (end period) 2.3  -2.1  -4.0  -2.8  3.7  6.0  ..  
Exchange rate        
HK$/US$ 7.791  7.799  7.799  7.787  7.788  7.777  ..  
Real effective exchange rate indexc 
(percentage change) -4.8  -0.1  -4.0  -7.0  -5.4  -2.0  ..  
Nominal effective exchange rate indexc 
(percentage change) 0.8  2.9  -0.6  -3.2  -2.4  -0.9  ..  
Government balanced (Per cent of GDP, unless otherwise indicated)  
Government opening reserve balance 33.8  33.1  29.2  25.6  21.3  21.4  21.4  
Total revenue 17.1  13.5  13.9  16.8  20.4  17.9  17.7  
Operating revenue 13.0  11.7  12.0  14.2  14.6  14.8  14.4  
Tax revenue 10.0  10.0  9.2  10.7  12.1  12.7  11.9  
Total expenditure  17.7  18.4  18.7  20.1  18.8  16.9  17.3  
Operating expenditure 14.2  15.3  15.7  16.5  15.2  13.9  14.4  
Public expenditure 20.3  20.7  20.6  22.0  19.9  18.1  18.2  
Consolidated budget balance -0.6  -4.9  -4.8  -3.3  1.7  1.0  0.4  
Fiscal reserves (at 31 March) 32.7  28.7  24.4  22.3  22.9  22.5  21.8  
Public sector tax burden ..  ..  ..  ..  ..  ..  ..  
Public sector total debt ..  ..  ..  ..  ..  ..  ..  
Domestic debt  ..  ..  ..  ..  ..  ..  ..  
Saving and investment          
Gross national savings 32.4  31.8  30.4  32.3  31.9  32.3  32.3  
Gross domestic savings 32.0  29.8  31.1  31.2  30.7  33.0  ..  
Gross domestic investment 27.5  25.3  22.8  21.9  21.8  20.5  ..  
Savings-investment gap 4.9  6.5  7.6  10.4  10.1  11.8  ..  
External sector        
Current account balance  4.1  5.9  7.6  10.4  9.5  11.4  ..  
Merchandise goods trade balance -4.9  -5.0  -3.1  -3.6  -5.6  -4.3  ..  
Merchandise goods exports 120.1  114.6  122.4  141.7  156.9  162.9  ..  
Merchandise goods imports 125.0  119.6  125.4  145.4  162.6  167.2  ..  
Services balance 9.3  9.7  11.4  12.9  14.5  16.8  ..  
Capital account -0.9  -0.7  -1.2  -0.7  -0.2  -0.4  ..  
Financial account  -3.5  -6.8  -10.6  -13.8  -14.1  -11.3  ..  
Direct investment 1.5  7.5  -4.8  5.1  -7.0  1.9  ..  
Overall balance of payments  6.0  2.8  -1.5  0.6  2.0  0.8  ..  
Table I.1 (cont'd)  WT/TPR/S/173/Rev.1 Trade Policy Review 
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  2000 2001 2002 2003 2004 2005 2006a 
Terms of trade (2000=100) 100.0  100.8  102.1  101.0  99.3  .. ..  
Merchandise exports (percentage change) 16. 5  -5.7  4.9  12.0  15.9  11.1  ..  
Merchandise imports (percentage change) 19.1  -5.4  3.1  12.0  17.0  10.1  ..  
Services exports (percentage change) 14. 0  1.8  8.4  4.2  18.5  12.5  ..  
Services imports (percentage change) 3.9  0.9  4.3  0.4  19.2  3.8  ..  
Gross official reserves (US$ billion) 107. 6  111.2  111.9  118.4  123.6  124.3  126.6  
in months of imports 18.0  20.4  22.6  23.2  20.7  19.5  18.4  
Gross external debt (HK$ billion;  end period)  ..  ..  2,735.0  2,893.3  3,343.8  3,463.5  ..  
Debt service ratio ..  ..  ..  ..  ..  ..  ..  
.. Not available. 
a Estimates.  
b Gross capital formation includes gross domestic fi xed capital formation and ch anges in inventories. 
c Trade-weighted. d Numbers are based on fiscal years, 1 April to 31 March (e.g. 2000 should read 2000/01). 
Source : Data provided by the Hong Kong SAR author ities, Census and St atistics Department.  
7. The services sector as a whole remained the driving force behind overall economic growth 
(Table I.2);  as a result of the ongoing structur al transformation of the economy towards knowledge-
based and high-value-added activities, labour-intensi ve manufacturing continued to migrate to the 
Mainland, and construction ac tivities remained in decline.8  According to the HKSAR authorities, 
average labour productivity increased by 2.3% per a nnum between 1997 and 2005,  significantly faster 
than the corresponding increases in many developed economies during the same period.  According to 
the authorities, labour productivity growth  during the period under review was due, inter alia,  to 
technological advancement, corporate restructuri ng and downsizing, as well as improved education of 
the workforce.  This suggests that  the HKSAR economy has continued to  reap considerable efficiency 
gains in resource allocation under a market system, amidst its economic integration with the rapidly 
growing economy of Mainland China. 
8. Since its previous Review in 2002, Hong Kong,  China's real GDP per capita has risen 
steadily, by an overall rate of 17.9%, to an estimated US$30,032.8 (2005) (Table I.2), among the highest in the world (17
th out of 177 countries, in 2003) and th e highest in East Asia and the Pacific.9  
With life expectancy situated second only to Japan, the HKSAR has been the b est performer in East 
Asia and the Pacific as regards the UN human development index (ranked 22nd out of 177 countries, 
in 2003).  According to the World Economic Fo rum Growth Competitiveness Index, the HKSAR 
moved from 14th (out of 117 countries) in 2005/06 to 11th (out of 125) in 2006/07.10 
  
                                                     
 
