Thursday, Dec 22, 2016
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 (T&C) 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 rising property market risk and its high exposure to mainland China.
The rating is underpinned by Hong Kong’s resilient and highly competitive economy. Hong Kong is a relatively rich country, with a per capita gross domestic product (GDP) on a purchasing power parity basis of 56,719.50 international dollars in 2015. With its integration into the large hinterland that is China, it has transformed itself into a service-based economy with a competitive advantage in finance. It has been ranked the world’s most competitive economy in 2016 by the International Institute for Management Development’s (IMD) World Competitiveness Centre. It is also highly ranked at number nine out of 138 countries in the World Economic Forum’s Global Competitiveness Report 2016-2017. Economic growth remains resilient, although growth volatility has been high. Over the 2011-2015 period, Hong Kong registered a growth volatility of 1.3%, compared to Malaysia’s 0.5%. In 2015, GDP growth moderated slightly to 2.4% (2014: 2.7%) as domestic demand expanded at a slower pace despite the rebound in contribution from net exports to GDP growth. Private consumption, at 66% of GDP (2015), remains a key driver of GDP growth.
Hong Kong’s strong fiscal performance and position are key rating supports. It has an impressive track record on fiscal prudence. In FY2015/16, it churned out a primary surplus of HKD14.4 billion. As a result of its strong fiscal performance, Hong Kong has managed to rack up a sizeable amount of fiscal reserves. The reserves are particularly important as Hong Kong has no independent monetary policy because of the exchange rate link to the USD. At end-FY2015/16, its reserves reached a sizeable HKD842.9 billion, 171.3% higher than a decade ago and equivalent to 34.9% of GDP. Thanks to its strong fiscal performance, the government has no fiscal-related debt. It has, however, issued HKD-denominated debt instruments mostly for the purposes of banking sector liquidity management and local bond market development. General government external debt is also negligibly small. At end-FY2015/16, it stood at just HKD18.2 billion, equivalent to 0.8% of GDP.
Another rating support is Hong Kong’s sturdy external position. In 2015, it churned out a current account (CA) surplus of HKD74.7 billion, equivalent to 3.1% of GDP, and significantly higher than the previous year’s HKD29.4 billion (1.3% of GDP). It was also higher than the 2.6% average for the 2011-2015 period. Thanks to persistent CA surpluses, Hong Kong has accumulated huge foreign exchange reserves that continue to keep its external position strong. In 2015, the foreign exchange reserves stood at USD358.8 billion. Hong Kong remains a net creditor nation. In 2015, its net external financial assets reached HKD7,588.2 billion, equivalent to 316.6% to GDP. Hong Kong’s gross external debt at end-2015 stood at HKD10,105.0 billion, equivalent to 421.5% of GDP. While this ratio may seem exceedingly high, it is to be expected because Hong Kong is a major financial centre. At end-2015, the aggregate external debt of banks accounted for 65.0% of the total.
The rating takes into account the fact that the property market in Hong Kong remains a large risk. As a result of a demand-supply imbalance, property prices continue to trend upwards. Hong Kong has the world’s least affordable market and there are concerns that the market could be due for a correction soon. In November 2016, the government imposed a 15% stamp duty increase for non-first time buyers to help cool prices. The impact could be mild as mainland money looking for higher investment returns continues to distort the market. As such, the property market remains at risk from a sharp correction in prices. Thanks to the property boom, the stock of household debt has risen to around 70% of nominal GDP, with residential mortgage debt making up around two-thirds. A faster-than-expected US Fed interest rate hike will increase debt service ratios and cause further deterioration of bank asset quality.
Hong Kong’s rating strengths are also tempered by the territory’s high exposure to mainland China on account of deep economic and financial linkages. A disorderly deleveraging in China could trigger a global contagion, with the expected impact on Hong Kong just across the border to be significant. China continues to face a rising risk of excessive credit, and Hong Kong banks’ mainland-related lending are already seeing some deterioration of asset quality. For example, the classified loan ratio of mainland-related lending of retail banks rose to 0.92% at end-June 2016 from 0.78% at end-December 2015. The China factor also has a political dimension to it. China’s political interference in Hong Kong has led to worsening political polarisation, which could have implications for policymaking. On November 15, two pro-democracy lawmakers were disqualified from the country’s Legislative Council (LegCo) by the High Court and therefore unable to carry out their duties as legislators.
The stable rating outlook reflects MARC’s expectations of continued strong governance and institutions. For example, Hong Kong’s policy management has been sound, and has supported steady economic growth and resilience, and low unemployment despite elevated global financial market volatility. Our stable outlook also reflects the anticipation of continued strong fiscal performance and balance sheet, as well as a sturdy external position. We also assume that there is no disorderly deleveraging in China and that US monetary policy normalisation proceeds at a gradual pace.
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