S&P maintains Hong Kong ratings, but outlook negative due to China economic risks

August 25, 2017

HONG KONG - S&P Global Ratings today affirmed its 'AAA' long-term and 'A-1+' short-term issuer credit ratings on Hong Kong, but said the rating outlook remains negative, mirroring S&P’s long-term rating on China (AA-/Negative/A-1+; cnAAA/cnA-1+).

“In the absence of a further strengthening of the independence of the SAR's already resilient and effective institutions, we would likely lower our rating on Hong Kong by one notch if we downgraded China,” S&P said.
 “On our current expectations of the trends in economic and financial risks in China, we could lower the rating on China this year or next.
 “In addition, we might lower our rating on Hong Kong without a downgrade of China, if Hong Kong's political polarisation worsens to a point where it compromises policymaking and the business environment.
 “In such a scenario -- which is not our base case -- we would expect a gradual deterioration of the SAR's strong economic, fiscal and external metrics.
 “We could revise the outlook on Hong Kong back to stable if we took the same action on China, all other things being equal.”
 S&P said it rates Hong Kong three notches higher than China for several reasons.
 “We believe Hong Kong's institutions and policies support an open and free economy with a generally predictable and effective policy framework and strong economic transparency,” it says.
 “In our view, this favourable assessment is valid compared with the other Governments we rate under our sovereign criteria.
 “We believe that relations between the (Chinese) Central Government and Hong Kong will remain constructive -- like they have been since the handover to China in 1997 -- because a stable and prosperous Hong Kong advances China's reform agenda.
 “The ratings on Hong Kong also reflect above-average economic growth prospects for a high-income economy, healthy fiscal performance, sizeable fiscal reserves, a strong external position, and the credibility of monetary policy.
 “This is despite the limitations of a pegged exchange rate regime in conducting independent monetary policy.
 “That said, we do not believe Hong Kong's credit standing can be completely disconnected from that of the Mainland, given financial and economic linkages, and the ultimate sovereign authority of
“We estimate Hong Kong's 2017 GDP per capita to be about US$45,500 (and) we believe Hong Kong's economy is likely to grow faster than the average of high-income economies over the next three years. 
“This forecast assumes resilient local demand, stable economic conditions in the advanced economies, and China maintaining economic growth close to 6% annually.
 “Hong Kong's role in facilitating China's economic and financial integration with the rest of the world should continue to support the SAR's financial and business services sectors. 
“Hong Kong's sizable and liquid fiscal reserves anchor its creditworthiness. The Territory's prudent fiscal policy, significant expenditure flexibility, and generally solid economic growth have led to consistent fiscal surpluses since 2005.
 “As a result, we project that the Government will hold liquid assets amounting to about one-third of GDP at the end of 2017. We expect Hong Kong to maintain a prudent fiscal policy, given its long-term fiscal planning.
 “We rank Hong Kong's banking system risk as '2' in our Banking Industry Country Risk Assessment (BICRA), with '1' being the strongest system and '10' the weakest. 
“However, the sheer scale of the system, with total assets of approximately 8.3x Hong Kong's GDP as of year-end 2016, suggests that a downturn in the economies of Greater China could quickly affect economic conditions in the SAR.
 “For this reason, the financial system is a source of contingent liability to the Government.
 “Hong Kong's strong external creditor position stems from its sustained current account surpluses.
 “We project Hong Kong's 2017 public and financial sectors' external assets net of total external debt at close to 65% of its current account receipts (CARs).
 “We expect the broader measure of Hong Kong's entire international investment position to be 140%-160% of its CARs for the next four years. In addition, the Hong Kong dollar is actively traded globally.
 “These strengths and the Hong Kong Monetary Authority's (HKMA) prudent regulations help maintain confidence in the banking sector and mitigates the risks of large short-term external debts typical of a global financial centre.
 “We believe Hong Kong's long-established Linked Exchange Rate System (LERS) has facilitated its monetary and financial stability.
 “While the peg of the Hong Kong dollar to the U.S. dollar under the LERS means that Hong Kong's short-term interest rate largely follows that of the U.S., the HKMA has been able to use regulatory and supervisory measures to lessen the impact of sharp economic and financial fluctuations.
 “We expect the HKMA to maintain a pegged exchange rate regime and safeguard financial stability with regulatory measures.” www.standardandpoors.com (ATI).