MARC has affirmed Hong Kong Special Administrative Region of China’s (Hong Kong) foreign currency sovereign rating of AAA with a stable outlook based on MARC’s national rating scale. The rating reflects MARC’s opinion of the sovereign’s ability to meet its foreign currency obligations in full and on time. The government of Hong Kong has no debt rated by MARC. The rating also serves as a country ceiling for ringgit-denominated debt issued locally by issuers domiciled in Hong Kong. Transfer and convertibility risks are reflected in the country ceiling. The analysis is based solely on information available in the public domain.

The AAA rating with a stable outlook reflects Hong Kong’s resilient and highly competitive economy, strong fiscal performance and position, and sturdy external position. Its strengths are, however, tempered by property market risk and its high exposure to mainland China.

The rating is underpinned by Hong Kong’s resilient and highly competitive economy. In addition, it is one of the world’s most thriving and cosmopolitan cities with very flexible goods, factor and asset markets. Gross domestic product (GDP) grew 2.5% in 2014, and the latest data show that it averaged 2.5% in the first three quarters of 2015. Economic growth had averaged 3.8% per annum over the 2010-2014 period. While average growth over the five-year period is relatively high on account of the country’s status as a high-income economy, annual growth has been volatile because the economy is small and highly open. It is heavily influenced by global developments, and the main external risks it currently faces are monetary policy normalisation in the United States (US) and the impact of developments in mainland China. Hong Kong’s growth momentum will likely weaken further as growth in mainland China continues to struggle, though it will benefit from further recovery of the US economy. The government expects the economy to grow between 2.0% and 3.0% in 2015. It will likely remain resilient on account of its competitiveness and continued proactive and credible economic management.

Hong Kong’s strong fiscal performance and position are key rating supports. Its track record on fiscal prudence has been impressive. For fiscal year (FY) 2014/15, its primary surplus came in at HKD82.5 billion, and fiscal reserves reached a sizeable HKD828.5 billion, equivalent to 36.1% of GDP and about 23 months of government expenditure. Having sizeable fiscal reserves, the Hong Kong government is a net creditor with no fiscal-related debt. Debt instruments denominated in Hong Kong dollars (HKD) have been issued mostly for the purposes of banking sector liquidity management and local bond market development. As at end-FY2014/15, government debt and government-guaranteed debt stood at 0.1% and 2.5% of GDP, respectively. General government external debt is also negligibly small, standing at 0.5% of GDP.

Another rating support is Hong Kong’s sturdy external position. The current account (CA) balance remained in surplus in 2014 at HKD42.2 billion, equivalent to 1.9% of GDP, thanks largely to services exports. While the services balance will likely remain in surplus going forward, there could be some negative impact from slowing economic growth in mainland China. As for Hong Kong’s overall balance of payments position, it chalked up a surplus of HKD139.1 billion in 2014, its ninth consecutive year of surpluses. Persistent CA surpluses have generated huge foreign exchange reserves that keep Hong Kong’s external position strong. Thanks to sizeable financial resources, together with proactive supervision and regulation of the financial sector, risks coming from potential volatile capital flows will be limited. Meanwhile, Hong Kong is a net creditor nation. As of end-2014, its net international investment position stood at around 284% of GDP.

The rating takes into account the fact that the property market in Hong Kong remains a large risk. Over the past five years, negative real interest rates and solid demand from mainland China have led to real estate prices increasing more than 100%. In the first seven months of 2015 alone, private property prices rose 19% year-on-year. Given Hong Kong’s currency board arrangement with the US dollar as an anchor currency, US monetary policy has a major and direct influence on monetary conditions in Hong Kong. As such, domestic liquidity conditions are set to tighten when the US Fed hikes interest rates. Property prices are expected to undergo a correction due to higher domestic interest rates, and there will be implications for bank and household balance sheets. The main risk here comes from a disorderly correction.

Hong Kong’s rating strengths are also tempered by the territory’s exposure to mainland China. For instance, the rate of growth of mainland China-related lending has continued to expand. In 2014, it rose 19.2% to HKD3,117 billion from HKD2,616 billion a year ago. With economic growth in the mainland having slowed significantly, mainland-related lending is a concern for both the Hong Kong banking sector and the overall economy. In addition, Hong Kong serves as an important gateway between the mainland and the rest of the world and as such, a hard economic landing in the mainland would have significant economic consequences for the territory. While the US is a dominant force as a driver of cyclical fluctuations in Hong Kong, mainland China is a more important force in driving the territory’s trend growth.

The stable rating outlook reflects MARC’s expectations of continued strong governance and institutions. It also reflects the anticipation of Hong Kong’s continued strong fiscal performance and balance sheet, as well as sturdy external position.

Triggers that could prompt a rating review include a hard economic landing in China, a disorderly correction of the property market following the US Fed interest rate hike, as well as disputes over territorial claims in the South China Sea escalating militarily.

Contacts:
Quah Boon Huat, +603-2082 2231/ boonhuat@marc.com.my;
Nor Zahidi Alias, +603-2082 2277/ zahidi@marc.com.my;
Afiq Akmal Mohamad, +603-2082 2274/ afiq@marc.com.my.