8 IMF (2005b). 
9 UNDP country fact sheet online.  Viewed at:  http://hdr.undp.org/statistics/data/country_fact_ 
sheets/cty_fs_HKG.htm l [3 December 2005]. 
10 The Index comprises the technology index, the public institutions index, and the macroeconomic 
environment index.  More information is available online at:  http://www.weforum.org/site/homepublic.nsf/ 
Content/Growth+Competitiveness+Inde x+rankings+2005+and+2004+compari sons;  http://www.weforum.org/ 
site/knowledgenavigator.nsf/Content/Hong+Kong+KN+sessions;  http://www.weforum.org/site/homepublic.nsf/ 
Content/Nordic+countries+and+East +Asian+tigers+top+the+rankings+in+the+World+Economic+Forum%27s+
2005+competitiveness+rankings;  and http://www.weforum .org/pdf/Global_Competitiveness_Reports/Reports/ 
gcr_2006/gcr2006_rankings.pdf [6 July 2006]. Hong Kong, China WT/TPR/S/173/Rev.1 
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Table I.2 
Basic economic and social indicators, 2000-06  
 2000 2001 2002 2003 2004 2005 2006a 
Real GDP (HK$ billion, 2000 prices) 1,314. 8 1,323.2 1,347.5 1,390.6 1,510.2  1,620.0  .. 
Real GDP (US$ billion, 2000 prices ) 168.8 169.7 172.8 178. 6 193.9  208.3  .. 
Nominal GDP (HK$ billion) 1,314.8 1,298.8 1,276.8 1,234.0 1,291.6  1,382. 1  1,451.6  
Nominal GDP (US$ billion) 168. 8 166.5 163.7 158.5 165.8  177.7  .. 
GDP per capita at current market price 
(HK$) 197,268.0 193,135.0 188,118.0 181,385.0 187,657.0  199,261.0  .. 
GDP per capita at current market price 
(US$) 25,320.0 24,764.1 24,120.8 23,293.3 24,095.7  25,621.8  .. 
GDP per capita at real (2000) market price 
(HK$) 197,268.0 196,756.0 198,541.0 204,408.0 219,420.0  233,565.0  .. 
GDP per capita at real (2000) market price 
(US$) 25,320.0 25,228.4 25,457.2 26,249.9 28,174.1  30,032.8  .. 
 Annual percentage change  
GDP by economic activity at 2000 prices         
Agriculture, forestry, and fishing .. 4.1 -0.7 -5.6 2.8  2.1  .. 
Mining and quarrying .. -14.1 -11.1 2.2 -17.0  10.3  .. 
Manufacturing .. -9.1 -10.0 -10.3 1.7  2.1  .. 
Electricity, gas, and water .. 1.7 3.8 1.8 2.0  3.4  .. 
Construction .. -2.2 -1.5 -4.9 -9.8  -6.6  .. 
Services .. 1.8 2.8 4.5 9.9  7.9  .. 
Wholesale and retail trades .. 1.1 -3.0 -1.1 7.8  5.2  .. 
Import/export trade .. 1.8 7.7 13.3 15.4  12.1  .. 
Restaurants and hotels .. -10.3 -8.7 -13.7 22.6  8.3  .. 
Transport and storage .. 0.1 5.2 -1.6 14.0  14.5  .. 
Communications .. 8.2 10.8 7.8 13.8  10.8  .. 
Financing and insurance .. -0.3 4.0 10.3 21.7  11.0  .. 
Real estate .. -0.6 2.4 1.8 -1.2  3.5  .. 
Business services .. 3.6 -0.2 -2.3 3.9  7.5  .. 
Community, social, and personal 
services .. 4.0 -0.6 0.6 2.6  0.9  .. 
Ownership of premises .. 3.4 2.0 2.7 0.9  4.2  .. 
Share of main sectors in current GDP         
Agriculture and fishing 0.1 0.1 0.1 0.1 0.1  .. .. 
Mining and quarrying 0.0 0.0 0.0 0.0 0.0  .. .. 
Manufacturing 5.4 4.8 4.2 3.7 3.5  .. .. 
Electricity, gas, and water 2.9 3.1 3.2 3.2 3.2  .. .. 
Construction 4.9 4.6 4.2 3.7 3.2  .. .. 
Services 86.6 87.5 88.4 89.3 90.0  .. .. 
Wholesale and retail trades 3.2 3.3 3.1 2.9 3.5  .. .. 
Import/export trade 18.5 19.0 19.6 20.6 21.3  .. .. 
Restaurants and hotels 2.9 2.7 2.4 2.1 2.6  .. .. 
Transport, storage, and communications 9.5 9.4 9.9 9.8 10.1  .. .. 
Transport and storage 7.4 7.2 7.6 7.6 8.3  .. .. 
Communications 2.1 2.2 2.3 2.2 1.8  .. .. 
Financing and insurance 11.9 11.3 11.5 12.3 12.2  .. .. 
Real estate 5.1 4.6 4.3 4.0 4.2  .. .. 
Business services 4.4 4.3 4.3 4.5 4.9  .. .. 
Table I.2 (cont'd) WT/TPR/S/173/Rev.1 Trade Policy Review 
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 2000 2001 2002 2003 2004 2005 2006a 
Community, social, and personal 
services 19.9 21.1 21.5 21.8 21.0  .. .. 
Ownership of premises 11.3 11.8 11.8 11.2 10.2  .. .. 
Share of sector in total employment         
Agriculture and fishing 0.4 0.3 0.4 0.3 0.4  0.4  .. 
Mining and quarrying 0.0b 0.0b 0.0b 0.0b 0.0b 0.0b .. 
Manufacturing 7.1 6.6 6.0 5.6 5.4  5.3  .. 
Electricity, gas, and water 0.4 0.4 0.4 0.4 0.4  0.4  .. 
Construction 9.4 9.0 8.9 8.3 8.1  8.0  .. 
Services 82.7 83.7 84.3 85.4 85.7  86.0  .. 
Wholesale, retail and import and 
exports trades, restaurants and hotels 33.9 33.6 33.4 33.8 34.3  34.4  .. 
Transport, storage, and communication 10.9 10.7 10.5 10.4 10.6  10.5  .. 
Financing, insurance, real estate, and 
business services 14.1 14.7 14.7 14.6 14.6  15.0  .. 
Community, social, and personal 
services 23.8 24.7 25.7 26.5 26.2  26.0  .. 
.. Not available. 
a Estimates. 
b Less than 0.05%. 
Source : Data provided by the Hong Kong SAR author ities, Census and St atistics Department.  
9. During the period under review, most of the HKSAR's labour force (86.0% in 2005) has 
remained engaged in services activities (Table I.2).  As a result of the economic upturn, job creation 
has steadily gathered strength, which has brought down the annual unemployment rate from 7.3% 
(2002) to 5.6% (2005), i.e. back to the level of th e seasonally adjusted quarterly unemployment rate in 
mid 2001, although the annual unemployment rate for lower-skilled workers rema ined relatively high  
at 6.4% in 2005.11  Nevertheless, the overall unemployment rate remains higher than in the 1990s.12   
(ii) Prices 
10. After 68 months of deflation due, inter alia,  to price convergence with and the moderation of 
inflation in Mainland China13, the Composite CPI rose by 1.0% in 2005 along with the buoyant 
economic upturn, and as a result of the progressive feed-through from the earlier rebound in rents and 
higher import (oil and other world commodity) prices.14  Yet concurrently, a slower increase in import 
                                                      
