After strong GDP date, Moody's downgrades Hong Kong: Natixis outlook going forward

Moody’s followed its downgrade on China’s sovereign rating yesterday by lowering Hong Kong’s rating (Aa2 from Aa1), citing close ties between the two as key reason. While we may not agree with the timing - as Hong Kong Q1 QDP again beat market expectations (17Q1: 4.3%; 16Q4: 3.2%), lifted by further stabilization of the retail sector, strengthening export performance and a favorable base – China is undeniably behind such strong cyclical rebound.

China’s recent stabilization has helped Hong Kong in several ways. First, mainland-related retail spending has improved over months and recorded the first yearly growth since early 2015 (+1.1% in March). This, coupled with the relatively resilient domestic spending – benefitted from a robust labor market (unemployment rate: 3.2% in April) amid sharp fall in retail unemployment since H2 2016 - pushed the headline retail sales to the highest level in more than 2 years (+3.1% in March). Second, on the external front, China’s climbing demand caused the abrupt surge in Hong Kong’s re-exports to the mainland in the first quarter, which had boosted good exports’ contribution to GDP growth markedly last quarter (13.7%).

Taming the property market remains an uphill battle for the government. Residential price further accelerated in March (+17.8 %YoY), with prices of smaller flat significantly outpacing their larger counterparts. In response, HKMA recently announced tightening measures, which mainly lowered the loan-to-value cap for borrowers with one or more mortgage loans and cut debt servicing ratio of borrowers with income mainly derived from outside of Hong Kong. Such prudential measures, together with reduced outflows from China, should keep the property market in check for the rest of 2017. Regarding financial conditions, HKD and CNH HIBOR went down in May along with a slower rates tightening cycle expected in the US and RMB’s stabilization. The relatively clam RMB market also reined the fall in RMB deposits in Hong Kong.

All in all, Hong Kong’s rebound in external trade and retail sales are mainly cyclical and we expect GDP to grow at 2.5% in 2017 (2016: 2%). Yet with structural issues like increasing competition from mainland in the sectors where HK has the largest comparative advantage, and an ageing population, it will be hard for the HK economy to keep its growth momentum beyond a few quarters. Moody’s recent sovereign downgrade may even make it more short-lived.