The International Monetary Fund (IMF) recently completed its first Article IV Consultation with the Macao SAR since the territory was handed back to China in 1999. The consultation is a health check by the IMF, during which a team of IMF economists visits each of its members countries to assess economic and financial developments and discuss macroeconomic policies with government and central bank officials, as well as business representatives and ordinary people.

Macao, of course, falls under Chinese membership and is not an independent member of the IMF - so a stand-alone consultation is not obligatory. However, with the city progressing a long way in the last 15 years and its connections with the global economic and financial system growing significantly, the time was opportune for the IMF to conduct a separate consultation at the request of the Macao and mainland authorities, of the kind that it has already been conducting with Hong Kong for a number of years. From now on, the IMF intends to repeat this exercise with Macao every two years, which should provide Macao and the outside world with an independent assessment of the territory's economic performance and prospects.

This year's consultation concluded that Macao has made impressive strides since the handover. Prudent macroeconomic management has underpinned rapid development in the territory. A sleepy backwater 15 or so years ago, the SAR has been transformed into the world's largest gaming center, bringing in seven times more revenue than Las Vegas, and now has one of the highest levels of per capita GDP in the world. The policy framework - anchored by the combination of a currency board pegged to the Hong Kong dollar, flexible markets, and a commitment to safeguarding fiscal discipline and financial stability - has served Macao extremely well and allowed it to successfully face several external shocks, including the recent global financial crisis. At the same time, inflationary pressures have picked up during this period of high growth and inequality remains a concern.

The outlook for Macao is very bright, and the IMF expects growth to remain close to 10 percent for the next few years as the global economic recovery strengthens and private investment remains strong. As a small, open and tourism-dependent economy, Macao is also benefiting from loose global monetary conditions and a mainland-related boom. However, Macao needs to prepare for future shifts in the global and domestic landscape, including implications from the unwinding of unconventional monetary policy by the United States and the mainland engaging in major structural reforms to rebalance its growth. These shifts will bring both opportunities and challenges.

Macao's recent strong economic growth has been concentrated in the tourism sector. Moreover, tourism is mainly related to the gaming industry, which accounts for four-fifths of exports, three-quarters of fiscal revenue, one-quarter of employment, and more than half of GDP. Given the economy's narrow base, external shocks to major economies like the US and the mainland could quickly spill over through reduced tourism inflows. Coping with such shocks will have to remain a top priority of the government in the coming years.

In the next few years, we should begin to see the US withdraw from unconventional monetary policy. At some point, this will translate into higher interest rates in the US, which will be mirrored in Macao due to the currency board regime. If this happens quickly, it may complicate the global recovery as well as put pressure on borrowers that have benefited from rapid credit growth and low interest rates in the last few years, notably households in Macao that have borrowed for mortgages as well as borrowers in Hong Kong, Portugal, and the mainland that have also benefited from rapid credit extension by banks in Macao. If these pressures are strong enough, they could lead to repayment difficulties, with negative implications for the quality of bank lending and the property market in Macao. However, the Macao government's strong track record of prudent macroeconomic management gives us confidence that they will remain alert to such pressures and use the tools at their disposal to monitor and address such risks.

Over the longer term, two key issues will confront policymakers. First, how Macao can more fully benefit from the on-going change in the growth model in the mainland to diversify its economy away from gaming. As the mainland rebalances its economy toward households and private consumption, Macao can adapt itself to meet the new demands related to legal, education, accounting and other services coming from mainland residents, which will create new growth engines to bolster the economy's resilience.

Second, how the government can best use its considerable fiscal savings to ensure sustainable and inclusive growth in Macao as the population ages and the gaming sector matures in the decades ahead. Options include investing more in social sectors and infrastructure, adopting a medium-term budget framework, and allocating some part of Macao's fiscal reserves to a sovereign wealth fund with a clear mandate to achieve better risk-adjusted returns over a long horizon.

The author is International Monetary Fund mission chief for the Macao SAR.

(HK Edition 08/15/2014 page9)