Nov. 14 (Bloomberg) -- Hong Kong's economy entered its first recession since the outbreak of a deadly epidemic in 2003 as the global financial crisis cut exports and spending cooled, forcing the government to lower its full-year growth forecast.

Gross domestic product shrank a seasonally adjusted 0.5 percent in the third quarter from the previous three months, the government said today. The measure fell 1.4 percent in the second quarter. The decline was more than the median estimate of a 0.2 percent drop in a Bloomberg News survey of six economists.

The financial crisis has cut demand for Chinese products shipped through the city, damped confidence and slashed share prices. Chief Executive Donald Tsang said Nov. 3 that the risk of a recession was rising even after the monetary authority cut the key interest rate.

``As an open economy, exports and financial services are extremely crucial to Hong Kong and their slowdown will spill over to the domestic sector,'' said Joe Lo, senior economist at Citigroup Inc. in Hong Kong.

On a year-on-year basis, Hong Kong's economy grew 1.7 percent in the third quarter, the government said, after expanding 4.2 percent in the previous three months. The technical definition of a recession is two consecutive quarters of negative growth.

The government today cut its forecast for economic growth this year to between 3 percent and 3.5 percent from the previous estimate of between 4 percent and 5 percent. The economy expanded 6.4 percent in 2007.

Consumption Cools

``The substantial fall-off in stock market triggered by the global-wide stock market crash and the spillover to the property market, coupled with the less promising job prospect, will continue to restrain consumers' propensity to spend,'' the government said in a statement today. ``Businesses are also likely to turn more cautious in making machinery and equipment acquisitions.''

Household consumption rose 0.2 percent in the quarter from a year earlier, after gaining 3.2 percent in the previous three months, the government said today. Business investment increased 3 percent, after previously climbing 3.5 percent.

``Consumption growth will slow further with the impact of a softer labor market and the negative-wealth effect setting in,'' said Enoch Fung, an economist at Goldman Sachs Group Inc. in Hong Kong.

The year-on-year expansion in GDP was the weakest since the second quarter of 2003, when the economy shrank because of the severe acute respiratory syndrome epidemic.

Chinese Demand

The monetary authority reduced the base rate for banks by 1 percentage point last month, as well as matching cuts by the Federal Reserve. The rate is now 1.5 percent, down from 6 percent a year ago. A currency peg to the dollar means Hong Kong's rates follow moves in the U.S.

Exports rose 1.4 percent in the quarter from a year earlier, down from 4.4 percent in the previous three months. Demand for Chinese goods is slipping because of an economic slowdown that has already pushed Europe's largest economy, Germany, into a recession.

Consumer confidence fell in the second half of this year to the lowest level in four years, the Nielsen Company said last week, and retail sales grew by the least in 17 months in September.

The 51 percent slump this year in the city's benchmark stock index, the Hang Seng Index, and weakness in the real estate market have damped spending. The number of home sales posted the biggest drop in almost nine years in October.

Companies are failing as the economy slows. The franchisee of Krispy Kreme Doughnuts Inc., the second-largest U.S. doughnut chain, started shutting stores in the city last month after going into liquidation.

U-Right International Holdings Ltd., operator of about 600 clothing outlets in Hong Kong and China, and Tai Lin Radio Service Ltd., a 60-year-old electrical appliance retail chain, are also casualties.

To contact the reporters on this story: Nipa Piboontanasawat in Hong Kong at npiboontanas@bloomberg.net; Wendy Leung in Hong Kong at wleung12@bloomberg.net

Last Updated: November 14, 2008 05:07 EST