Ryan Lam, CFA Senior Economist ryancwlam@hangseng.com Addressing Three Questions About The Hong Kong Economy In this note, we address what we believe are some of the most important questions in assessing the outlook for the Hong Kong economy over the next 12 months. How much of a drag on growth is a stronger Hong Kong dollar? We believe the impact on the Hong Kong economy will be noticeable but not overwhelming. A 10% rise in the real Hong Kong dollar exchange rate will, on average, suppress service exports by about 4.4 percentage points and take about 0.4 percentage points off Hong Kong GDP over the course of a year. Will the recent equity rally give the economy a much-needed boost? In our analysis, the impact is not as significant as some observers might think, given the distribution of the associated wealth gains. In short, wealthier households that hold more stocks tend to have a lower marginal propensity to consume. In fact, income expectations generally exert a greater influence. Wealth is not a proximate cause of higher consumption, but rather reflects changing expectations that drive consumption. The latest round of capital inflows, however, has little to do with improved labour income prospects. We estimate the recent equity rally could potentially raise GDP growth by 0.8 percentage points this year. Will retail sales experience a significant drop this year? We expect to see a 1% expansion in the retail sector this year. Although the Mainland government has announced new limits on cross-border visits, multiple-entry permit holders are likely to lift their spending per visit to partly compensate for the more limited number of visits. It is also important to not lose sight of the still-robust growth in overnight tourism. The slack created by a slowdown of Chinese tourist flows will be picked up by stronger local spending.
Hong Kong s economy recorded a lacklustre performance in the first quarter of 2015. The slowdown in GDP growth to just 2.1% has led to new discussions over whether the city has moved into a prolonged period of stagnant growth. In this note, we address what we believe are some of the most important questions in assessing the outlook for the Hong Kong economy over the next 12 months. How much of a drag on growth is a stronger Hong Kong dollar? In order to add up all the currency movements, we looked at Hong Kong s tradeweighted real effective exchange rates. The Hong Kong dollar has been one of Asia s best performing currencies over the past year, surging 15.6% 1 since its most-recent low in the summer of 2014 (Exhibits 1 & 2). Many observers are asking how the economy will be affected by this stunning appreciation of the Hong Kong dollar. Exhibit 1: Real Effective Exchange Rate for Hong Kong Dollar Exhibit 2: Real Effective Exchange Rate for Asian Currencies (rebased 2011 Jan = 100) Source: BIS, Macrobond, Hang Seng Bank Source: BIS, Macrobond, Hang Seng Bank Accurately estimating the impact of a rising currency is conceptually straightforward but enormously difficult in practice 2. First, it is hard to separate out other closely linked factors such as sliding oil prices and feeble demand in emerging economies. Second, import intensity is another prime determinant of exchange rate pass-through. Where the import content of exports is high, domestic exporters can enjoy a gain from lower costs of imported goods and pass- 1 Changes throughout this report are on a year-on-year basis unless otherwise stated 2 Amiti, Itskhoki, and Konings (2014), Importers, Exporters, and Exchange Rate Disconnect, American Economic Review: Vol. 104(7): 1942-78 2
