Economics DBS Focus Hong Kong: Stormy Seas Ahead Group Research October 218 Samuel Tse Economist Please direct distribution queries to Violet Lee +6 6878281 violetleeyh@dbs.com Hong Kong s economy is facing strong headwinds from the Sino-US trade war Real GDP growth will slow in 2H18 from its robust 4% performance in 1H18. Trade activities are set to weaken in 4Q18 after the front-loading of activities in July-August (exports and imports grew by 9.2% and 11.3% YOY (3mma) respectively). This was evident from trade finance growth falling at a faster pace than local HKD loans (Chart 1). China and the US are the top two trading partners of Hong Kong. Exports to China and the US accounted for 79.1% and 12.4% of its GDP (Table 1 and 2). In 217, 9.2% of Hong Kong s re-exports flowed from China to the US (HKD278bn), while another 1.9% flowed from the US to China (HKD73bn). Table 1: Total export with top trading partners Main countries/territories China USA Taiwan Japan Singapore All countries Total trade (HKD mn) 2,1,829 33,198 8,63 128,474 89,371 3,87,898 Share of total export 4.3% 8.% 4.1% 3.3% 2.3% 1.% Share of total export excluding China N/A 18.7% 9.% 7.3%.% N/A Share of HK GDP 79.1% 12.4% 6.% 4.8% 3.4% 14.7% Table 2: Re-export through Hong Kong 212 213 214 2 216 217 From China to US (HKDmn) 297,12 286,328 292,66 294,787 276,73 277,18 From US to China (HKDmn) 73,668 84,36 88,133 72,23 73,1 73,188 Share of re-export to US in total re-export from China 14.1% 13.3% 13.% 13.6% 13.3% 12.% Share of Sino-US trade in total re-export 11.% 1.6% 1.% 1.3% 9.9% 9.2% If China and the US impose tariffs on the remainder of goods headed to each other s shores, it will dampen Hong Kong s trading businesses and outward direct investment. Hong Kong remains the largest source of realised foreign direct investment for China (3.1% share in 217), especially in the Guangdong province (63.8% share in 216). There will be repercussions for the domestic economy from the unfriendly external environment. The import/export trade and wholesale sectors account for 11.6% of the labour force. Despite a 2-year low jobless rate of 2.8%, labour demand is set to slow. Domestic consumption (6% of GDP), investment and visitor spending have been dampened by sharp falls in both the Hang Seng Index and the Renminbi exchange rate since June (Charts 2 & 3). Chart 1: Foreign and domestic finance, and trade finance % (YoY) - - Local use Trade finance Foreign use - Aug-14 Aug- Aug-16 Aug-17 Aug-18 Chart 2: Hang Seng Index and CNY 32, 31, Hang Seng Index 31, 3, 3, USD/CNH (RHS) 29, 29, 28, 28, 27, 27, 26, 26,,, 1-Jun 2-Jul 2-Aug 2-Sep 3-Oct 6.3 6.4 6. 6.6 6.7 6.8 6.9 7. Refer to important disclosures at the end of this report.
Hong Kong: Stormy Seas Ahead October 218 Chart 3: Retail Sales and Hang Seng Index % (YOY) Index 4 Retail sales value 34, Chart : Interest rate spread and HKD bps -12 USD / HKD 7.81 3 2 1-1 -2 Hang Seng Index (RHS) -3 19, Oct-14 Oct- Oct-16 Oct-17 Oct-18 Rate hikes will pressure asset prices 31, 28,, 22, Hong Kong banks have, in September, raised the prime lending rate for the first time in the past decade. The mild 12. bps increase by major banks was attributed to varying cost of funding amongst banks. Looking ahead, we expect another five increases in the prime rate over the next months. HIBORs have been steadily rising since the latest round of HKMA interventions (Appendix 1). The Aggregate Balance dropped to HKD76bn, less than half of the early-218 level (Chart 4). Short term liquidity has also tightened due to giant IPOs, quarter-end effect and the recent implantation of the Faster Payment System (FPS). As a result, HIBOR-LIBOR spreads were neutralised. Carry trade activities of the past 9 months paused and triggered a strengthening in the HKD from the weak side (7.8) towards the mid-point (7.8) of its convertibility undertaking. The HKD has since slid back to 7.84 (Chart ) Chart 4: HIBOR and liquidity % HKD bn 2.2 21 2. 