Fiscal Sustainability in Hong Kong Under the Linked Exchange Rate System: Risks, Challenges, and Policy Recommendations for Deficit Reduction and Structural Reform

Abstract

Hong Kong’s public finances have entered a period of heightened scrutiny following the recent expansion of the government bond issuance ceiling to HK$900 billion to finance ambitious infrastructure projects, including the Northern Metropolis (NM) development. Despite official projections maintaining a government Debt-to-GDP ratio at a prudent 12-16.5% level during the Medium Range Forecast (MRF) period, this paper project the Debt-to-GDP ratio will be more than 20% in beyond 2030’s, so, we argues that such metrics understate underlying vulnerabilities inherent in Hong Kong’s currency board arrangement. The Linked Exchange Rate System (LERS) precludes independent monetary policy, compelling interest rates to shadow U.S. Federal Reserve decisions and amplifying fiscal leverage risks amid volatile revenue streams from land sales, stamp duties, and property markets. Drawing on monetary economics and fiscal theory, including Ricardian equivalence and debt sustainability analysis, this study examines the interplay between structural deficits, contingent liabilities from large-scale public works (infrastructure project), and the credibility of the LERS. Policy recommendations emphasize administrative competency gains through new tech adoption in tax administration, and supplyside diversification of the tax base via regulated gaming in order to maximize the revenue, and Build-Operate-Transfer (BOT) models for infrastructure in order to minimize the expenditure. These measures aim to enhance fiscal resilience, broaden the revenue base, and safeguard intergenerational equity without compromising the currency peg’s stability. The analysis underscores that sustained fiscal prudence is essential for maintaining investor confidence and Hong Kong’s role as an international financial center.