wider Economic Research KDN No.: PP14787/11/212(3811) Vol.: ER/4/218 Country Risk Monitor Hong Kong SAR of China Economic Research Led By: Nor Zahidi Alias Chief Economist +63 2717 2936 zahidi@marc.com.my www.marc.com.my 2 February 218 1 Country Risk Monitor: Hong Kong SAR of China Please read the disclaimer on the last page of this report
In a nutshell Hong Kong SAR of China (Hong Kong) is a relatively rich country with a high gross domestic product (GDP) per capita (in purchasing power parity terms (PPP)) of 58,553 international dollars (216). Its economic integration into China has seen it transforming itself into a very open and competitive servicebased economy. In 217, the IMD World Competitiveness Center, for the second year in a row, ranked Hong Kong the world s most competitive out of the 63 economies it covered. Hong Kong has a strong track record of policy effectiveness, transparency, as well as flexibility of economic and fiscal policy. These strengths should continue to keep the economy resilient and competitive going forward. With an impressive track record in fiscal prudence, its fiscal position is strong and therefore fiscal risk is low. This is important because fiscal policy is Hong Kong s main demand management tool. For the fiscal year ending March 217, the government s consolidated surplus came in at an equivalent of 4.4% of GDP. Hong Kong has considerable fiscal reserves (end-march 217: 37.7% of GDP) that it can draw down on to stabilise the economy in the event of a downturn. As expected from its strong fiscal performance, Hong Kong has no fiscal-related debt. It has, however, issued Hong Kong dollar-denominated debt instruments for banking sector liquidity management and local bond market development. Hong Kong s external balances remain strong and its vulnerabilities low. While there has been some narrowing of its current account (CA) surplus in recent years, it should be noted that there have been recent improvements. This narrowing in the post-global Financial Crisis (GFC) period is not due to a loss of competitiveness. Rather, it is due to Hong Kong s trade structure adapting to China s trade patterns and capital account liberalisation, as well as changes in offshore merchandise trade activities. Hong Kong is a net creditor with a net international investment position (NIIP) equivalent to a robust 391% of GDP (3Q217). Together with a large fiscal buffer, Hong Kong is expected to be able to ride out negative shocks over the short to medium term. Property market risk remains a concern in Hong Kong, as demand over the short term will likely continue to be supported by low interest rates, a perceived housing shortage, and aggressive promotion and financing plans. In 2Q217, the housing price-to-income ratio reached 16.6 (1997 peak: 14.6), while the income-gearing ratio registered 75.5%, significantly above the long-term average of about 5%. The household debt-to-gdp ratio also climbed higher in 2Q217 to 68.3%. Driven by fast growth of household loans, residential mortgages make up around two-thirds. With central banks worldwide moving away from economic stimulus, there are concerns about potential impacts on global housing prices. Hong Kong s high and still rising exposure to China is a major risk concern. China is its largest trading partner, and slower Chinese growth has negative spillover effects. Going forward, there are fears that Hong Kong may find itself become increasingly irrelevant to the mainland especially after the latter makes its currency fully convertible. Meanwhile, the rising share of mainland-related lending of Hong Kong s banks given the rising credit-to-gdp ratio and corporate sector leverage in China is a concern. Political polarisation has worsened, with potentially adverse implications for policymaking. Many see Carrie Lam s election as Chief Executive in March 217 as proof of Beijing s continued interference in domestic politics. Table 1: Selected economic indicators 211 212 213 214 215 216 Real GDP (% y-o-y) 4.8 1.7 3.1 2.8 2.4 2. Headline composite CPI inflation (%) 5.3 4.1 4.3 4.4 3. 2.4 Primary surplus (% of GDP)* 3.8 3.1 1. 3.6.6 4.4 Government debt (% of GDP)*.6.5.5.1.1.1 Current account balance (% of GDP) 4.9 1.5 1.4 1.3 3.3 4.7 Net international investment position (% of GDP) 285.5 274.5 274.9 298.9 316.6 368. Foreign currency reserve assets (USD billion) 285.4 317.4 311.2 328.5 358.8 386.3 Unemployment rate (annual average in %) 3.4 3.3 3.4 3.3 3.3 3.4 Source: HKMA, Census and Statistics Department, CEIC, MARC Economic Research Note: * Hong Kong s fiscal year (FY) runs from April to March of the following year. 214, for example, refers to FY214/15. 2 Country Risk Monitor: Hong Kong SAR of China