1.8 1.6 1.4 1.2 1..8.6.4 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Aggregate balance (RHS) 1-month HIBOR 19 17 13 11 9 7-1 -8-6 -4-2 Jan-18 Apr-18 Jul-18 Oct-18 1-M HIBOR-LIBOR spreads HKD spot (RHS) after 1M Hibor fell to 1.2% in late October and widened to 7-8 bps against its respective Libor rate. We expect carry trades and the HKMA interventions to resume in the coming months. The loan-to-deposit ratio has climbed to 8.1% in August from its low of 7.7% in March 217 (Chart 6). Unfortunately, this was attributed to deposit growth falling at a faster pace than loan growth. In response, banks seek to attract deposits with higher rates. Looking ahead, banks will reduce their exposure to Chinese businesses amidst uncertainties (Chart 7). The loan-todeposit ratio is likely to reach its peak soon (Appendix 2). Temporary break of the property market bubble 7.82 7.83 7.84 7.8 Property price rose by % in the past 48 months (Chart 8). We believe the market has probably peaked in August; the Centa-city Leading Index registered a 1.9% decline since end-july. Chart 6: Loans and Deposits % (YoY) Ratio Loans growth 88 2 Deposits growth 86 Loan-to-deposit ratio 84 1-7 Aug-14 Aug- Aug-16 Aug-17 Aug-18 82 8 78 76 74 72 Page 2
Hong Kong: Stormy Seas Ahead October 218 Chart 7: Non-Bank China Exposures HKD bn 7, 6,, 4, 3, 2, 1, SOEs Private Non-China entities Others Jun-14 Jun- Jun-16 Jun-17 Jun-18 Hong Kong s property market has started to soften. The confidence of Hong Kong s businesses in China, particularly in the Greater Bay Area, has been hurt by the escalation in trade tensions (Guangdong s exports to GDP ratio was 1.7% in 217, compared to national average of 18.6%). The government s latest macro-prudential management measures imposed in July has also encouraged property developers to clear unsold units (Chart 9). The fall in property prices will, however, be moderate and manageable. With the unemployment rate at a 2- year low (2.8%), the healthy job market has kept the delinquency ratio of mortgage loans outstanding for more than 6 months (.1%), and the share of private cofinancing scheme among total mortgage value (1.7%) low. Global and local interest rates have also remained low by historical standards. For example, the prime rate is well below the high (1.%) seen in 1997. Chart 8: Property price and interest rate % % (YOY) 3. Property price (RHS) 3 2. 2. 1. 1... -. -1. 1-M Hibor -1-1. - Sep-14 Sep- Sep-16 Sep-17 Sep-18 2 1 - Chart 9: Completed but unsold units Unit 1, 9, 8, 7, 6,, 4, Dec-14 Dec- Dec-16 Dec-17 Dec-18 The deterioration in the demand-supply balance will only cease in the longer term. The Chief Executive has, in the latest policy address, proposed a new 1,7-hectare reclamation project. The first phase of the development is expected to complete by 232. Assuming this 2-year plan can satisfy housing demand for 1.1mn people, the newly-built artificial islands can only meet the demand of the immigrants from China ( persons x 36 days x 2 years). More land is required to fulfil the demand from local natural events (e.g. marriage and birth-death). The allocation of land will also add upward pressure to the private housing prices over the long run. The authority proposed to raise the ratio between public and private housing of new land supply from 6:4 to 7:3. Building purpose of 9 pieces of private property land will be changed to public housing. Hong Kong economy in muddy waters The increasing infrastructure investment may pose challenges to the management of HK s fiscal reserves over the long run. Hong Kong s infrastructure spending is currently larger than most of the advanced economies. The proposed reclamation project will cost HKDbn, or % of the Hong Kong fiscal reserves (Chart 1) in the next 1-2 years (without discounting for inflation and assuming a final cost that will not exceed the budget like the high-speed railway). Although the investment will be spent in phases and financed by debt, there will be no revenue until the reclaimed land is sold. Since the government revenue is over dependent on the volatile land related income (due to low income tax rate and no value-added tax), any unforeseen exogenous economic shocks to the local property market will affect the potential income stream (Chart 11). Page 3