11 According to the IMF, as th e quality of human capital in the HKSAR economy did not keep pace 
with the need of economic restructuring, a skills mismatch resulted.  This is evidenced on the one hand by the 
much higher unemployment rate in the lower-skilled segm ents of the labour market  and amongst workers that 
have lower educational attainment, and on the other hand by an increase in wage disparity and a rise in the 
return to education.  The inflow of low-skilled arri vals from the Mainland has aggravated the skills mismatch 
problem (IMF, 2005b).  The authorities indicated that the annual unemployment rates for lower-skilled workers 
were 5.6% in 2001, 8.1% in 2002, 9.1% in 2003, 7.8% in 2004 and 6.4% in 2005 (IMF, 2005a;  and 
Government of the HKSAR, 2006c). 
12 Government of the HKSAR (2006c). 
13 Significant price differentials between the HK SAR and neighbouring mainland cities, such as 
Shenzhen and Guangdong, along with the bursting of the property bubble, have been gradually translated into 
downward pressures on HKSAR's domestic price level (IMF, 2004a;  and EIU, 2005). 
14 According to the IMF, higher oil prices are unlikely to directly derail the economic recovery given 
HKSAR’s predominantly service-based economy and small manufacturing sector.  However, a persistent increase in oil prices could have a si gnificant effect th rough its impact on HKSAR's major trading partners.  The Hong Kong, China WT/TPR/S/173/Rev.1 
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prices, and the appreciation (section (3)(i)) of th e Hong Kong dollar (against the Japanese yen, the 
pound sterling, the euro) along with the U.S. dolla r, as well as the sustained improvement in labour 
productivity,  have helped to keep the Composite CPI very low.15  The property market has continued 
to play a pivotal role in the economy and in price developments;  this market has rebounded, 
reflecting the economic recovery.16  Deflation during the early part of the period under review 
improved HKSAR's external competitiveness.17  Inflation is expected to rise modestly as rents pick up 
and the labour market tightens.18 
(3) MAIN MACROECONOMIC DEVELOPMENTS  
(i) Monetary and exchange rate policy 
11. Operating under a currency board system, Hong Kong, China does not have an autonomous 
monetary policy.  The Hong Kong Monetary Author ity (HKMA), an integral part of the HKSAR 
Government, operates with a high degree of autonomy within the relevant statutory powers conferred 
upon, or delegated to, it.19  The primary monetary objective of the HKSAR is to maintain currency 
stability under the linked exchange rate system ( LERS) by pegging the value of the Hong Kong dollar 
(HK$) to the U.S. dollar (at the fixed rate of HK$7.8 to US$1). 
12. The authorities are aware of the costs and benefits of the exchange rate system involving 
currency board arrangements, and remain fully co mmitted to the LERS and consider that it remains 
the best option for Hong Kong, China.  The authoriti es believe that this stability is required because of 
the high degree of openness of Hong Kong, China's economy.  The success of the currency board exchange rate system depends, however, on Hong K ong, China's ability to maintain prudent fiscal 
policies (see below), ample foreign reserves, a sound banking system, flexible prices, and a well-
functioning labour market, all of which are crucial to  facilitate adjustment to shocks.  The authorities 
note that although HKSAR's fiscal position worsened until 2003, fiscal reserves remained sizeable at 
around 22% of GDP (Table I.1), and the Government is not in debt.
20  As a result, the budget deficit 
(until 2003) did not pose an immediate threat to the stability of the currency board exchange rate 
system.  Moreover, as indicated at the previous Review, the Government succeeded in addressing the 
fiscal imbalance in 2004 (section (ii) below).  In addition, foreign exchange reserves remain ample 
(equivalent to 19.5 months of imports) (section (5)).  
                                                                                                                                                                     
impact on consumer prices is likely to be small as the weight of oil-related components in the CPI basket is only 
about 1%  (IMF, 2005b).  
15 Government of the HKSAR (2006c). 
16 Residential property prices bottomed out in July 2003, and subsequently soared by about 40%.  
Nonetheless, by late 2004, prices remained below their October 1997 peak .  Developers may purchase land from 
the private market, modify the lease of their existing land holdings or purchase existing buildings for 
re-development.   The Government continues its efforts to reduce its direct involvement in this market.  Effective 
1 January 2004, new government land is being sold only through the Application List, which is a market-driven mechanism enabling the market to determine flexibly the quantity and timing of land to be put up for sale (IMF, 
2005a and b). 
17 IMF (2006a). 
18 IMF (2005a). 
19 HKMA (2005). 
20 Fiscal reserves are built up from government re venue to meet contingency requirements, including 
the financing of fiscal deficits.  The Government's target for such reserves is the equivalent of around 12 months 
of total government expenditure, which stood at HK$310.7 billion by end-March 2006, equivalent to 16 months of government expenditure, exceeding the target.  HKSA R's fiscal reserve comprises mainly cash and bank 
balances and investments deposited with HKMA's Exchange Fund.  The fiscal reserves are not permanently 
appropriated for the use of the Exchange Fund, but are repaid to the Government to meet its general revenue 
obligations.   WT/TPR/S/173/Rev.1 Trade Policy Review 
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13. Since the inception of the LERS in  1983, despite several external  shocks, the exchange rate 
(i.e. the Hong Kong dollar against the U.S. dollar) has remained stable in nominal terms.  The spot 
rate of the Hong Kong dollar was subject to depr eciation (also termed as "weak side") pressures 
during the earlier part of the period under review .  However, between Se ptember 2003 and October 
2004 appreciation ("strong-side") pressures emerged; these pressures related mainly to market 
reaction to the G-7 communiqué calling for upward flexibility in Asian currencies and  market 
speculation about a revaluation of the renminbi, for which the Hong Kong dollar may have been a 
proxy vehicle for trading.  The spot rate of  the Hong Kong dollar appreciated by 1.25% on 22 
September 2003.  In reaction, the HKMA employed  a strategy of "randomized" sales of Hong Kong 
dollars while nursing the spot rate back to the li nk in order to inject a degree of constructive 
ambiguity into the process.21  The resulting depreciation of the Hong Kong dollar, along with the 
weakening of the U.S. dollar particularly during 20 02-04, against other major currencies, as reflected 
in the movement of Hong Kong, China's real effe ctive exchange index, might have helped improve 
the price competitiveness of Hong Kong, Chin a's exports to the markets concerned. 
14. In May 2005, the HKMA introduced refinements to the LERS, with a view to removing 
uncertainty about exchange rate expectations a nd promoting smooth functioning of the money and 
foreign exchange markets.  Essentially, these cha nges involved curbing the HKMA's discretionary 
powers and bringing the LERS closer to functioning like a pure currency board, with the result that 
the HKMA has not actively interven ed in the exchange market since May 2005.  Under its "strong-
side" convertibility undertaking22, the HKMA is now committed to buying U.S. dollars from licensed 
banks at a rate of HK$7.75:US$1 (in an effort to  remove uncertainty over appreciation).  The "weak-
side" convertibility undertaking to sell U.S. dollars  at HK$7.80:US$1 has been shifted to a rate of 
HK$7.85:US$1, creating symmetrical convertibil ity undertakings around the linked rate of 
HK$7.80:US$1.23  According to the IMF, these refinement s have successfully dampened speculative 
inflows related to market expectations of a renminbi appreciation.24  They have also helped to keep 
financial markets calm in the afte rmath of the changes in the renminbi regime (see above and 
Chapter IV).  By capping the potential upside in  the spot rate, the traditional tight link between 
HKSAR and U.S. interest rates has been re-established.25  Moreover, the two-sided flexibility 
afforded by the band now allows the nominal exchange  rate to aid adjustment in the face of moderate 
temporary shocks. 
15. In his policy address delivered on 12 October 2005, the Chief Executive announced that the 
Central Authorities had given in-principle approval to extend the scope of existing renminbi (RMB) 
business in HKSAR (Chapter IV), including:  raising the current transaction limits on foreign exchange, credit card business, and remittance;  extending RMB settlement to designated merchants 
in more sectors;  and permitting designated me rchants in HKSAR to open RMB cash deposits 
accounts.
26 
                                                      