through to export prices. Third, exporting firms tend to adjust their mark-ups to blunt the impact of currency appreciation. Last, invoicing practices could also play a role. If Chinese producers invoice their exports in US dollars, an appreciation in the US dollar will cut the profits of Chinese producers but will not increase the dollar price paid by US importers. Given these considerations, it is not surprising that the correlation between Hong Kong s exports and the exchange rate is rather loose (Exhibit 3). In order to better understand the causal relationship between different factors, we extended our general equilibrium model 3 that allows us to trace the impact of a shock in the exchange rate on exports over time. After controlling for the weighted demand of Hong Kong s trading partners, the model results suggest that re-exports of goods, accounting for over 73% of Hong Kong s total exports, are largely uninfluenced by fluctuations in Hong Kong s real effective exchange rate. We believe one reason for this interesting finding is that the high import content of Hong Kong s re-exports mitigates the adverse effect of a rising dollar by making imported intermediate inputs cheaper. Exhibit 3: Hong Kong s Total Exports and Real Effective Exchange Rate (% YoY) Exhibit 4: Impact of a 10% Rise in Real Effective Exchange Rate for Hong Kong Dollar Source: BIS, Macrobond, Hang Seng Bank Source: Hang Seng Bank That does not, however, mean that the economy as a whole is completely unaffected by exchange rate fluctuations. Based on our analysis, trade in services is much more sensitive to the real exchange rate than trade in goods. A 10% rise in the real Hong Kong dollar exchange rate will, on average, suppress 3 Revised Small Forecasting Model For Hong Kong, HKMA Research Memorandum 13/2004, December 2004 3
service exports by about 4.4 percentage points. Analysis by the Hong Kong Monetary Authority used a different modelling approach, but calculated much the same effect 4. Of note, the impact of the strong dollar not only reduces the attractiveness of Hong Kong to tourists but also to locals. A thorough analysis requires a potential leakage of local purchasing power into higher overseas spending to be taken into account. Overall, we estimate that the combined impact of the dollar appreciation since last summer will take about 0.4 percentage points off Hong Kong s GDP over the course of a year (Exhibit 4). The takeaway point in all this is that the impact of a strengthening dollar on the Hong Kong economy will be noticeable but not overwhelming. Will the recent equity rally give the economy much-needed boost? Driven by a pickup in flows from mainland China by investors seeking more attractive valuations, the Hong Kong equity market rallied across the board and hit a seven-year high in April. Even with the recent correction, the Hang Seng Index has risen by 17.4% since the beginning of 2015 (Exhibit 5). The market capitalisation of the Hong Kong market at the end of April have reached HKD30 trillion, an increase of 20% since the end of 2014 (Exhibit 6). Taken at face value, such a massive increase in wealth, which amounts to about 226% of GDP, should generate a substantial wealth effect that will boost consumer spending. Exhibit 5: Hang Seng Index Exhibit 6: Market Capitalisation of Listed Companies in Hong Kong (HKD tn) 4 Hong Kong s Trade Patterns And Trade Elasticities, HKMA Working Papers 0618, March 2007 4
