Hong Kong Special Administrative Region of China - 2014

MARC has assigned a foreign currency sovereign rating of ‘AAA’ with a stable outlook to the Hong Kong Special Administrative Region of China (Hong Kong) based on the rating agency’s national rating scale. The government of Hong Kong has no debt rated by MARC; the country ceiling applies to ringgit-denominated issuances by entities domiciled in Hong Kong to reflect the transfer and convertibility (T&C) risk in ringgit-denominated debt issuances by foreign issuers. The rating is based solely on an analysis of information in the public domain.

Hong Kong enjoys a strong sovereign credit profile. It has sturdy economic fundamentals, is solid fiscally, and has a strong external position as well as a well-managed resilient financial sector. However, it faces high property market risks, and event risk associated with its substantial exposure to mainland China.

With its integration into China, and with the opening up of the Chinese economy, Hong Kong is an important gateway to the world’s largest market. This has helped boost its economic strength, which supports the rating. It is a very open free market economy, and has been named the third best country in the world for business. It is highly ranked at number seven in the World Economic Forum’s (WEF) Global Competitiveness Index (GCI) 2014–2015. Economic growth has been resilient because of its sturdy economic fundamentals, and is expected to remain so going forward. Over the 1991-2013 period, the Hong Kong economy grew 3.9% per annum (p.a.) on average, a commendable level considering its high-income status (per capita purchasing power parity gross domestic product or PPP GDP of 53,203 current international dollars in 2013). Growth volatility over the same period has been relatively low, lower than in Malaysia.

The rating is further supported by Hong Kong’s track record on fiscal prudence, which has been impressive. The Hong Kong government has no fiscally related debt. Thanks to tight expenditure control, the government continued to register a small surplus even during the Global Financial Crisis (GFC) years (2008–09). Sustained fiscal discipline has led to a sizeable accumulation of fiscal reserves. As at the end of the 2013-14 fiscal year, fiscal reserves reached a sizeable 35.2% of nominal GDP, which is more than 20 months of government expenditure. Prudent fiscal policies are especially important for Hong Kong to ensure that its Linked Exchange Rate (LER) system is not affected by government debt or fiscal deficits.

Hong Kong’s strong external position is also a key rating support. For the eighth consecutive year in 2013, it churned out a balance of payments surplus equivalent to 2.7% of nominal GDP. Its current account structural surpluses are largely due to its services exports in which it has a strong edge in the region. As a result of Hong Kong’s solid current account surpluses, the level of foreign reserves is high. And with net external financial assets amounting to 280.0% of nominal GDP in 2013, Hong Kong is a net creditor, thanks to years of concerted savings and productive investment overseas. While overall external debt as a percentage of nominal GDP may seem high at 425.5% (2013), it is made up mostly of short-term inter-bank placements from overseas banks because of Hong Kong’s position as a major financial centre.

Also underpinning the rating is the resilience of Hong Kong’s financial sector, one of the largest and most developed in the world and which is ranked number one in the WEF’s Financial Development Index 2012. The banking system has assets of USD2 trillion, which is equivalent to 705% of GDP, and is highly capitalized, profitable and liquid. As at end-March 2014, the total capital adequacy ratio stayed high at 15.9%, with banks’ Tier 1 capital ratio at over 13%. Stress tests conducted by the International Monetary Fund (IMF) confirm that the banking sector is highly resilient, as the results suggest that even a severe economic shock would not cause an aggregate capital shortfall over a five-year forecast horizon. Net interest income has steadily improved, and the liquidity ratio of 39% remains well above the statutory minimum of 25%. The asset quality of the banking sector also remains good.

The rating also takes into account Hong Kong’s residential property market which is a large risk factor for its economic outlook. There is potential for the combination of factors like a surge in new supply, cooling measures, and an impending interest rate rise to trigger a correction in the property market. Also worrisome is the possibility of a contagion effect resulting from falling prices in China’s sputtering property market. However, the active deployment of macro-prudential policies that include tighter limits on loan-to-value ratios and debt-servicing ratios by the Hong Kong Monetary Authority (HKMA) have somewhat mitigated systemic risks.

As the level of economic and financial integration between Hong Kong and China continues to rise, so is Hong Kong’s exposure to China, and any adverse development on the mainland can significantly impact Hong Kong’s real or financial sector. On the other hand, any positive development in China, be it economic, social, or political, will be credit positive for Hong Kong. China has drawn great benefits from Hong Kong’s unique status - a territory sealed off from the mainland but closely connected to and controlled by it, and one fully integrated into the global economy. While the ongoing pro-democracy protests have somewhat affected financial business in Hong Kong, one thing is clear; it is certainly in China’s interest not to jeopardise the “one country, two systems” relationship and ensure that Hong Kong’s future is not put at risk.

The stable outlook reflects MARC’s assumption that the Chinese economy will not experience a hard landing. It also reflects expectations of continued mainland Chinese commitment to ensuring Hong Kong’s peaceful and stable development. MARC also assumes that the ongoing broad assault against corruption in state-owned enterprises in mainland China, which suggests that Beijing is committed to improving governance, will continue. This will be a positive development for Hong Kong as it implies continued effective policymaking and implementation in Hong Kong going forward.

Major Rating Factors

Strengths

• Sturdy economic fundamentals with positive growth prospects;
• Solid fiscally;
• Strong external position; and
• Resilient financial sector

Challenges

• Property market risk; and
• Rising exposure to China