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					August 2011       Country Report Hong Kong

              1. Structural data

              Geographical extension:    1,099 km²
              Population size:           7.12 million (2010)
              Population density:        6,433 inhabitants / km²
              Per-capita GDP:            USD 31,600 (2010)
              Currency:                  Hong Kong dollar (HKD)
              Exchange rate (July 2011): HKD/EUR 11.11
                                         HKD/USD 7.79 (dollar peg)

              2. Political situation

              The situation on the domestic-policy and foreign-policy fronts is comparatively
              stable. It is true that the Special Administrative Region (SAR) is directly subject to
              the central government in Beijing; on the other hand, it enjoys a large amount of
              autonomy except when it comes to foreign and defence policy. More specifically,
              Hong Kong has its own currency, is an independent member of a number of inter-
              national organisations, and makes its own decisions on immigration and emigra-
              tion policy. It would appear that the legal construct in operation - “one country,
              two systems“ - which is unusual from the point of view of international law, is
              accepted by a majority of the population. The population’s attitude as well as the
              SAR's political stance are going to be shaped in future, too, by the interest in con-
              tinuing with Hong Kong’s successful economic tack, and this interest will ensure
              that relations with the People’s Republic remain largely tension-free. Nevertheless,
              the domestic-policy climate is not entirely cloudless. Attempts to push through
              more democracy are being blocked due to the influence of mainland China; in
              cases of doubt, legal decisions in particular are liable to be overridden by Chinese
              laws. As a consequence of this, demonstrations calling for more democracy are
              repeatedly taking place. This year, a surprisingly large number of people joined the
              annual demonstrations held on 1st July, which commemorate Hong Kong's return
              to the People's Republic. The demonstrators took to the streets to express their
              disappointment about rising real-estate prices and the policy pursued by the terri-
              tory's Chief Executive, Donald Tsang. The pledge made by the People's Republic to
              allow free elections from 2017 onwards does not go far enough in the eyes of both
              Hong Kong's pro-democracy parties and large swathes of the population. The terri-
              tory’s dependent status and the influence being exercised by the People’s Republic
              also constitute a significant potential risk hanging over the future development of
              Hong Kong as a major trading and financial metropolis. Alterations to the eco-
                                                          Country Report Hong Kong     2

nomic system would inevitably detract from the location’s attractiveness. At the
same time, however, China is stepping up the process of economic integration.

3. Macroeconomic development

Being a small, open economy with a structure oriented towards services, Hong
Kong was severely hit by the slump in global trade in late 2008. After a 2.8% de-
cline in real GDP in 2009, however, the economy quickly pulled out of recession on
the back of the dynamic cyclical trend across the whole of the Asian region. In
2010, Hong Kong recorded a rate of expansion of 6.8%. Real GDP growth rates of
5.4% and 4.2% are being projected for 2011 and 2012, respectively. The upswing is
being underpinned in particular by strong external demand as well as by a flour-
ishing domestic market. Between 2009 and 2022, the government will invest some
USD 70 billion in the construction of subway and suburban-train systems, bridges
and new metropolitan neighbourhoods. This corresponds to roughly one third of
Hong Kong's aggregate economic performance and should boost GDP growth by
an average of two to three percentage points per annum in the next eleven years.
Driven by the fiscal stimulus which has been imparted (above all in the form of tax
rebates and tax repayments), consumer confidence - and therefore consumer ex-
penditure - has made a notable leap forward of late. This trend is being lent addi-
tional support by the relaxation in the situation on the labour market, which is
responding very flexibly. Having climbed by almost two percentage points to 5.2%
in 2009, the average unemployment rate is set to recede to 3.6% by the end of

Inflationary pressure has accelerated in reaction to the upsurge in consumer
spending. In June, the year-on-year increase in the Consumer Price Index reached a
35-month high of 5.6%. On an annual average, inflation will presumably level off
at a shade under 5%. So far, the central bank (the Hong Kong Monetary Authority)
has left its key policy rate unchanged at a record low of 0.5% in order to support
the cyclical upswing. To counter the increase in prices, the HKMA would have to
raise its key rate somewhat in the not-too-distant future. Due to the currency peg
to the USD, however, Hong Kong's central bank is tied to the steps taken by the
Federal Reserve in the United States. With the latter announcing that it will not
increase its key rate until 2013, a tightening of the monetary reins on the part of
the HKMA is not to be expected before then either. Given the strained supply
situation on the housing market, the adequate liquidity that is available and the
strong demand for real estate by mainland Chinese and employees from the finan-
cial industry, price pressures will, in all likelihood, increase further in the near fu-
ture, especially in the residential real-estate market.

