Hong Kong’s economy still heading south

• Hong Kong’s GDP declined by another -9% in Q2 2020, which should not be read as a surprise amid the worsening US-China relationship with a particular focus on the Eastern Pearl as well as the several waves of Covid-19.
• This has been the second contracting quarter for Hong Kong’s economy after a terrible 2019, when Hong Kong was the only economy in Asia to experience negative growth. Hong Kong‘s economy looks trapped by both domestic and international uncertainties. While a number of fiscal packages have been deployed, they clearly fall short of the strength needed to avoid such big recession. The fact that an intense third wave of Covid-19 cases is taking place at the beginning of Q3 does not bode well for any relevant recovery of activity soon.
• Consumption remains very weak. The most worrying aspect about the Hong Kong economy lies in the plummeting retail sales even when mobility restrictions were much milder in June with large pent-up demand. In fact, retail sales have kept negative year-on-year growth of -36.1% to -32.8% from April to May. The weakness in retail sales comes from the high dependence on visitors (about half of total retail sales) and the slack in the labour market with unemployment having hit 6.2% in May from 3.4% in January before the pandemic started. As it were not enough, July marked the start of a tougher wave in the pandemic with harsher mobility restrictions. This means that July retail sales may head further South.
• As for investment, improved business sentiment in Q2 might not be maintained in Q3. Before the third wave of infections started, business sentiment in Hong Kong improved from April to June, reaching 49.6 – a level close to the expansion-contraction threshold. However, the current third wave – by far the worst – is likely to hit confidence in July and probably beyond.
• On the external front, Hong Kong’s imports remained weak in June because of the sluggish labour market and the absence of tourists. While its poor export performance seemed to have improve in June with a smaller negative growth rate (-1.3% YoY) from May (-7.4% YoY), the merchandise trade deficit widened in June after the contraction in the first two months of Q2.
• Financial markets have performed quite well. The liquidity environment started from a tight position in Q2 with 3-month HIBOR at about 1.9% at the beginning of April but moving down quickly, narrowing down the HIBOR-LIBOR spread from more than 100 basis points at the peak in late April to only 22 bps as of July 21. Still, the positive spread with HIBOR and the large volume of IPOs of Chinese giant companies as well as bond issuance, has led to significant capital inflows, which have kept the HKD close to its most appreciated value within the band, namely 7.75 to the USD.
• On the property market, the beginning of a recovery has been noticeable for residential price since May, but its year-on-year growth rate remained negative. The most worrisome part comes from the sharp reduction in rents, especially for commercial property.
• Outlook: Moving forward, retail sales and business sentiment are likely to suffer from the renewed outbreak of Covid-19, especially for the hospitality and airline sectors as no easing of travel rules is to be expected any time soon. One potential silver lining is the improved external economic environment, be it in China or the West. However, this better prospect may be dampened by the uncertainties about US-China relationship and the role of Hong Kong within such a relationship. All in all, the extension of mobility restrictions due to the pandemic and the possible worsening US-China relationship prompts us to revise down Hong Kong’s GDP forecast to -7% for 2020, notwithstanding the support from the financial sector and capital inflows.

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