In his 1999 Budget Speech, the Financial Secretary gave an update of the progress of EPP. He also emphasised that EPP was not a slogan. It signified the public sector's concerted efforts to secure lasting and sustainable improvements in the delivery of public services. 

Seen against the fiscal situation described in the 1999 Budget Speech, EPP has added significance. This article explains why.

Controlling Government Expenditure Growth
Hong Kong prides itself in its prudent public financial management, i.e. living within our means. One of our well-established budgetary principles is to ensure that government expenditure over time grows no faster than the trend growth of the Gross Domestic Product (GDP) -- a principle which is enshrined in Article 107 of the Basic Law. Figure 1 below compares cumulative growth in government expenditure with that in GDP. 
Figure 1

For years, we have been keeping government expenditure in line with GDP growth. However, for 1998-99 and indeed throughout the entire medium term, government expenditure has outstripped and will continue to outstrip GDP growth. This is the result of continuous spending to meet community needs during the economic downturn. For 1998-99, the economy contracted by 5.1% while spending was planned at 5% growth. For 1999-2000, the economy is forecast at a modest growth of 0.5% with spending continued at 3.5%. Together, they have produced a gap of 13%. Action must be taken to bridge the gap. To do so, we need to ensure that government expenditure grows at a rate slower than the forecast growth rate of economy in the years ahead. FS has announced in his 1999 Budget Speech that while a trend GDP growth of 3.5% in real terms is adopted for the Medium Range Forecast1, we will only allow government expenditure to grow by 3% in 2000-01 (over the estimates for 1999-2000) and by 2.5% in both 2001-02 and 2002-03. 

"One of our fundamental budgetary guidelines is to ensure that, over time, government expenditure grows at a rate no faster than the economy as a whole. In pursuit of this guideline we have, for many years, planned the growth of government expenditure in line with the forecast trend growth of GDP."

- The Financial Secretary,  1999 Budget Speech

Maintaining Fiscal Balance
Article 107 of the Basic Law also stipulates that in drawing up its budget, the HKSAR shall strive to achieve a fiscal balance and avoid deficits.

The conscious decision to continue government spending so as not to drive the economy into deeper recession and to avoid substantial tax increases so as not to hit businesses and individuals means that a budget deficit in the short term is inevitable. Figure 2 on the next page shows the fiscal position over the Medium Range Forecast, projected at the time of the 1999-2000 Budget.
Figure 2

Given the circumstances, a deficit budget in the short term is entirely consistent with the provisions of the Basic Law so long as it is set in the context of a return to balanced budgets over the medium term. To achieve this, we need to implement the moderate revenue raising measures as proposed in the 1999 Budget as well as to strictly control government expenditure.

A balanced budget over the medium term is vital to the HKSAR as we need to maintain strong fiscal reserves. The importance of a healthy reserve was exemplified during the financial turmoil last year. Because of the short-term fiscal deficit, it is expected that our fiscal reserves will fall from $458 billion at 1 April 1998 to $383 billion at 31 March 2001 before picking up again over the next two years to a level of $406 billion at 31 March 2003. This leaves the fiscal reserves within the guidelines set in the 1998 Budget Speech, albeit at the lower end of the range.

"Even this reduced level of growth will not bring the cumulative growth in expenditure fully back in line with cumulative economic growth by the end of the forecast period. We may well need to maintain a similar degree of restraint over the growth in  expenditure for a further two years after 2002-03. This underscores the need for us to achieve the savings targeted under the EPP and to re-prioritise the different areas of government spending."

- The Financial Secretary,  1999 Budget Speech

Attacking Baseline Expenditure
The target of the short-term phase of EPP is to reduce recurrent baseline expenditure by 5% by 2002-03. One may not realise how significant the baseline expenditure accounts for Government total recurrent expenditure. Baseline expenditure means the recurrent resources required to fund current activities. The baseline expenditure is built up over the years. It may contain expenditure on services or activities which are of lesser priority than other newly emerging public demand. It may be spent on doing things in an obsolete mode. As illustrated in Figure 3 on this page, baseline expenditure accounts for 96% of the total amount of recurrent resources available in 1999-2000 under the budgetary guideline used for planning in 1998. If we are able to take just 1% from the vast pyramid bottom (the baseline expenditure), it already represents $1,635 million, more than double the total amount of money available for funding new services in the annual Resource Allocation Exercise.
Figure 3

Between the baseline expenditure and new money available for allocation to new or improved services is the earmarked growth. This chunk of expenditure, in recent years, takes up no less than 3% of expenditure growth. It is for meeting our obligations, statutory or contractual, and living up to our past promises. For example, pension payments to retired civil servants, social security payments to increasing number of people requiring financial assistance, recurrent consequences of capital projects coming on stream such as new hospitals and schools. With expenditure growth moderating, earmarked growth is also an area we need to examine more closely if we wish to preserve some headroom for allocating to worthwhile initiatives in the coming years. 

"There are specific targets to achieve at every stage of EPP. By 2002-03, managers are required to reduce operating expenditure by a total of 5 per cent without prejudicing the quality of services to the public. Concurrently, we will seek more fundamental reforms in the management and delivery of public services."

- The Financial Secretary,  1999 Budget Speech

EPP is expected to make significant contribution to controlling government expenditure growth and to achieving fiscal balance. Through its short-term phase, we aim to reduce baseline expenditure by over $5 billion by 2002-03. Under the mid-term phase of EPP under way, we seek to achieve greater rationalisation in use of public resources through a number of Fundamental Expenditure Reviews in related areas. Our efforts in this and other areas are described in Phase Two of EPP in this issue. 

1 For those who are interested in Medium Range Forecast, please refer to the supplement attached to the printed version of the Budget Speech.

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