In the year 1998 immediately following the asian

In the year 1998, immediately following the Asian Financial Crisis,
the real export fell by 4.3% following almost a decade of double digit
growth. Real GDP also fell by 5.5% and real consumption dropped by
6.8%. Import price inflation was negative 4.9% and the nominal effective
exchange rate appreciated by 5.5%. The nominal best lending interest
rate reached a peak of 9.9% with consumer price inflation at 2.9%, the
real best lending interest rate was at 7%. In the sub-period 1999-2002 the
economy rebounded briefly but succumbed to the 2001 global economic
recession and deflation began to set in firmly; the bursting of the internet
asset bubble in 2000 also took its toll.
The year 2003 was one of a great reversal in economic fortune. At the
beginning of the year there was great promise of an economic recovery
starting from the rebound that began towards the end of 2002 in real
exports growth. The Hong Kong Dollar followed the US Dollar and
started to depreciate. Import price deflation was beginning to end.
Nominal interest rates were beginning to adjust downwards. But Hong
Kong would be ravaged by Severe Acute Respiratory Syndrome (SARS).
the Hong Kong economy shrank by 0.7% year-on-year in the second
quarter from the 4.3% growth achieved in the first quarter of 2003. Real
consumption dropped 1.1%. Nevertheless, strong global economic
growth contributed to the rapid economic rebound starting from the third
quarter of 2003.
In the sub-period 2004-2005 the evidence of broadly based economic
recovery is reflected in strong growth of external trade, falling interest
rates, and rising consumption and investment. The Hong Kong Dollar

Alan K. F. Siu and Yue-Chim Richard Wong 48
continued to weaken and import prices were rising. Deflation had
disappeared and a modest amount of price inflation emerged. Real GDP
was growing at 7.8%.
To what extent is deflation in Hong Kong a result of structural factors
as opposed to cyclical factors?
According to a recent study by the Hong Kong Monetary Authority
(April 2002), the average price differential, based on 300 products,
between Hong Kong and 4 Mainland cities, namely Shenzhen,
Guangzhou, Shanghai and Beijing, was estimated to be around 20 per
cent in 2001. They found that this differential would depress the overall
price level in Hong Kong by less than 0.5 per cent over a one-year
period. Prices in Hong Kong and the four Mainland cities have been
converging, albeit very slowly. The existing price differential would on
average be reduced by half in 6.5 years.
Another recent study by the International Monetary Fund (May
2002), using the ratio of the consumer prices indices in Hong Kong and
Shenzhen as a measure of the average price gap, suggests that the price
level gap plays only a minor role in explaining the deflation in Hong
Kong. Cyclical factors, as proxied by unemployment rate, credit growth
and the nominal effective exchange rate, are much more important
determinants of deflation in Hong Kong.