The IMF also says the SAR's economy will expand next year more than initially expected and contract less this year than previously forecast.

But the IMF warned that Hong Kong could face sharp asset-price inflation after a steep climb in prices for certain real estate and financial assets.

Noting that recent monthly indicators have been positive, the IMF revised up its economic growth estimate for the SAR to 5 percent in 2010 from a previous estimate of 3.5 percent.

It forecast a 2 percent decline this year, against a 3.5 percent fall previously.

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"The recovery is now under way," said the IMF annual report on Hong Kong, adding that it is being fueled by growth in the mainland, stimulative fiscal policies, the government's stimulus measures and highly accommodative monetary conditions imported from the United States. "However, although mainland growth is gathering strength, the world economy is still fragile and the global recovery is likely to be drawn out and subject to downside risk," the IMF said.

Irina Fan Yuen-yee, Hang Seng Bank (0011) senior economist, said low consumption demand in the United States will hinder Hong Kong's export businesses.

"Overseas economic activities are steady now and unemployment in Hong Kong is falling," Fan said. "But people in the US are not as willing to spend as before and that will be bad news for Hong Kong's exports."

Bank of East Asia (0023) chief economist Paul Tang Sai-on attributed the improved economic data for next year to a lower base of comparison since the city dipped into a trough during the end of last year and the first half of 2009.

Asset prices have surged since March and the SAR government is concerned that a credit-asset price cycle could take hold.

The IMF shares the same view, saying "there is a risk that prices could become driven more by short-term liquidity conditions, divorced from fundamental forces of supply and demand."

It welcomes "the consideration that is being given to increasing the supply of land to the market as one of the possible means" to help moderate potential property price surges.

Financial Secretary John Tsang Chun-wah said the IMF's overall assessment of Hong Kong is fair and balanced. "We will continue to pursue the strategy of `stabilizing the financial system, supporting enterprises and preserving employment' until the recovery is firmly in place," Tsang said.

Hong Kong Monetary Authority chief executive Norman Chan Tak-lam said the body "will continue to be vigilant in maintaining banking and financial stability in Hong Kong."