                                                         Country Report Hong Kong    3

Apart from its role as a pre-eminent trading and financial centre in the Asian re-
gion, Hong Kong is increasingly gaining importance as a financial intermediary as
well. On account of the capital controls which are in force in the People's Republic,
the road to international capital markets leads via Hong Kong in the case of com-
panies located in mainland China. This, at the same time, provides foreign inves-
tors with an opportunity to take a financial exposure to China. In spite of its posi-
tive macroeconomic framework conditions and the important strategic role which
it plays in the region, Hong Kong's extremely open economy, which is dependent
on trade as well as tourism, remains susceptible to exogenous shocks.

4. Foreign trade

Extremely high export-to-GDP and import-to-GDP ratios of over 175% in each case
illustrate to what a pronounced extent the Special Administrative Region is inte-
grated into the world economy - but, at the same time, reveal its economic de-
pendence on the export-goods industry. The economic recovery is also evident
from the revenues generated by both the export and import sectors. At present,
Hong Kong is benefiting to a particular extent from China's booming economy: the
People's Republic is the destination of more than half of the goods shipped by the
Special Administrative Region. In June, merchandise exports went up by approxi-
mately 9% year-on-year, while imports soared by as much as a tad under 12%. In
the sphere of merchandise trade, however, where re-exports (mainly to and from
China) are predominant with a share of more than 98%, heavy deficits have been
registered for years (USD 43 billion in 2010). Thanks to the fact that the balance of
services is well into the black (with tourism making a particularly positive contribu-
tion here, along with banking and insurance services) and to proceeds from
earned and unearned income, Hong Kong's current account has nevertheless been
in positive territory for years. Its current-account surplus is going to correspond to
approximately 5.5% of GDP in the coming years as well.

5. Financial status

Not least on account of its efficient banking system and the second-largest stock
exchange in Asia, Hong Kong enjoys a good reputation on the international finan-
cial markets. The territory is a net creditor vis-à-vis the rest of the world. Due to
sizeable budget surpluses, the state sector is almost debt-free, with liabilities cor-
responding to less than 5% of GDP. This status has not deteriorated to any signifi-
cant extent in the wake of the financial crisis – despite an extensive economic-
stimulus programme. A budget surplus of slightly under 5% is expected for the
present year.

                                                            Country Report Hong Kong      4

In the Country Credit Rating published in the March 2011 issue of the magazine
“Institutional Investor“, Hong Kong came 17th in a field of 178 countries which
received ratings, gathering 85.5 out of a possible total of 100 points.

6. Outlook

Thanks to strong external and robust domestic demand, Hong Kong's economy
has returned to a stable growth path. At present, the Special Administrative Re-
gion is facing a number of challenges – brisk demand in the real-estate market is
fanning noticeable price increases and the economy is highly dependent on the
export sector. In addition, economic integration into the People's Republic – with-
out mainland China exerting an excessive amount of influence – is tantamount to
a balance act. That said, the city state’s long-term prospects continue to look aus-
picious. Current-account surpluses, a large stock of foreign-currency reserves and -
above all - intact public finances provide Hong Kong with plenty of scope to re-
spond to any possible negative developments.

Completed on 17th August 2011.

Author:                      Editorial staff:               Corporate address:

Verena Strobel               RO Country Risk and Sectoral   Bayerische Landesbank
Tel +49 89 2171- 21320       Analysis                       Brienner Straße 18                D-80333 Munich
                                                            Tel +49 89 2171-01


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