The International credit rating agency Standard & Poor's may raise its ratings outlook for Hong Kong this year if the economy continues to improve and the government carries through on promises to cut spending and fix structural problems.

Paul Coughlin, the agency's managing director of Asia-Pacific corporate and government ratings, was quoted by Wednesday's South China Morning Post as saying that "We're seeing some windfall gains as the stock market and the economy bounce back" in Hong Kong.

But with the budget deficit expected to hit 78 billion Hong Kong dollars this year, he said the government still had to cut spending.

"We'll be looking for implementation of policy and biting the bullet and taking difficult decisions to restrain expenditure growth" in the upcoming March budget," Coughlin said.

"If that occurs, I think the prospects of going from negative to stable are quite reasonable," he said.

S&P rates Hong Kong's long-term local currency debt at AA-minus,the fourth highest of 10 investment grades, with a negative outlook, which means the rating is more likely to be downgraded. It rates the city's foreign currency debt at A-plus, the fifth-highest rating, with stable outlook.

However, the report said the Hong Kong government still needs to fix structural problems. The biggest problem is the narrow tax base. Only about 1.24 million of Hong Kong's working population of3.2 million pay taxes.

At the same time, the government's main source of revenue, landincome, has disappeared amid the slumping property market. That has prompted calls for a general sales tax and cuts in spending, particularly on the civil service.

At Fitch Ratings, Brian Coulton, senior director of Asia sovereign ratings, was also cautiously optimistic.

"We certainly recognize that the picture is improving quite sharply," Coulton said.

"It seems to have gone past a post-SARS rebound, but because ofour view on deflation as still not being out of the way, and also because we're still concerned about the fiscal deficit, we maintain a negative outlook." Fitch has an AA-minus rating on HongKong's long-term debt.

A better credit ratings means governments and companies can borrow money more cheaply.

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