21 IMF (2005b);  and EIU (2005). 
22 The "strong-side" and "weak-side" convertibility unde rtakings effectively limit the movements of the 
Hong Kong dollar market exchange rate within a band. 
23 Previously, the HKMA was committed to selling U.S.  dollars to licensed banks at the pegged rate, 
but was not obliged to intervene when the Hong Kong dollar strengthened beyond this rate, as it did in late 2003 
and once again in late 2004 (EIU, 2005). 
24 IMF (2005a). 
25 In mid 2004 a combination of speculation about a revaluation of the renminbi, weakened sentiment 
toward the U.S. dollar, and improved economic conditi ons, led to strong capital inflows that resulted in 
abnormal levels of liquidity in the HKSAR banking syst em as measured by the aggregate balance (settlement 
accounts held by banks with  the HKMA).  Consequently, in late 2004 and early 2005, th ere was a drop of 
Hong Kong, China's interest rates below U.S. rates, gi ving impetus to the property market and domestic credit 
expansion  (ADB, 2005;  and EIU, 2005). 
26 Hong Kong Trade Development Council (2006). Hong Kong, China WT/TPR/S/173/Rev.1 
 Page 9 
 
 
(ii) Fiscal policy 
16. Articles 107 and 108 of the Basic Law stipulate that the HKSAR should strive to maintain a 
balanced budget, and maintain low ta x rates;  hence, the pursuit of a prudent fiscal policy.  To further 
strengthen the fiscal position, the authorities have co ntinued to rein in gove rnment expenditure and 
take advantage of high growth.   Although the Territory ran a consolidated fiscal deficit until 2003 
(Table I.1), the fiscal balance improved gradually from a deficit of 4.9% of GDP in 2001 to surpluses 
of 1.7% in 2004 (after government bond issue) and 1% in 2005 (Table I.1).  Fiscal reserves (a key 
factor in maintaining the currency board system, section (3)(i)), declined as a share of GDP from 
28.7% to 21.8% between 2001 and 2006 (Table I.1);  fiscal reserves in March 2006 were 
HK$310.7 billion, equivalent to 16 months of gove rnment expenditure, and are forecast to rise in 
2006-07 to HK$316.3 billion (equivalent to 15 months).27  In 2005-06, the authorities achieved, 
three years ahead of schedule, all three fiscal ta rgets set in the 2004 Budget:  reducing operating 
expenditure to less than HK$200 billion by 2008-09;  restoring fiscal balance by 2008-09;  and 
bringing public expenditure down to 20% of GDP or be low, so as to be in line with the principle of 
"Big Market, Small Government".28  The consolidated surplus for 2005-06 was HK$14 billion. 
17. Between 2001 and 2005, the share of total govern ment revenue to GDP rose progressively 
from 13.5% to 17.9% (Table I.1), mainly as a result of the relatively volatile non-tax-related revenue 
(Table I.3), which increased gradually from 3.5% of  GDP to 5.2% during the same period.  According 
to the authorities, the average annual contribution of  this type of revenue to GDP was about 3.5% in 
the period 1983/84-2005/06.29  Between 2001 and 2005, the share of tax revenue to GDP increased 
from 10% to 12.7% (Table I.1).  Direct taxes contributed about two thirds to total tax revenue 
(Table I.3).  On the expenditure side, during the pe riod under review the share of public expenditure 
as a percentage of GDP has declined progressi vely, except for 2003 when it peaked at 22% 
(Table I.1).30  The authorities maintained a policy of expenditure cuts, including reducing the number 
of civil servants and cutting the pay of the rema ining personnel by 2.46% in October 2002, 3% in 
January 2004, and 3% in January 2005.  In the 2006-07 Budget, the authorities projected surpluses in 
both the operating and consolidated accounts over th e five years to 2010-11, based on the forecast 
economic growth.  Taking such growth into acc ount, the authorities plan to increase operating 
expenditure moderately over the next five year s to enhance the quality of government services.  
Despite the improved fiscal position, the authorities w ill continue to manage public finances prudently 
and keep expenditure within revenue limits.31  The Government revised the fee structure of its public 
health care services in 2003 to contain rising health ca re costs, and plans to encourage the provision of 
health care by the private sector (Chapter IV). 
 
                                                      
27 As the consolidated surplus as at 31 March 2006 was HK$9.9 billion higher than the revised 
estimate, the projected fiscal reserves as at end March 2007 would be HK$316.3 billion (ADB, 2005;  and 
Government of the HKSAR, 2006a). 
28 Government of the HKSAR (2005b) and (2006a). 
29 The investment income (6.2% of total government revenue) contributes about 1 percentage point to 
this finding, while the land premium (13.3% of total government revenue) contributes about 2.4 percentage points.  More information on this issue is available in IMF (2006b). 
30 Government expenditure in Hong Kong, China seems to be rigid.  This rigidity is bound to be 
accentuated by the aging population (sec tion (7)), which may increase the need  for public spending, especially 
on health care and social welfar e expenditure for the elderly. 
31 In the 2006-07 Budget the authorities undertook to invest more than 60% of the budgeted 
expenditure on education, social welfar e, health and security.  By March 2 007, they expect to reduce the civil 
service establishment from some 198,000 (at the beginning of 2000) to about 160,000;  they intend to retain 
existing temporary jobs in the public sector for a furt her year (Government of the HKSAR, 2006a;  and IMF, 
2005b). WT/TPR/S/173/Rev.1 Trade Policy Review 
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Table I.3 
Structure of government revenue, 2000-06 
(HK$ million and per cent) 
 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 
Government revenue (HK$ million) 225,060  175,559  177,489  207, 338  263,591  247,035 
of which:       
Tax revenue (HK$ million) 130,993  129,726  117,395  132,513  156,303  175,589  
 (Per cent of tax revenue) 
Direct taxes 56.4 59.9  62.2 60.7 61.9  63.6  
Earning and profit tax 56.4  59.9  62.2 60.7  61.9  63.6  
Indirect taxes 43.6  40.1  37.8  39.3 38.1  36.4  
Fees and charges (tax-loaded 
fees) 3.7 3.6 3.2 3.6 3.3 3.1 
Bets and sweeps tax 9.6 8.9 9.3 8.8  7.7  6.8  
Hotel and accommodation tax 0.2  0.2  0.2  0.1  0.2  0.2  
Stamp duties 8.3 6.7 6.4 8.5  10.1  10.2  
Air passenger departure tax 0.4  0.5  0.8  0.6  0.9  0.8  
Duties 5.6 5.4 5.6 4.8  4.2  3.7  
General rates 11.0 9.8 7.6 8.4 8.1  8.1  
Motor vehicle tax 2.3 2.1  2.1 2.1  2.2  2.2  
Royalties and concessions 1.3 1.4 1.5  1.3  0.5  0.4  
Estate duty 1.1 1.5  1.2  1.1  0.9 1.0  
Non-tax revenue (HK$ million) 54, 422 26,920  40,140  45, 420 35,394  33,618  
Investment income and interest 19,516  331  16,047  23,082  11,476  8,083  
Others 34,906  26,589  24,057  22,338  23,918  25,535  
Funds (HK$ million) 39,645  18, 913  19,990  29,405  71,894  37,828  
Land premium 29,531  10,327  11,476  5,415  32,033  29,472  
Investment income and interest 4,003  541  1,503  2,813  3,198  2,289  
Others 6,111  8,045  7,011  21,177  36,663  6,067  
Source:  Data provided by the Hong Kong SAR author ities, Census and St atistics Department.  
(4) STRUCTURAL MEASURES  
(i) Tax reforms 
18. The economic downturn has exposed certain weaknesses in the tax structure of the HKSAR.  
Despite the return of public finances to surplu s, the HKSAR Government is nonetheless considering 
the possibility of widening the tax base to stab ilize public finances and t hus place Hong Kong in a 
position to achieve sustainable economic growth.  In the light of tax revenue concerns arising from an 
ageing population and over-relianc e on a limited range of taxes and volatile non-tax revenue (from 
land sales and investment income), the HKSAR Government began a public consultation on 
18 July 2006 on the feasibility of introducing a low, single-rate goods and services tax (GST).32  A 
GST would, inter alia , help to avoid further increases in the ra tes of salaries and profits taxes that 
could weaken HKSAR's competitiveness.  Some im portant features of the proposed GST framework 
include33:  exports of goods, international supplies of  services, and financial supplies would not be 
                                                      