27-8 28-9 29-1 21-11 211-12 212-13 213-14 214-2-16 216-17 217-18 218-19 Germany France United Kingdom South Korea (212) Russia United States (216) Hong Kong (216) Hong Kong: Stormy Seas Ahead October 218 Chart 1: Fiscal reserve HKD bn 12 Chart 12: Gini coefficient (2) 1 8 6 4 2 16 Lantau Tomorrow Project 6 4 4 3 3 Before After Hong Kong s labour force is expected to reach a plateau in 219-222. The addition to the labour force in the past year comprised mainly elderly part-time workers who were less productive compared to a prime working age full-time employed person. The dependency ratio (i.e. the population over 6 years old to the population aged -64 years old) is expected to rise to 68. by 2 from 22.2 in 2. This coupled with Hong Kong s high Gini coefficient index point to an increasing need of social welfare (Chart 12). Conclusion In the near-term, Hong Kong s economic outlook is clouded by the deterioration in Sino-US trade relations. External uncertainties will eventually weaken economic activities. Local interest rates will increase in the coming months. Property prices are expected to consolidate in a moderate manner. In the longer run, the large-scale reclamation project and an ageing population will its fiscal health. Hong Kong will face fiscal challenges over the long run. The healthy fiscal surplus of 7.% of GDP in 217 will, according to the International Monetary Fund (IMF) and the Hong Kong Government, give way to a structural deficit within the next decade. The IMF expects health and pension spending to double in Hong Kong by 2. The government s large-scale infrastructure projects mentioned above will damage the fiscal flexibility in the years ahead. Chart 11: Government revenue HKD bn 7 6 Profits Tax Land Premium Investment Income Salaries Tax Stamp Duties Other Incomes 4 3 2 1 Page 4
Hong Kong: Stormy Seas Ahead October 218 Appendix: Appendix 1: HKMA intervention in 218 The market has started to price-in the rate hike expectation one week before the Fed Fund rate hike and local prime rate hike. Hibor overshot on the last trading day of the month alongside quarter-end effect. Interest rate spread and HKD bps -12-1 -8 Fed Fund rate hike Quarter-end and giant IPO effects Fed Fund rate hike, Prime rate hike USD / HKD 7.81 7.82-6 -4-2 1-M HIBOR-LIBOR spreads HKD spot (RHS) HKMA withdrawal in April and May: HKD7.4bn HKMA withdrawal in August: HKD33.1bn Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 7.83 7.84 7.8 Appendix 2: Prelude of the next financial crisis? Loan-to-deposit ratio usually reaches the peak before the financial market meltdown. Loan growth outpaces deposit growth during economic expansion. Market enters bearish zone when banks tighten borrowings to corporates. Risk of the next financial crisis is increasing at the margin. Loans and deposits (3mma) % (YoY) Loans growth Ratio 3 1 Financial crisises Deposits growth Loan-to-deposit ratio 1 - - Prelude of - financial crisises? Jan-97 Jan- Jan-3 Jan-6 Jan-9 Jan-12 Jan- Jan-18 1 9 8 7 6 Page
Hong Kong: Stormy Seas Ahead October 218 Group Research Economics & Strategy Taimur Baig, Ph.D. Chief Economist - G3 & Asia +6 6878-948 taimurbaig@dbs.com Nathan Chow Strategist - China & Hong Kong +82 3668-693 nathanchow@dbs.com Masyita Crystallin, Ph.D. Economist Indonesia & Philippines +62 2988-43 masyita@dbs.com Joanne Goh Regional equity strategist +6 6878-233 joannegohsc@dbs.com Neel Gopalakrishnan Credit Strategist +6 6878-272 neelg@dbs.com Eugene Leow Rates Strategist - G3 & Asia +6 6878-2842 eugeneleow@dbs.com Chris Leung Economist - China & Hong Kong +82 3668-694 chrisleung@dbs.com Ma Tieying Economist - Japan, South Korea, & Taiwan +6 6878-248 matieying@dbs.com Radhika Rao Economist - Eurozone & India +6 6878-282 radhikarao@dbs.com Irvin Seah Economist - Singapore, Malaysia, & Vietnam +6 6878-6727 irvinseah@dbs.com Duncan Tan FX & Rates Strategist - ASEAN +6 6878-214 duncantan@dbs.com Samuel Tse Economist - China & Hong Kong +82 3668-694 samueltse@dbs.com Philip Wee FX Strategist - G3 & Asia +6 6878-433 philipwee@dbs.com Sources: Data for all charts and tables are from World Bank, IMF, Hong Kong Government, CEIC, Bloomberg and DBS Group Research (forecasts and transformations). Disclaimer: The information herein is published by DBS Bank Ltd (the Company ). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified. DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 18982. Tel: 6-6878-8888. Company Registration No. 196836E. Page 6