2011.11.1603:06:00UTC+00Hong Kong May Face Recession If European Crisis Worsens: IMF

The Hong Kong economy is likely to fall into recession in the event of a sudden downside shock from Europe, the International Monetary Fund (IMF) said in a report published Wednesday.

In the event of a sudden downside shock that radiates out from Europe and reduces global growth by around 3 percentage points, Hong Kong would fall into recession with growth dropping 4 to 4.5 percentage points below the baseline forecast, the Fund said.

Risks in the euro area have risen as policy uncertainty has interacted with sovereign funding strains and banking sector stress, feeding back into the real economy. Should such downside risks materialize, Hong Kong would be hit hard through both trade and financial channels, according to the report.

Another risk faced by the Special Administrative Region of China is the possibility of a hard landing in the Mainland. If this risk materialize, it will create significant turbulence in Hong Kong's economy through multiple channels of transmission.

"Trade in goods and services would decline, Hong Kong equity markets would fall, the quality of credit supplied to Mainland corporations would weaken, and overall confidence would be negatively affected," the report said.

IMF expects economic growth to ease to 5.75 percent this year, slowing further to 4 percent in 2012, due to weak external demand.

Referring to the region's rapid credit growth, the Fund said this has the potential to lead to a worsening of average credit quality, particularly if the business cycle swings into reverse. The rise in lending is also creating strains on bank funding.

IMF endorsed Hong Kong's Linked Exchange Rate System, saying that it is the "best option" for Hong Kong.

It cautioned that the proposals to abandon the currency board and repeg the Hong Kong dollar to a basket of currencies or pursue some form of crawling peg are ill-conceived.

"Such changes to the currency regime would give Hong Kong no more monetary autonomy than it has today but would sacrifice the benefits of monetary and financial stability," IMF said.

Inflation has been a cause of concern for Hong Kong. A rise in food price inflation, largely imported from the Mainland, and the pass through of higher property prices have added to the cost of living.

Though the slowing economy and waning food prices on the Mainland should take some of the impetus out of inflation going forward, the delayed pass-through from higher house prices, to rents, and on to consumer prices will likely continue for much of 2012, the report observed.

IMF forecasts inflation to end the year at 5.5 percent, remaining in the 4-5 percent range throughout 2012.