Our estimates, however, indicate that the wealth effect is not as big as might be assumed. It is worth recalling that exposure to the domestic stock market among Hong Kong households is much smaller than that suggested by headline stock market capitalisation. In 2013/14, local retail investors only accounted for 24.5% of Hong Kong s total market turnover value (Exhibit 7). What is also often overlooked is that the distribution of wealth gains generates substantial moderating effects. High-income households holding more stocks tend to have higher savings rates and lower marginal propensities to consume. Finally, income expectations matter. Wealth is not a proximate cause of higher consumption, but rather reflects changing expectations that drive consumer spending. It is easy to see how the bull market after the global financial crisis coincided with a strong run for consumer spending. That has not been the case in this cycle, however. Renewed capital inflows this time around have little to do with improved labour income prospects and much more to do with the valuation gap between Hong Kong and Shanghailisted companies. Few studies have specifically estimated the financial wealth effect in Hong Kong. Among the large body of analyses based on US samples, researchers conclude that consumers spend between 2 and 3 per cent of their extra financial wealth. Most studies also find that the effect of wealth gains on consumption spreads over time. Drawing lessons from these studies, we smoothed the wealth effect by assuming that HKD1 of net financial wealth has a HKD0.01 impact in the current quarter, HKD0.005 in the next quarter, and HKD0.0025 in the following two quarters. Exhibit 8 illustrates the results of this exercise. Exhibit 7: Contribution of Local Retail Investors to Total Market Turnover (%) Exhibit 8: Impact on Wealth Effect Hong Kong s GDP (percentage points) Source: HKEx, Hang Seng Bank Source: Hang Seng Bank 5
The exhibit suggests two conclusions. First, equity market strength could potentially raise Hong Kong s private consumption and GDP growth this year by 1.3 percentage points and 0.8 percentage points, respectively, assuming the current valuation level can be sustained. Second, the wealth effect of the recent stock market rally is expected to gain traction and will act as an important cushion for external shocks in the second half. In fact, our baseline forecast for an acceleration in consumption growth in the quarters ahead requires no pickup in the underlying trend. We remain sanguine over the consumption momentum of local residents. Retail sales set to see a plunge? Over the past few quarters, the performance of retail sales has been generally disappointing. Retail sales contracted by 2.3% in the first quarter of 2015, and only grew by 0.2% in the fourth quarter of last year (Exhibit 9). The April announcement that a once-a-week cap on cross-border visits to Hong Kong was to be applied to multiple-entry permit holders from the Mainland has further soured sentiment. Exhibit 9: Retail Sales Value (% YoY) Exhibit 10: Local Spending and Mainland Tourist Spending (% YoY) Source: CEIC, Hang Seng Bank In our view, Hong Kong s retail sector in 2015 will be characterised by the convergence of spending by residents and tourists (Exhibits 10). Mainland travellers have long been the dominant driver of Hong Kong s retail growth, but this is no longer the case. While the outlook for visitation growth is positive, a squeeze on visitors spending power lies just beneath the surface (Exhibit 12). Further, as noted before, we expect a pickup in local demand on the back of wealth gains and 6
the HKD34bn in relief measures announced by the Hong Kong government in its most recent Budget. The actual outcome for retail market is a balance of these two forces. So far, the market has predominately focused on the adverse impact of a reduction in receipts from same-day visitors. We argue that the market is potentially being overly pessimistic as the new visa arrangement is mainly aimed at multi-entry day trippers. Consumer demand from overnight tourists is likely to remain solid. Exhibits 11 and 12 show our baseline forecasts for retail sales in 2015-16. To get a sense of the relative contributions of tourists and residents, we broke down sales figures into resident spending