Mar-5 Oct-5 May-6 Dec-6 Jul-7 Feb-8 Sep-8 Apr-9 Nov-9 Jun-1 Jan-11 Aug-11 Mar-12 Oct-12 May-13 Dec-13 Jul-14 Feb-15 Sep-15 Apr-16 Nov-16 Jun-17 Mar-6 Sep-6 Mar-7 Sep-7 Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Economic Research Key Strengths Resilient and competitive economy A relatively rich country, Hong Kong s per capita PPP GDP reached 58,553 international dollars in 216, 47% higher than in 26. With its economic integration into China, it has transformed itself into a very open and competitive service-based economy. In 217, the IMD World Competitiveness Center, for the second year in a row, ranked Hong Kong the world s most competitive out of 63 economies it covered. Economic growth remains resilient, and the latest available data show real GDP expanding by 3.9% y-o-y in the first three quarters of 217. The government expects full year growth in 217 to come in at 3.7%. With positive labour market conditions and better economic sentiment, private consumption expenditure has continued to grow. Overall investment expenditure growth has strengthened on rebounding machinery and equipment acquisition, as well as a sustained uptrend in building and construction activity. Meanwhile, external demand continues to recover, and Hong Kong s total goods exports growth has improved. In addition, reviving regional trade flows and increased cross-border financial activities have led to a steady growth of its services exports. All this has helped boost Hong Kong s CA surpluses, and consequently its external position. With its robust NIIP (end-september 217: 391%), together with its large fiscal buffer, Hong Kong should be able to navigate shocks going forward. Hong Kong may have benefitted significantly from its economic integration into China though this also means that it has become highly susceptible to developments on the mainland, not only via trade and financial but also tourism channels. As the spillover into Hong Kong from China s economic rebalancing act is significant, there have been concerns. Nevertheless, there are signs that the rebalancing act is finally starting to pay off. There are also concerns over whether it would remain economically relevant to China, especially after the latter makes its currency fully convertible. Other downside risks include impact from the US Fed s monetary policy and balance sheet normalisation moves, especially if the hike pace is faster than expected. According to the Hong Kong Monetary Authority (HKMA), a 1-basis point rise in domestic interest rates would cumulatively decrease private consumption by.7% at the one-year horizon and 1.6% in the long run. Chart 1: Hong Kong and China: GDP growth (% y-o-y) 2 15 1 5-5 -1 Chart 2: Industry performance (% y-o-y) 3 25 2 15 1 5-5 -1-15 -2 Hong Kong China Log. (Hong Kong ) Log. (China ) Accomodation & food services Wholesale & retail trades Financial & insurance Source: Census and Statistics Dept., MARC Economic Research 3 Country Risk Monitor: Hong Kong SAR of China
Jan-5 Aug-5 Mar-6 Oct-6 May-7 Dec-7 Jul-8 Feb-9 Sep-9 Apr-1 Nov-1 Jun-11 Jan-12 Aug-12 Mar-13 Oct-13 May-14 Dec-14 Jul-15 Feb-16 Sep-16 Apr-17 Nov-17 Economic Research Strong fiscal position Hong Kong s fiscal position remains strong due to its impressive track record in fiscal prudence. This is a particularly important point because with its currency board regime, fiscal policy becomes its main demand management tool to support economic stabilisation. For the fiscal year ending March 217, the government s consolidated surplus came in at HKD11.8 billion, equivalent to 4.4% of GDP. Fiscal reserves as of end-march 217 stood at HK$953.7 billion, corresponding to 37.7% of GDP. With the government s strong fiscal performance, there is no fiscal-related debt. The government has, however, issued HKD-denominated debt instruments mostly for the purposes of banking sector liquidity management and local bond market development. As a percentage of fiscal reserves, government debt and government-guaranteed debt at end-fy216/17 stood at.2% and 3.