32 According to the IMF, a GST rate of 5% (the current rate in Japan and Singapore) would probably 
increase the cost of the consumption ba sket of the poor by about 3.3%.  It is estimated that a GST of between 
3% and 5% would bring in between HK$18 billion and HK$30 billion a year, compared with the HK$34 billion 
collected in salaries tax and HK$58.6 billion in profits tax in fiscal year 2004/05.  EIU (2005);  IMF (2005a);  
IMF (2005b);  ADB (2005);  and Government of the HKSAR (2005b). 
33 Government of the HKSAR (2006d). Hong Kong, China WT/TPR/S/173/Rev.1 
 Page 11 
 
 
subject to GST;  generous GST postponement sch emes would be provided to alleviate importers' 
cashflow problems arising from the GST;  a Tourist Refund Scheme would allow visitors to obtain a 
refund of GST on goods they purch ased in Hong Kong, China and were taking home with them;  
residential property sales and rentals would not be subject to GST;  the HKSAR Government would 
be GST-registered for commercial and non-regulator y activities to provide a level playing field with 
the private sector;  and charities would be treated as  "taxable persons" to allow them to reclaim the 
GST paid on purchases. 
19. In order to mitigate the erosion of purchasing power owing to the introduction of a GST, the 
authorities envisage offsetting tax relief, such  as income tax deductions, as well as and other 
compensatory measures, including an upfront s upplement for Comprehensive Social Security 
Assistance (CSSA) households.  Furthermore, it is not the HKSAR Government’s objective to 
generate additional tax revenue;  therefore, all additional revenue (after deducting administrative 
costs) generated during the first five years of th e GST would be returned to the community as tax 
relief, other compensation measures or for increasing expenditure for the provision of public services.  
Even if a decision were made to introduce a GST, it would probably take two to three years to implement it.  The authorities intention is to keep all the primary elements of the tax reform package 
unchanged for the first five years, once they are introduced 
(ii) Labour markets 
20. Tackling the problems of unemployment and st ructural weaknesses in the already highly 
flexible labour market (a key factor behind the eco nomy's resilience to exte rnal shocks) remain key 
policy priorities; the HKSAR Government intends to  reform the education system and proceed with 
its ongoing retraining and skills upgrading programmes.
34  At the same time, the tripartite Labour 
Advisory Board is studying the issues of a statutory minimum wage and standard working hours.  Furthermore, in order to attract skilled immigrants and further enhance the quality of the labour force, 
the HKSAR introduced the Quality Migrant Admissi on Scheme in June 2006, on top of its already 
liberal policy towards entry for employment.  U nder the Scheme, talented people from the Mainland 
and overseas who meet specified eligibility criteria are allowed to enter Hong Kong, China without 
securing an offer beforehand of local employment.  An initial annual quota of 1,000 persons has been 
established and there is no sectoral restriction.  Applicants are assessed under a point-system, which 
contains criteria such as age, language skill, academ ic attainment, and professional qualifications.  
The first batch of successful applicants is exp ected to receive entry approval within 2006.  The 
HKSAR Government considers that a larger pool of talent will increase the Territory's 
competitiveness, and help attract more  capital and create more jobs. 
(iii) Governance 
21. Issues relating to the transparency and account ability of public administration as well as the 
proper management of public affairs have an im portant impact on the economic environment and 
growth prospects.  Transparency International places HKSAR in 15
th position (out of 159) on its 2005 
Corruption Perceptions Index.35 
22. Since 1974, the Independent Commission Agains t Corruption (ICAC) has had a crucial role 
in building a clean society in Hong Kong, China.36  The HKSAR Government supports ICAC's work, 
including efforts to improve the effectiveness of its law enforcement actions in response to changes in 
the legal system and society.  In 2005, the Chie f Executive accepted the need  for his office to be 
                                                      
34 IMF (2005b);  and IMF (2004b). 
35 Transparency International (2005). 
36 Detailed and up-to-date information on ICAC's activities and achievements is available online.  
Viewed at:  http://w ww.icac.org.hk/eng/abou/ abou_icac_1.html# [27 June 2006]. WT/TPR/S/173/Rev.1 Trade Policy Review 
Page 12 
 
 
subject to anti-corruption regulation.37  The Administration has been preparing the necessary 
legislative amendments.  The HKMA has continued its efforts to  further develop the supervisory 
framework for the prevention of money laundering an d terrorist financing;  in June 2004, the HKMA 
issued a revised version of the Supplement to the Guideline on Prevention of Money Laundering, 
together with a set of Interpretative Notes;   compliance was required as from 1 January 2005 
(Chapter IV).38 
23. The Legislative Council enacted the Financial Reporting Council Ordinance in July 2006 to 
enhance corporate governance (Chapter III) and the financial reporting regime in the HKSAR.  The 
new Ordinance provides a statutory framework fo r the establishment of the Financial Reporting 
Council, which will be responsible for investiga ting irregularities of auditors and accountants, and 
non-compliance of financial statements of listed corp orations and collective investment schemes.  The 
authorities expect that the Financial Reporting Coun cil will come into operation formally in early 
2007. 
(iv) Competition 
24. In the 2006-07 Budget Speech, the authorities consid ered that steps must be taken to maintain 
an orderly market and ensure that it provides a leve l playing field for all enterprises.  In order to 
promote the development of such a market, fair  competition has become all the more important.39  
Hitherto, the HKSAR has maintained a sector-speci fic approach to competition policy, allowing 
powerful conglomerates to hinder competition from dom estic and foreign firms (Chapters III and IV).  
In July 2006, the authorities were considering the recommendations of a Competition Policy Review 
Committee (CPRC), made up mostly of non-government  stakeholders (business, academic, consumer 
protection, and other sectors), for introducing a cros s-sector competition law, targeting specific types 
of anti-competitive conduct, with a view to consu lting the public later in 2006 on the way forward. 
(5) BALANCE -OF-PAYMENTS DEVELOPMENTS  
25. As a result of the high level of saving in re lation to gross domestic investment during the 
period under review, Hong Kong,  China’s balance of payments position remained strong, 
characterized by a rising current account surplus (except for 2004), with the surplus on trade in 
services exceeding the merchandise trade deficit (T able I.4).  This reflects the economy's ongoing 
shift towards services.  The current account surplus rose from 7.6% of GDP in 2002 to 11.4% in 2005 
(Table I.1), reflecting, inter alia,  increase in the invisible trade surp lus.  The merchandise trade deficit 
has been and is expected to remain offset by  the large surplus on the services account.  The 
accumulation of foreign external reserves has been substantial throughout th e period, amounting to  
US$126.6 billion at the end of June 2006, equivalent to 18.4 months of retained imports (i.e. total 
merchandise imports minus imports for re-exports) (Table I.1) and over six times the currency in 
circulation or about 35% of Hong Kong dollar M3.40  This level of reserves seems to be sufficient to 
cover external requirements and to ma intain the exchange rate system. 
                                                      
