Hong Kong is slowing down rapidly as uncertainty increases

• The social and economic situation in Hong Kong has deteriorated since the end of Q2 2019, casting doubts on the future of the Eastern Pearl. Along with the deceleration of Hong Kong’s real GDP to 0.5% in Q2, a series of negative shocks have pushed Hong Kong government official to cut this year’s growth forecast radically to 0% to 1% from 2% to 3%.
• The reasons for Hong Kong’s economic slowdown go beyond the protests as they also include the deteriorating relationship between China and the US and much more negative sentiment globally. On the former, Hong Kong’s exports are doing very poorly, with a reduction of 9% YoY in June. In particular, Hong Kong’s exports to the US and Japan experienced sharp declines. Although imports have also seen a sharp deceleration, export performance has been poorer, leading to a widening of the trade deficit to widen to $125 billion (18% of GDP) in the second quarter from $118 billion (17% of GDP) in Q1.
• Against the backdrop, business confidence has deteriorated sharply as shown by the PMI moved further downward to 43.8, within the contraction territory. In the same vein, Hong Kong gross investment dropped by -12% in Q2 from the earlier -7% in Q1. Given that the Q2 only incorporates two weeks of the 11-week long of protests so far, investment is bound to perform even worse in Q3.
• Beyond trade and investment, since the social unrest started, Hong Kong’s retail sales slumped across the board as inbound travellers from Mainland China have come down quickly and a number of countries have issued travel alert warnings to Hong Kong. Because the overseas consumers account for more than half of the whole consumption, we should expect very negative data for retail sales during Q3.
• To counteract the economic downturn, the Hong Kong government has laid out a fiscal plan of $19.1 billion to relieve the pressure on enterprises and residents, but the amount was only 4% of the total fiscal expenditure or 0.7% of Hong Kong’s 2018 GDP in 2018. Moreover, the relief measures were too broad based to target at the main problems faced by Hong Kong. In addition, we should realize that weaker government revenue is to be expected, which would worsen the fiscal situation well beyond the recently announced package.
• As for Hong Kong financial markets, the liquidity environment has been tightened as the 3-month HIBOR moved up from 1.76% in March to 2.44% in June. This has pushed the HIBOR-LIBOR spread to the positive territory after three and a half years in which HIBOR generally remained below LIBOR. This should have induced capital inflows, but the reality points to the opposite amid the economic weakness. While there have lately been some short instances of rapid appreciation of the HKD in early July thanks to the retreat of carry trade activities towards USD, the HKD moved back towards the weak end of the band thereafter as capital outflows become the dominant trend. In fact, a climbing loan to deposit ratio testifies to the reduction in the deposit base.
• Amid the social and economic uncertainties, residential property prices declined significantly in the second quarter together with lower transaction volumes. On the commercial front, both office and retail rental growth rates dipped lower as business confidence weakened.
• Moving forward, the pressure weighing on Hong Kong’s growth will become tougher. This is not only because of the US-China trade war and a more negative global economic outlook but also disruptions in activities stemming from the protests as well as market’s worries over Hong Kong’s reputation as a global offshore financial centre. Against this background, we expect bolder fiscal measures to be announced by the government soon, which support our forecast above zero but hard to avoid rapid growth deceleration. Thus, we expect 2019 growth to hover around 0.5% for 2019.

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