% respectively. Hong Kong s large holdings of fiscal reserves help ensure that there is capacity for fiscal spending support for the economy when necessary, at least over the near- to medium-term. Over the longer term, however, this may no longer be possible. With a rapidly ageing population and a decidedly narrow tax base, structural fiscal deficits are expected to emerge within a decade or so if nothing is done. By 226, the government foresees one person aged 65 or above for every three persons of working age. In addition, the economy is maturing and new fiscal challenges related to a moderating growth pace are emerging. It is critically important for the government to maintain a positive fiscal reserve position to preserve the credibility needed to operate a countercyclical fiscal policy. As mentioned earlier, fiscal policy is its main demand management tool. Several ongoing economic restructuring measures, if successfully implemented, should help stem the expected deterioration of fiscal performance. While it is likely that the government will eventually impose a goods and services tax (GST) to broaden the tax base, this should be pushed through as soon as possible. This is because the bulk of government revenue tax revenue from corporate profits, and property and personal income is highly exposed to economic uncertainties. Chart 3: Consolidated account: receipts and payments 7 6 5 4 3 2 1 Chart 4: Fiscal reserves and debt 12 1 8 6 4 2 14 12 1 8 6 4 2 24 25 26 27 28 29 21 211 212 213 214 215 216 Fiscal reserves (LHS; HKD bn) Revenue (HKD bn) Expenditure (HKD bn) Government debt (RHS; % of fiscal reserves) Operating expenditure (HKD bn) Capital expenditure (HKD bn) Government guaranteed debt (RHS; % of fiscal reserves) 4 Country Risk Monitor: Hong Kong SAR of China
Strong external position Hong Kong persistently remains a large net external creditor. At end-3q217, its net international investment position reached 391% of GDP, significantly higher than the 354% recorded a year earlier (end-3q216). Even against a backdrop of economic and financial uncertainties, the island territory has continued to churn out CA surpluses. This has led to the accumulation of large official foreign currency reserve assets, which as of end-december 217 amounted to USD431.3 billion. Hong Kong s external vulnerabilities are expected to remain low given its large external buffers. While Hong Kong s CA surplus did show signs of narrowing in the post-gfc years, there are indications of it rebounding after falling to the recent low of 1.5% of GDP in 213. In 216, the CA surplus came in at 4.5% of GDP (215: 3.3% of GDP) largely due to a fall in the goods deficit and a rise in the net inflow of primary income, partly offset by a fall in the services surplus. The latest available data show the CA surplus coming in at HKD58. billion in 3Q217, equivalent to 8.5% of GDP (3Q216: 5.9% of GDP). Notwithstanding its strong external position, Hong Kong faces many sources of external vulnerability. China, its largest trading partner, is in an ongoing struggle to reduce financial sector risks as credit continues to grow faster than GDP. Against such a backdrop, there are concerns that China s GDP growth momentum may weaken in 218 because of the economic rebalancing. As such, it is likely that Hong Kong s CA performance will depend, to a large extent, on economic and financial developments on the mainland. As Hong Kong becomes even more integrated into mainland China, its status as a proxy for the mainland s economic health has sometimes led to pressure on its fixed exchange rate link (ERL) as investors make bets against the mainland. It is important to note, though, that the ERL has worked well to keep Hong Kong s external position broadly in balance. Given the HKMA s strong war chest of reserves, the ERL should remain safe at least over the short to medium term. Chart 5: CA balance and goods and services flows Chart 6: HKD/USD (monthly average) 3 7.83 2 1 7.82 7.81 7.8 7.79-1 -2 7.78 7.77 7.76-3 25 26 27 28 29 21 211 212 213 214 215 216 CA balance (HKD bn) Goods (HKD bn) Services (HKD bn) 7.75 Strong convertibility limit: HKD7.75 7.74 Jan-1 May-1 Sep-1 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 5 Country Risk Monitor: Hong Kong SAR of China
Major Risks Property market risk After the GFC, property prices in Hong Kong soared by double-digit rates as it benefitted from capital shifts toward emerging economies. According to the UBS Global Real Estate Bubble Index 217 report, Hong Kong s housing market remains in bubble-risk territory with a score of 1.74, far above the threshold score of 1.5. The Hong Kong housing market is among the most volatile and least affordable in the world. In 2Q217, the housing price-to-income ratio reached 16.6 (1997 peak: 14.6), while the income-gearing ratio registered 75.5%, significantly higher than the long-term average of about 5%. Meanwhile, the household debt-to-gdp ratio also climbed higher in 2Q217 to 68.3%. The latest available data from the Rating and Valuation Department show that private home prices had risen by 13.1% y-o-y in November 217. Regulatory measures to reduce the dynamics of the housing price surge have not been as effective as hoped for. Prices continue to rise on generally positive sentiment, insatiable investor demand and speculative price expectations fuelled by fear