37 Government of HKSAR (2005g). 
38 HKMA (2005);  and IMF (2005b). 
39 The HKSAR Government (2006a). 
40 The HKSAR is the world's eighth largest holder of  foreign currency reserves, after Mainland China, 
Japan, the Chinese Taipei, the Russian Federatio n, Korea (Rep. of), India, and Singapore ( Government of the 
HKSAR, 2006b).  Hong Kong, China WT/TPR/S/173/Rev.1 
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Table I.4 
Balance of payments, 2000-05 
(HK$ million)  
 2000 2001 2002 2003 2004 2005 
Current account 54,494 76,315 96,800 128,240 122,491 157,692 
Goods and services balance 58, 753 61,649 105,936 114,050 114,542 172,276 
Trade balance -63,832 -64,970 -39,406 -44,970 -72,514 -59,347 
Exports 1,579,367 1,488,982 1,562,121 1,749,089 2,027,031 2,251,744 
Imports 1,643,199 1,553,952 1,601,527 1,794,059 2,099,545 2,311,091 
Services balance 122,584 126,620 145,341 159,020 187,056 231,623 
Credit 315,012 320,799 347,836 362,420 429,563 483,455 
Transportation 99,513 93,675 103,751 107,688 135,188 152,147 
Travel 46,019 46,362 58,134 55,575 70,084 79,994 
Insurance 3,452 3,556 3,421 3,065 3,197 3,506 
Financial 34,058 34,966 32,708 29,301 35,460 43,946 
Other 131,971 142,241 149,822 166,792 185,634 203,862 
Debit 192,427 194,180 202,494 203,400 242,507 251,832 
Transportation 48,628 50,916 48,518 52,305 67,657 73,067 
Travel 97,402 96,057 96,846 89,133 103,347 103,492 
Insurance 4,111 4,028 4,618 4,840 4,761 5,262 
Financial 6,421 6,969 7,694 6,835 9,070 8,450 
Other 35,865 36,210 44,818 50,287 57,672 61,561 
Income 8,754 28,543 5,652 28,491 23,410 2,463 
Credit 424,483 374,787 323,745 336,242 404,991 503,370 
Investment 423,427 373,597 322,805 335,310 403,122 501,504 
Compensation of employees 1,056 1,190 940 932 1,869 1,866 
Debit 415,728 346,244 318,093 307,751 381,581 500,908 
Investment 413,973 343,839 315,762 305,281 379,084 498,299 
Compensation of employees 1,755 2,405 2,331 2,470 2,497 2,609 
Current transfers, net -13,013 -13,878 -14,787 -14,301 -15,461 -17,046 
Credit 4,193 4,719 6,063 4,117 4,871 5,773 
General Government 0 0 0 0 0 0 
Other sectors 4,193 4,719 6,063 4,117 4,871 5,773 
Debit 17,205 18,597 20,850 18,418 20,332 22,819 
General Government 1,292 1,299 1,341 1,334 1,330 1,361 
Other sectors 15,913 17,298 19,509 17,084 19,003 21,458 
Capital and fina ncial account -57,863 -97,359 -151,179 -179,086 -184,640 -160,882 
Capital account -12,044 -9,155 -15,686 -8,292 -2,561 -5,237 
Financial account -45,819 -88,204 -135,493 -170,794 -182,080 -155,645 
Direct investment 19,976 96,948 -60,685 63,372 -91,038 25,845 
HKSAR's direct investment abroad -462,593 -88,476 -136,194 -42,937 -356,111 -253,402 
Foreign direct investment in HKSA R 482,569 185,424 75,509 106,310 265,072 279,247 
Portfolio investment 190,782 -322,045 -302,484 -264,619 -306,368 -168,100 
Assets -171,627 -312,992 -294,032 -275,341 -336,549 -238,631 
Equity securities -137,154 -176, 892 -122,884 -77,461 -237,423 -197,988 
Debt securities -34,472 -136, 100 -171,149 -197,880 -99,126 -40,643 
Liabilities 362,409 -9,054 -8,452 10,721 30,181 70,530 
Equity securities 366,060 -6,673 10,849 44, 879 15,349 84,487 
Debt securities -3,651 -2, 380 -19,301 -34, 157 14,832 -13,956 
Financial derivatives 1,661 39,640 51,563 78,288 44,319 13,754 
Other investment -179,917 133,783 157,573 -40,247 196,492 -16,464 
Net errors and omission 3,369 21,044 54,379 50,846 62,149 3,190 
Reserve assets (net change)a -78,321 -36,530 18,541 -7,589 -25,486 -10,679 
a As increases in external assets are de bit entries and decreases are credit entries,  a negative value for net change in reserv e assets 
represents a net increase and a positive value represents a net decrease.   
Source:  Government of the HKSAR, Census  and Statistics Department (2005), Balance of Payments  Statistics of 
Hong Kong,  Fourth Quarter.   WT/TPR/S/173/Rev.1 Trade Policy Review 
Page 14 
 
 
(6) DEVELOPMENTS IN MERCHANDISE TRADE  
26. In 2005, Hong Kong, China was the world's 11th largest merchandise trading economy and 
one of the most trade dependent.41  Supported by the strong performance of the global economy, the 
Mainland’s vibrant trade flows, and the increasing penetration of Mainland products in the world 
market, as well as the upsurge in inbound touris ts, the HKSAR's exports of goods and services 
attained significant growth (Tables I.1 and I.4).42  As indicated (section (i)) the GDP share of trade in 
goods and non-factor services has continued to increase since 2002, to reach 383% in 2005 (Table I.1).  Hong Kong, China remains a net exporter of services reflecting its shift from 
manufacturing to services.  Consistent with Hong K ong, China's role as an entrepôt, transportation 
and trade-related services are the most important service exports (Chapter IV).
43   
27. Merchandise re-exports increased steadily du ring the period under review, while domestic 
exports, after declining in 2002, rose progressively  without attaining their 2001 level until 2005.44  
The HKSAR is also handling an increasing amount of offshore trade45, which, according to 
Government estimates, amounted to US$236 billion in 2004 – equivalent to 97% of HKSAR's 
re-exports for that year.  Due to the expansi on of production capability in the manufacturing sector 
and availability of related supporting services in the lo w-cost countries in the region, particularly the 
Chinese Mainland, trading firms increasingly source goods offshore for sales in international markets.  
Some of these goods are trans-shipped via the HKSAR , or shipped directly without passing through 
Hong Kong, China.  
Composition of trade 
28. Imports and re-exports of office machines a nd telecommunications equipment and other 
electrical machinery have continued to increase since HKSAR's previous Trade Policy Review, 
reflecting its ongoing shift from manufacturing to  services and its role as a gateway to and from 
southern China (Chart I.1). 
29. Textiles and clothing, which are no longer cove red by quota arrangements in major markets 
(since end 2004)46, remains the largest category of domestic exports, accounting for 44.8% of 
domestic merchandise exports in 200 5, down from 52.4% in 2001;  its share in re-exports has also 
                                                      
