Hong Kong leader says Asian financial hub faces 'grave' challenges

By Donny Kwok and James Pomfret

HONG KONG (Reuters) - In her maiden policy speech Hong Kong's Chief Executive Carrie Lam on Wednesday warned the city faced "grave" challenges and must develop a diversified and high value economy, unveiling a mix of housing and tax relief policies to raise competitiveness.

Hong Kong, now among the world's most costly cities, has battled rising income inequality, the slow implementation of marquee public projects, political tensions with mainland China, and a slide in regional competitiveness.

"In the face of competition from other economies as well as the rise of protectionism in recent years, Hong Kong is facing increasingly grave challenges. We must develop a high value-added and diversified economy," Lam said.

Lam said she would bolster support for small and medium enterprises in the Asian financial hub by cutting company profits tax to 8.25 percent from 16.5 percent for the first HK$2 million of earnings. Earnings after that would be taxed at the current 16.5 percent.

On combating Hong Kong's soaring housing prices, Lam said that despite a raft of property cooling measures, the government had "no magic wands".

Lam pledged to increase land supply where possible and launch a new subsidised "starter homes" scheme to help families not eligible for cheap-rental public housing. The first phase would provide around 1,000 residential units.

"Even if our housing policy has broad community support, it takes time to find land for increasing the housing supply," conceded Lam, Hong Kong's first female leader.

Hong Kong -- where people are squeezed into an average living space of just 150 square feet (14 square metres) per person -- is the world's most expensive city for flats, according to a recent UBS report ranking 20 leading global cities including New York, London, Tokyo and Singapore.

Chinese President Xi Jinping also voiced concern over the financial hub's property market when he visited on July 1.

Some observers felt Lam's housing initiatives were not bold enough.

"Property shares are down because of the lack of mention of farmland conversion to build first homes. But the chief executive cannot be too specific, so the sell-off doesn't reflect the real picture," said Nicole Wong, a property analyst with CLSA.

Lam also said Hong Kong would aim to double expenditure on research and development over the next five years, to 1.5 percent of annual GDP from 0.73 percent, in a bid to bolster its sputtering tech prospects with neighbouring Chinese city Shenzhen having galloped ahead in recent years.

Income inequality is at its highest level in over four decades in the city of 7.3 million people, stoking discontent that has seen large-scale protests in recent years over calls for more affordable housing as well as democracy.

Since taking office Lam has sought to heal social divisions amid growing tensions with China, and to forge a softer and more socially engaged leadership style than her predecessor, the staunchly pro-Beijing Leung Chun-ying.

Britain returned Hong Kong to Chinese rule in 1997 under a "one country, two systems" formula which guarantees wide-ranging autonomy and judicial independence not seen in mainland China.

But tensions between Hong Kong and China have heightened in recent years amid concern over Beijing's interference in the former British colony, sparking large scale pro-democracy protests and some calls for outright independence from China.

Lam said Hong Kong has the responsibility "to say 'no' to any attempt to threaten our country's (China's) sovereignty, security and development interests."

"We need to have a society that is united, harmonious and caring," she said.

(Additional reporting by Venus Wu, Umesh Desai and Anne Marie Roantree; Editing by Michael Perry)