Hong Kong: Plumming the Bottom of Deflation

Some pretty depressing news from Morgan Stanley's Denise Yam looking into the realities of deflation, Hong Kong Style.

Consumers are heading to shopping malls again as SARS is brought under control. Tourist groups are arriving again. Is it business as usual already? Far from it. Business volumes may be seeing a noticeable rebound, but the top and bottom lines are not, as deflation once again deepens in Hong Kong. Special promotions, which are not fully captured in conventional CPI statistics, suggest that we may be underestimating deflation and are overoptimistic on corporate earnings this year. The aftermath of the SARS crisis is yet to be fully reflected in the labor market. Higher unemployment and reduction in spending power can be expected to continue to haunt business receipts for some time to come.

A price-conscious consumer like myself can hardly recall many retail purchases in the last few months that did not come with special offers, discounts, free parking coupons or loyalty cash rebates. However, not all of these popular customer-luring offers are accounted for in the CPI. The data collection methodology traditionally involves recording the “ticket price” that is available to all customers, although the Census and Statistics Department has, recently, in response to the increasing dominance of discounted sales, tried to incorporate the adjusted prices to the extent possible. The price of an item is normally taken at face value, with a limited adjustment for bulk-buying / credit card discounts depending on the proportion of customers taking advantage of the benefit. Nevertheless, coupons for parking and other gifts still cannot be accounted for. On the other hand, surveys generally cover similar outlets every month, and therefore give limited room for consumers capitalizing on viable and sensible substitutions. It is not possible to estimate the “true” extent of deflation with the limited availability of data on the increasingly innovative consumer choices and complex consumption patterns. In our view, the official CPI, which posted a drop of 1.9% YoY in January-May, likely underestimates the broad improvement in living standards resulting partly from “special promotions” and the availability of lower-priced alternatives relative to household income trends. How representative it is of the cost of living is therefore questionable.

A price-conscious consumer like myself can hardly recall many retail purchases in the last few months that did not come with special offers, discounts, free parking coupons or loyalty cash rebates. However, not all of these popular customer-luring offers are accounted for in the CPI. The data collection methodology traditionally involves recording the “ticket price” that is available to all customers, although the Census and Statistics Department has, recently, in response to the increasing dominance of discounted sales, tried to incorporate the adjusted prices to the extent possible. The price of an item is normally taken at face value, with a limited adjustment for bulk-buying / credit card discounts depending on the proportion of customers taking advantage of the benefit. Nevertheless, coupons for parking and other gifts still cannot be accounted for. On the other hand, surveys generally cover similar outlets every month, and therefore give limited room for consumers capitalizing on viable and sensible substitutions. It is not possible to estimate the “true” extent of deflation with the limited availability of data on the increasingly innovative consumer choices and complex consumption patterns. In our view, the official CPI, which posted a drop of 1.9% YoY in January-May, likely underestimates the broad improvement in living standards resulting partly from “special promotions” and the availability of lower-priced alternatives relative to household income trends. How representative it is of the cost of living is therefore questionable.

Deflation has lasted for four and a half years - so far - in Hong Kong, longer than anyone expected, and does not seem to be coming to an end yet. Consumer prices, based on the composite CPI compilation, have fallen by 13.8% from the peak in May 1998. However, the CPI, though the most common measure of inflation / deflation, only represents a cost-of-living index for households according to the prevailing consumer spending patterns, with the weights updated every five years. The domestic demand and GDP deflators derived from the national income accounts, which gauge economy-wide price trends, on the other hand, have fallen 18.3% and 20.5%, respectively, from the peak in 4Q 97, suggesting how severe deflation had been in Hong Kong over the past five years following the collapse in the asset bubble. On the whole, prices have proved to be rather flexible in Hong Kong’s free market economy, and this flexibility is what is vital under the 20-year-old fixed exchange rate system that is often blamed as the cause of the asset bubble and the subsequent collapse and economic hardship.
Source: Morgan Stanley Global Economic Forum
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