41 Around one in six employed persons in HKSAR are engaged in importing and re-exporting, a 
significant proportion of which involves Mainland China's ever-expanding external trade.  Nearly one fourth of the Mainland's foreign trade is handled via Hong Kong, China.  Hong Kong also has re-exports originating 
from/destined for markets other than the Mainland of China (Hong Kong Trade Development Council, 2005b;  
and WTO trade statistics profile (as of March 2006).   Viewed at:  http://stat.wto.org/CountryProfile/ 
WSDBCountryPFView.aspx?Language=E&Country=HK [3 July 2006]). 
42 Hong Kong Trade Development Council (2005a). 
43 Nevertheless, according to the IMF, the struct ure of trade between HK SAR and the Mainland is 
changing rapidly, reflecti ng China's increased competitiveness and access to world markets.  Thus, the share of 
HKSAR’s entrepôt trade (as a ratio of China's foreign tr ade) has declined significantly, and it is increasingly 
getting a share of "offshore" or "transhipment" trade, which takes advantage of its superior logistical services.  
However, the value-added of this type of trade is sign ificantly lower than that of traditional re-export trade 
(IMF, 2005b).  
44 UNSD, Comtrade database. 
45 Hong Kong Trade Development Council (2005b). 
46 Simmering trade disputes between China, and the United States and the EC earlier in 2005 created 
uncertainty over the prospects for HKSAR's re-exports following the phase-out of global quotas as scheduled 
under the WTO Agreement on Textiles and Clothing.  Ag reements reached between China and these trading 
partners alleviated uncertainty, and gave Chinese manufac turers a clearer idea of how  much production to shift 
to other countries, including Hong Kong, China (EIU, 2005). Hong Kong, China WT/TPR/S/173/Rev.1 
 Page 15 
 
 
declined.  As regards domestic exports, the shar es of office machines and telecommunications 
equipment, and other electrical machinery rose to 19. 3% and 5.2% respectively (Chart I.1) suggesting 
that these items remain comp etitive in overseas markets. 
Direction of trade 
30. China remains the largest market for Hong Ko ng, China's domestic exports, accounting for 
32.8% of domestic exports in 2005  (up 0.5 percentage points from 2001).   The HKSAR's other major 
export markets are the United States, the EC, and Ja pan (Chart I.2).  The shares of domestic exports 
destined for the United States and the EC both declined between 2001 and 2005.  The authorities 
indicate these market shares fluctuate from year to year, influenced by such factors as exchange rate 
movements, economic conditions in individual market s, and removal of textile and clothing quotas as 
from 2005.  Reflecting recent developments in th e Mainland China's economy, including vibrant 
industrial activity, Mainland China's share in HKSAR 's re-exports continued to increase.  Exports to 
most East Asian markets likewise grew strongly, in  tandem with the surge in intra-regional trade, 
thanks to the export boom throughout Asia and the recovery in global demand for information 
technology products.47  Mainland China, Japan, the EC, and Chinese Taipei have remained HKSAR's 
largest suppliers of merchandise imports;  Mainla nd China's share increased by 1.5 percentage points 
from 2001 to reach 45% in 2005, while Japan's and th e EC's shares dropped.  This development was 
largely due to the strong increase in Hong Kong, China’s imports from the Mainland for re-export, 
broadly reflecting the strong growth of Mainla nd China’s exports to the rest of the world.  
(7) TRENDS AND PATTERNS IN FOREIGN INVESTMENT  
31. Hong Kong, China remains a major destination for foreign direct investment (FDI).  
According to the UNCTAD World Investment Report 2005, the HKSAR was the second largest 
recipient of inward FDI in Asia and the seventh in the world in 2004.48  While world FDI inflows only 
grew by 2% in 2004, inflows to the HKSAR grew at a considerably higher rate. 
32. FDI inflows declined abruptly in 2002, like ly related to the weak external economic 
environment and to the outflow in inter-company  debt transactions ar ising from reduction and 
repayment of debts extended to HKSAR enterprises by  their non-resident direct investors and related 
companies.  Inflows have increased progressively  since 2004 in part due to Mainland enterprises 
taking advantage of CEPA and setting up businesses in the HKSAR49;  however, they have not yet 
attained their 2000 level.  Ne vertheless, net FDI inflows (the difference between inflows and 
outflows) remained positive only for a couple of years during the period under review (Tables AI.1 and AI.2).  Inward FDI remained predominantly in the services sector (Tables AI.1 and AI.3);  the 
sectoral pattern of investment has not changed in recent years.  The three major groups of economic 
activities persistently ranked at the top for inward FDI over the past few years, in terms of both the 
total stock and flow are services industries:  investment holding, real estate and various business services;  wholesale, retail and import/export trades;   and banks and deposit-taking companies.  The 
most important investors in the HKSAR (Tables AI .2 and AI.4) are the British Virgin Islands and 
Mainland China, accounting respectively for 23.7% and 23.4% of total inward FDI in 2004.  Inflows 
from the British Virgin Islands  reflect the common practice of HKSAR's enterprises in setting up non-
operational companies in offshore financial centres (i .e. in tax havens) for the purpose of channelling 
funds back to Hong Kong, China. 
                                                     
 
47 Government of the HKSAR (2006c). 
48 Hong Kong Trade Development Council (2006);  and UNCTAD (2005b). 
49 The HKSAR authorities indicate that trade and investment facilitation measures under CEPA fit well 
with the Mainland's policy of assisting its enterprises to  "go out", and hence bringing business opportunities to 
Hong Kong.  For example, at the end of August 2004, the Ministry of Commerce significantly streamlined the 
application procedure for Mainland enterprises to invest in HKSAR (ADB, 2005). WT/TPR/S/173/Rev.1 Trade Policy Review 
Page 16 
 