and tourist spending. This is an out-of-consensus call, but we still expect a 1% expansion in the retail sector this year, based on the following reasons : Many of the affected same-day travellers may simply increase their spending per visit to compensate for the fact that they make fewer trips. In addition, existing multiple-entry permit holders would still be entitled to unlimited visits until their one-year permit expires and it will therefore take about a year for its full impact to be felt. If we assume tighter controls on multiple-entry permit holders will cut the number of visitors by 1mn this year, the decline in retail spending by same-day visitors from the Mainland could be contained at 1%. It is important to not lose sight of the still-robust growth in overnight tourism. The number of overnight visitors is growing at a healthy rate, rising by 14.5% per annum over the past five years. Overnight tourists are also heavy spenders, with average per-head spending of HKD6,252 in 2014 more than double the average spend of day trippers (Exhibit 12). We estimate overnight tourists spent a total of HKD119bn last year, more than 60% of total spending by Mainland travellers. As long as growth opportunities for overnight tourism remain intact, total spending by Mainland visitors should at least grow at a single digit rate in 2015 and 2016 (Exhibit 11). The slack created by a slowdown in tourism growth will be picked up by stronger local spending, which still represents about 58% of Hong Kong s retail sales. As our calculations show (Exhibit 11), the key drag last year was the significant contraction in spending by local residents. Local spending was xxxxxx 7
dragged down by the adverse wealth effect and a scaling down of relief assistance. These factors should become positive contributors in 2015. With support from positive wealth effects and an expansion of government relief measures, a drop in local spending this year will likely be avoided. Exhibit 11: Hong Kong s Retail Sales Value 2010 2011 2012 2013 2014 2015E 2016E Total retail sales Retail sales by residents Retail Sales by Mainland visitors Source: CEIC, Hang Seng Bank HKD mn 324,968 405,733 445,498 494,449 493,238 497,834 517,838 YoY 18.3% 24.9% 9.8% 11.0% -0.2% 0.9% 4.0% HKD mn 215,377 272,160 287,367 305,104 284,355 298,573 310,516 YoY 11.8% 26.4% 5.6% 6.2% -6.8% 5.0% 4.0% HKD mn 87,936 110,793 136,981 168,895 189,562 199,068 207,323 YoY 32.0% 26.0% 23.6% 23.3% 12.2% 5.0% 4.1% Exhibit 12: Underlying Assumptions for Chinese Tourist Spending 2010 2011 2012 2013 2014 2015E 2016E Total arrivals 11,678,035 13,599,768 15,110,372 17,089,509 19,077,014 20,317,020 21,637,626 Overnight visitors YoY 20.8% 16.5% 11.1% 13.1% 11.6% 6.5% 6.5% Per capita spending HKD5,483 HKD5,794 HKD6,062 HKD6,402 HKD6,252 HKD6,377 HKD6,505 YoY 8.6% 5.7% 4.6% 5.6% -2.3% 2.0% 2.0% Total arrivals 11,006,404 14,500,361 19,801,023 23,655,768 28,170,661 27,043,835 25,150,766 Same-day YoY 32.7% 31.7% 36.6% 19.5% 19.1% -4.0% -7.0% visitors Per capita spending HKD2,172 HKD2,207 HKD2,292 HKD2,515 HKD2,495 HKD2,570 HKD2,647 YoY 1.1% 1.6% 3.9% 9.7% -0.8% 3.0% 3.0% Source: CEIC, Hang Seng Bank 8
Hong Kong Economic Monthly Statistics GDP HKD bn Real growth yoy (%) yoy (%) yoy (%) HKD bn yoy (%) HKD bn yoy (%) HKD bn % yoy (%) 2006 1,503 7.0 7.2 5.7 2,461 9.4 2,600 11.6-138.8 4.8 2.0 2007 1,651 6.5 12.8 10.1 2,688 9.2 2,868 10.3-180.5 4.0 2.0 2008 1,707 2.1 10.6 5.0 2,824 5.1 3,025 5.5-201.1 3.5 4.3 2009 1,659-2.5 0.6-0.8 2,469-12.6 2,692-11.0-223.3 5.2 0.5 2010 1,776 6.8 18.3 15.5 3,031 22.8 3,365 25.0-333.8 4.3 2.4 2011 1,934 4.8 24.8 18.4 3,341 10.1 3,767 11.9-426.4 3.4 5.3 2012 2,037 1.7 9.8 7.2 3,434 2.9 3,912 3.9-477.8 3.3 4.1 2013 2,139 3.1 11.0 10.8 3,562 3.6 4,065 3.8-502.9 3.3 4.3 2014 2,256 2.5-0.2 0.6 3,675 3.2 4,225 