of missing out on capital gains. Since 29, the HKMA has instituted eight rounds of mortgage tightening. Meanwhile, the secondary market remains frozen as people, expecting prices to rise further, hang on to their properties. With local real income having virtually stagnated, home prices in Hong Kong have decoupled from household earnings. Central banks worldwide have started moving away from economic stimulus and towards monetary policy tightening as global synchronised growth gradually strengthens. With the HKD linked to the USD, an unexpectedly fast pace of US Fed rate hikes could potentially trigger a correction in the local property market. The cost of money market borrowing has remained relatively stable because of ample liquidity. However, there could eventually be more significant upward pressure on local interest rates as US monetary policy normalisation proceeds further. An added concern is the potential of an economic or financial crisis in China. Over the past two years, mainland buyers have been a major factor pushing up property prices. With the property market distorted by mainland money, a crisis on the mainland could cause a knee-jerk reaction in Hong Kong. It is important to note that residential mortgages make up around two-thirds of household debt. Chart 7: Domestic loans by economic sectors (% of total) Chart 8: Property price indices (1999 = 1) 4 35 3 25 2 15 1 (as of 3Q217) 9 8 7 6 5 4 3 2 1 5 Property To purchase Trade financing development & other residential investment properties Wholesale & retail trade Manufacturing Jan-3 Sep-3 May-4 Jan-5 Sep-5 May-6 Jan-7 Sep-7 May-8 Jan-9 Sep-9 May-1 Jan-11 Sep-11 May-12 Jan-13 Sep-13 May-14 Jan-15 Sep-15 May-16 Jan-17 Sep-17 Domestic Offices Retail Flatted factories Source: HKMA, MARC Economic Research Source: Rating & Valuation Dept., MARC Economic Research 6 Country Risk Monitor: Hong Kong SAR of China
Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 Economic Research Exposure to China Hong Kong is widely exposed to the mainland on many fronts economic, financial and political. With its economic integration into the mainland, the latter is Hong Kong s largest trading partner. In 216, China absorbed 43.3% of Hong Kong s total domestic exports. In the same year, the value of goods re-exported through Hong Kong from and to the mainland accounted for a significant 89.1% of the former's total reexport trade value. Heading into the 1997 handover of Hong Kong to China, many had thought that the island territory would help lead the mainland's economic development. This has not happened, and Hong Kong may find itself increasingly irrelevant to the mainland even as it becomes more and more dependent on it, especially after the latter makes its currency fully convertible. With the Chinese yuan (CNY) fully convertible, global deals would more likely be handled out of Shanghai rather than Hong Kong. Meanwhile, the rising share of mainland-related lending of Hong Kong s banks (end-june 217: 16.6% of total assets) given a rising credit-to-gdp ratio and corporate sector leverage in China as economic rebalancing efforts continue is a concern. At end-june 217, the gross classified loan ratio of mainlandrelated lending of authorised institutions (AI) stood marginally higher at.88%, up from.8% at end- 216. While regulators see risks contained by the fact that 76% of the loans are to state-owned enterprises and non-mainland multinational companies, there are nevertheless concerns. Tensions between Hong Kong s defiant youth and the pro-beijing establishment can only escalate against a backdrop of a city buffeted by change and uncertainty. Many see civil servant Carrie Lam s election as Chief Executive in March 217 by a largely pro-beijing election committee as proof of Beijing s interference in domestic politics. It is unlikely that the Hong Kong government and Beijing will back away from confronting pro-democracy politicians and activists. The likely result is rising conflict and a standstill in Hong Kong s constitutional development. Unbridled tensions in the city could distract the government from policymaking, as well as affect government effectiveness, regulatory quality and rule of law. Chart 9: Banking sector s non-bank China exposure (HKD bn) Chart 1: World Governance Indicators (217 update) 6 5 4 3 Control of corruption Voice and accountability 1. 8. 6. 4. 2. Political stability and absence of violence/terrorism Malaysia Indonesia Hong Kong 2. 1 Rule of law Government effectiveness Regulatory quality Source: World Bank, MARC Economic Research Note: Percentile ranking; higher is better 7 Country Risk Monitor: Hong Kong SAR of China
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