 
Chart I.1
Product composition of merchandise trade, 2001 and 2005
2001 2005
Imports
Source :Data provided by the authorities.Chemicals
5.7Office machines & 
telecommunication
equipment
28.6
Textiles
6.1Other consumer 
goods
16.8Per cent
Domestic exports
Re-exportsAgriculture
5.3Other semi-
manufactures
10.1
Other electrical 
machinery   7.7
Transport equipment
2.2Other
1.8Chemicals
6.2Office machines & 
telecommunication
 equipment
37.4Mining  2.9
Textiles
4.6Other consumer 
goods
13.6Agriculture  3.6Other semi-
manufactures
10.2
Other electrical 
machinery   8.8Other  1.8
Office machines
 & telecom. equip.  
15.3
Textiles 
5.3
Clothing
47.1
Other consumer 
goods
12.9Other semi-manuf. 
3.1
Other  3.2Non-electrical
 machinery  
1.7Office machines & 
telecom. equip.  
19.3
Textiles
  3.5
Clothing
41.3Other consumer goods
12.0Mining  3.4Other semi-
manufactures  3.0Other electrical
 machinery
5.2
Other  1.6
Chemicals
5.0Office machines & 
telecom. equipment  
27.7
Textiles 
6.6Agriculture  
2.6
Other consumer 
goods
24.7Other semi-
manufactures  8.1
Other electrical
 machinery
9.3Other  
 3.3Chemicals  4.8Office machines & 
telecom. equipment
  39.1
Textiles 
4.9Other consumer 
goods
17.1Other semi-
manufactures   7.8
Other electrical
machinery
10.2Non-electrical
 machinery
4.5
Other   3.0Clothing
6.2
Total:  US$201.1 billion Total:  US$299.5 billion
Total:  US$19.7 billion Total: US$17.5 billion
Total:  US$170.2 billion Total:  US$271.8 billionMining  2.3Non-electrical 
machinery
5.4Non-electrical 
machinery 
4.8
Agriculture  3.1 Agric. 2.0Other electrical
  machinery  3.9
Mining  1.4Non-electrical 
machinery 
  2.1
Non-electrical 
machinery
4.4Clothing
8.0
Chemicals  3.6Chemicals  6.1
Clothing
7.4Clothing
8.3Agriculture  1.3
 Hong Kong, China WT/TPR/S/173/Rev.1 
 Page 17 
 
 
Chart I.2
Direction of merchandise trade, 2001 and 2005
2001 2005
Imports
Source :Data provided by the authorities.Other 
10.3
EC25
9.7
China
43.5Japan
11.3Per cent
Domestic exports
Re-exportsSingapore
4.6
Chinese
Taipei 
6.9Korea, Rep. of
4.4United
States
5.1
Singapore
5.8
Chinese Taipei
7.2
Japan
11.0EC25
7.6
China
45.0
United States
31.0
EC25
16.8China
32.3Japan
2.6Chinese Taipei 
3.5Other
12.9United States
27.8
EC25
16.6Other 
12.1
Japan   3.2Singapore  3.0
China
32.8
Singapore  2.0United States
21.3
EC25
14.7Chinese Taipei 2.3
China
37.4Other America
2.5Singapore  2.0United States
15.3
EC25
14.4
China
45.8Other America
2.7Other
10.1
Japan   6.3Chinese Taipei   2.1Total:  US$201.1 billion Total:  US$299.5 billion
Total:  US$19.7 billion Total: US$17.5 billion
Total:  US$170.2 billion Total:  US$271.8 billionKorea, Rep. of
4.5United 
States
6.7Other
11.3
Chinese Taipei  3.8Singapore 
  1.7
Other
13.7
Japan  5.4Malaysia
2.5 Malaysia
2.5
Korea, Rep. of   2.2
 WT/TPR/S/173/Rev.1 Trade Policy Review 
Page 18 
 
 
33. FDI outflows varied considerably during the pe riod under review (Tables AI.1 and AI.2).  
While FDI outflows between 2002 and 2003 dropped, they rose in 2004 reflecting investors interest in 
opportunities arising under CEPA openings in Mainland China as well as to major merger and 
acquisition activities by some prominent enterprises.50  Mainland China remain s the largest recipient 
of Hong Kong, China's direct investment.  A ccording to the IMF, the HKSAR's cumulative 
investment in the Mainland probab ly includes FDI that is "round tripped" via HKSAR and back to 
China to take advantage of the favour able tax treatment for foreign firms.51  In terms of cumulative 
amount on approval basis, the HKSAR was the larg est investor in the Chinese Mainland, and was 
among the leading investors in Indonesia, Chinese Ta ipei, Thailand, Viet Nam, and the Philippines. 
(8) OUTLOOK  
34. Hong Kong, China has overcome many challenges during the period under review, and its 
outlook for 2006 appears bright.  With brisk economic growth of 6.8% in the first three quarters, the 
authorities expect the economy to attain 6.5% growth in 2006, following the exceptionally strong growth in each of the past two years;  the Com posite CPI is expected to edge up by 2%, and the 
unemployment rate to drop further to 5% or below.
52  With sustained strong growth in and increasing 
integration with the Mainland53, the HKSAR economy is expected to pursue its structural shift 
towards higher-value-added services and more know ledge-based activities;  the labour productivity 
gain achieved in this process is expected to enable  the economy to attain a 4% trend growth over the 
medium term.  Given the general openness of the economy, risks to this medium-term outlook seem broadly balanced and are largely external.
54  They include a steeper than expected rise in U.S. interest 
rates, a sharper decline in world trade (i.e. global demand), and an outbreak of protectionist measures 
against Mainland China, as well as higher world energy costs.55  As HKSAR's population is aging 
rapidly, in the absence of a change in policies,  aging could adversely affect growth and living 
standards.56 
                                                      
50 Census and Statistics Department (2005). 
51 IMF (2005b). 
52 An increasing number of employees are to reach re tirement age in the medium term.  A revival of 
building activity (residential, commercial, and public wo rks) is expected to further reduce unemployment.  
Some of the major projects in the pipeline are extensions of railway lines;  a 29km bridge to link the city with 
Macau and Zhuhai;  and a new ocean liner terminal.  S ee also Hong Kong Trade De velopment Council (2005a). 
53 According to the IMF, sustained robust growth over the medium term will depend largely on the 
extent to which HKSAR meets the challenges of integration with the Mainland. Competition from regions 
within the Mainland as well as from other financial centres in Asia implies that the HKSAR will need to 
continue to bolster its competitiveness by complementing its traditional strengths – flexible product and factor 
markets, and strong institutions – with sound macroeconomic policies and productivity-enhancing reforms 
(IMF, 2005b). 
54 IMF (2004b). 
55 An element of downside risk to the global economic outlook  is the rise in oil prices.  For example,  
according to International Energy Agency  estimates, a sustained increase of US $10 in the oil pri ce is believed to 
reduce economic growth by one half of a percentage point in the first year of higher prices.  Asia as a whole 
would experience a 0.8% fall in economic output and a one percentage point deterioration in its current account 
balance (expressed as a share of GDP)  one year after the price increase (In ternational Energy Agency, 2004;  
and ADB, 2005). 
56 While higher labour productivity growth and in creased migration of young er skilled workers from 
the Chinese Mainland would attenuate the economic impact of aging, it appears that they would not offset it 
fully.  Aging will also put pressure on public finances, pa rticularly as a result of rising health-care costs.  In 
recent years, the HKSAR authorities have  been focusing on policies that c ould help limit the fiscal impact of 
aging, including continued expenditure restraint on non-age-sensitive areas, reform of health-care financing 
(including introducing private health insura nce system), and tax reforms (Leigh, 2006).