3.9-550.0 3.2 4.4 2015F 2,356 2.4 1.0 1.0 3,859 5.0 4,479 6.0-619.8 3.5 3.5 2016F 2,471 3.0 4.0 3.0 4,052 5.0 4,747 6.0-695.5 3.7 4.0 Q1 2014 532 2.7 4.2 4.0 818 0.7 942 2.1-124.0 3.1 4.1 Q2 522 2.0-7.0-7.2 901 4.8 1,042 4.6-140.7 3.2 3.7 Q3 580 2.9 1.6 1.6 985 5.9 1,109 5.7-124.0 3.3 4.8 Q4 612 2.4 0.2 3.5 971 1.2 1,133 3.3-161.3 3.3 5.1 Q1 2015 572 2.1-2.3 0.0 836 2.3 955 1.4-119.1 3.3 4.4 Jan 2014 N/A N/A 14.4 16.7 303-0.4 323-2.7-20.0 3.1 4.6 Feb N/A N/A -2.2-2.2 213-1.3 267 6.8-53.7 3.1 3.9 Mar N/A N/A -1.5-2.5 302 3.4 352 3.2-50.4 3.1 3.9 Apr N/A N/A -9.9-9.6 286-1.6 341 2.4-55.3 3.1 3.7 May N/A N/A -3.9-4.6 306 4.9 348 3.7-42.4 3.1 3.7 Jun N/A N/A -6.9-7.5 309 11.4 352 7.6-43.1 3.2 3.6 Jul N/A N/A -3.2-4.6 326 6.8 368 7.5-42.1 3.3 4.0 Aug N/A N/A 3.5 2.8 327 6.4 359 3.4-31.5 3.3 3.9 Sep N/A N/A 4.8 6.6 332 4.5 382 6.3-50.4 3.3 6.6 Oct N/A N/A 1.4 4.3 332 2.7 382 5.6-49.8 3.3 5.2 Nov N/A N/A 4.2 7.6 327 0.4 379 2.4-52.2 3.3 5.1 Dec N/A N/A -4.0-1.4 313 0.6 372 1.9-59.3 3.3 4.9 Jan 2015 N/A N/A -14.5-13.8 312 2.8 349 7.9-37.0 3.3 4.1 Feb N/A N/A 14.8 18.3 228 7.2 264-0.9-35.9 3.3 4.6 Mar N/A N/A -2.9 0.8 296-1.8 342-2.7-46.2 3.3 4.5 Apr N/A N/A N/A N/A N/A N/A N/A N/A N/A 3.2 N/A YTD 572 2.1-2.3 0.0 836 2.3 955 1.4-119.1 3.3 4.4 Total Deposits Retail sales (value) Retail sales (volume) RMB Deposits Exports Total Loans Foreign Trade Money supply (Total M3) Trade balance Office Rental Index Tourist Arrivals HKD bn yoy (%) RMB bn yoy (%) HKD bn yoy (%) yoy (%) ytd (%) ytd (%) '000 yoy (%) 2006 4,757 17.0 23 3.6 2,468 6.7 15.5 4.1 15.0 25,251 8.1 2007 5,869 23.4 33 42.7 2,962 20.0 20.6 25.7 14.6 28,169 11.6 2008 6,060 3.2 56 67.8 3,284 10.9 2.6-11.1 9.2 29,500 4.7 2009 6,381 5.3 63 11.9 3,289 0.1 5.2 28.5-9.8 29,590 0.3 2010 6,862 7.5 315 402.2 4,227 28.6 8.0 21.0 12.5 36,030 21.8 2011 7,591 10.6 589 86.9 5,081 20.2 12.9 11.1 15.5 41,921 16.4 2012 8,297 9.3 603 2.5 5,569 9.6 11.0 25.7 7.7 48,615 16.0 2013 9,180 10.7 860 42.7 6,457 16.0 12.4 7.7 7.1 54,299 11.7 2014 10,074 9.7 1,004 16.6 7,276 12.7 9.6 13.3 4.3 60,839 12.0 2015F 11,182 11.0 N/A N/A 8,149 12.0 12.0 0.0 0.0 66,315 9.0 2016F 12,468 11.5 N/A N/A 9,168 12.5 12.5-3.0-3.0 71,620 8.0 Q1 2014 9,189 10.0 945 41.4 6,826 19.0 12.2-0.6 1.0 14,698 15.3 Q2 9,612 13.3 926 32.7 7,074 16.0 15.0 2.1 2.3 13,831 9.6 Q3 9,920 11.4 944 29.4 7,210 12.7 12.3 8.6 3.8 16,130 11.2 Q4 10,074 9.7 1,004 16.6 7,276 12.7 9.6 13.5 4.4 16,180 12.1 1Q 2015 10,406 13.2 952 0.7 7,627 11.7 11.9 4.7 1.4 15,421 4.9 Jan 2014 9,184 7.6 893 43.2 6,697 17.8 9.6-0.2-0.2 5,455 17.8 Feb 9,330 10.6 920 41.2 6,908 21.8 12.9-0.3 0.4 4,417 9.8 Mar 9,189 10.0 945 41.4 6,826 19.0 12.2-0.6 1.0 4,825 18.1 Apr 9,392 10.8 960 41.8 6,852 18.1 12.5 0.0 1.3 4,748 10.9 May 9,522 11.0 956 36.8 6,966 18.0 12.7 0.9 2.0 4,591 10.8 Jun 9,612 13.3 926 32.7 7,074 16.0 15.0 2.1 2.3 4,493 6.9 Jul 9,848 14.4 937 34.8 7,141 15.5 16.0 4.6 3.3 5,374 11.2 Aug 9,855 13.9 937 32.0 7,142 14.0 15.4 6.6 3.6 6,010 12.2 Sep 9,920 11.4 944 29.4 7,210 12.7 12.3 8.6 3.9 4,747 10.2 Oct 10,037 11.9 944 20.7 7,282 13.7 12.2 10.4 3.9 5,214 12.6 Nov 10,075 11.1 974 17.8 7,287 12.8 11.2 11.8 4.2 5,300 15.7 Dec 10,074 9.7 1,004 16.6 7,276 12.7 9.6 13.5 4.4 5,666 8.5 Jan 2015 10,186 10.9 981 9.9 7,366 10.0 10.4 2.3 0.3 5,610 2.8 Feb 10,152 8.8 973 5.7 7,365 6.6 8.3 4.7 0.7 5,406 22.4 Mar 10,406 13.2 952 0.7 7,627 11.7 11.9 4.7 1.4 4,405-8.7 Apr N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A YTD 10,406 13.2 952 0.7 7,627 11.7 11.9 4.7 1.4 15,421 4.9 Note: (F) Forecast Source: Census and Statistics Department of HKSAR, Hong Kong Monetary Authority, Rating and Valuation Department, Hong Kong Tourism Board, CEIC, Hang Seng Bank Imports Residentia l Property Price Index Unemployment rate (s.a.) Consumer prices 9
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