September 4, 2017 / 1:14 AM / a year ago

Fitch Affirms Hong Kong at 'AA+'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, September 03 (Fitch) Fitch Ratings has affirmed Hong Kong's Long-Term Foreign- and Local-Currency Issuer Default Ratings at 'AA+' with a Stable Outlook. A full list of rating actions is at the end of this Rating Action Commentary. KEY RATING DRIVERS Hong Kong's ratings are underpinned by its exceptionally strong public and external finances, a credible policy framework, high income levels, and a resilient and flexible economy. The ratings are principally constrained by the territory's deeper integration with lower-rated mainland China (A+/Stable). The territory's robust external finances are exemplified by its status as the third-largest net external creditor among Fitch-rated sovereigns (275% of GDP), as well as its record of current account surpluses going back more than 20 years. Exports have recovered in 2017 alongside the expansion in global trade, but imports have grown slightly more rapidly, resulting in a modest widening of the merchandise trade deficit. Fitch nevertheless expects a recovery in services exports to keep the current account in substantial surplus at a projected 4.1% of GDP in 2017. The Hong Kong dollar has weakened since early 2017, as ample liquidity across the territory's financial system has impeded domestic interest rates from rising in tandem with US interest rates. Fitch believes these price developments are consistent with the territory's rules-based currency board system, which only requires automatic intervention should fund outflows result in the Hong Kong dollar hitting the weak end of the convertibility band of HKD7.85 versus the US dollar. Foreign reserve holdings equivalent to 1.9x the monetary base at end-July 2017 also suggest the authorities have ample financial resources to defend the currency board, if required. Public finances are a key rating strength compared with 'AA' peers, and the territory has run a consistent budget surplus for over a decade. The surplus for the fiscal year ending March 2017 (FY16) was recorded at 4.4% of GDP (HKD110 billion), significantly above the original budget estimate of 0.5% (HKD11.4 bilion), due in large part to higher revenues from land sales and stamp duty associated with a buoyant property market. Fitch projects a FY17 budget surplus of 2% of GDP - above the government's original estimate of 0.6% - as three major land auctions in June 2017 have resulted in stronger-than expected revenue performance thus far in 2017. Reported government debt of 42% of GDP does not reflect the accumulation of fiscal liabilities, and consists almost entirely of notes issued by the Hong Kong Monetary Authority to manage the currency board. Fiscal reserves rose to 38% of GDP in FY16, equivalent to 23x the FY17 projected budget expenditure, which provides substantial flexibility in the event of an unexpected fiscal shock. The authorities appear to be taking a more proactive approach to housing and tax policy, and have proposed the introduction of a two-tiered tax system to reduce the burden on SMEs, while affirming their commitment to maintaining balanced budgets, as enshrined in Article 107 of the Basic Law. Fitch forecasts economic growth to remain robust at 3.4% in 2017, but expects a deceleration to 2.4% in 2018, a level broadly in line with our assessment of Hong Kong's trend growth rate. Growth has accelerated over the past year due to a cyclical rebound in mainland China and the global economy. Real GDP grew by 3.8% in 2Q17, up from 2.0% in 2016, with substantial contributions from private consumption and investment. A stabilisation in visitor arrivals has supported retail sales, which returned to positive growth in early 2017 following two consecutive years of contraction. These developments have had a positive spill-over effect on the labour market, with the seasonally-adjused unemployment rate falling to 3.1% in July 2017 from 3.4% a year prior. Property prices remain at historical highs, and have risen by a further 9% year-to-date despite the introduction of higher stamp duties in late-2016 and a further round of counter-cyclical measures in May 2017. Rising domestic interest rates alongside Fed normalisation will increase borrowers' debt-servicing burden, raising the near-term likelihood that the property market will enter a gradual downward cycle. A sharp price decline would undoubtedly have an impact on consumption through a negative wealth effect, while Fitch believes that strict prudential measures and low loan-to-value caps enacted since 2010 mitigate direct banking-sector risks. Fitch views the mainland China exposures of Hong Kong's banks as the territory's most salient rating constraint. The agency estimates that these exposures accounted for 29% of sector-wide assets at end-1Q17, up from a trough of 27% at end-1Q16 when market concerns over Chinese yuan depreciation lead to a reduction in cross-border bank claims. The classified loan ratio for mainland-related lending remains low at 0.8%, and we expect the system's liquidity and capitalisation to remain sound. Official disclosures suggest the majority of loans are backed by collateral, but recovery rates in the event of an economic shock in China could be much lower than expected - given that bankruptcy procedures are still largely untested. Hong Kong's new Chief Executive Carrie Lam was sworn into office in July 2017 during President Xi's official visit to mark the 20-year anniversary of the territory's return to Chinese sovereignty. The new administration is seeking to prioritise socioeconomic issues such as high income inequality and youth employment opportunities in order to create a more conducive atmosphere under which future constitutional reforms - as envisioned under the Basic Law - could successfully take place. Unresolved social cleavages over Hong Kong's long-term political development could potentially spark periodic social demonstrations, but Fitch does not expect disruptions in the size or scale experienced during the 2014 "Occupy Central" movement. SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Hong Kong a score equivalent to a rating of 'AA+' on the Long-Term Foreign-Currency IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR by applying its QO, relative to rated peers, as follows: - Public Finances: +1 notch, to reflect that Hong Kong's government debt stock is not fiscal in nature and primarily constitutes notes issued by the Hong Kong Monetary Authority to manage the currency board. Hong Kong's fiscal reserves also add an additional buffer to the credit profile. - Structural Features: -1 notch, reflecting Hong Kong's significant linkages with lower-rated mainland China (A+), including via the banking sector. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. RATING SENSITIVITIES The main factors that could lead to negative action, individually or collectively, are: -Further concentration of banking sector exposures to mainland China that make it increasingly difficult to distinguish financial sector risks in Hong Kong from those in mainland China. - Heighted risk of a sharp slowdown in mainland China or evidence that its structural rebalancing will have a destabilising effect on Hong Kong's financial sector or broader economy. - Political disruption sufficiently large and prolonged to disrupt Hong Kong's economic growth or attractiveness as an international financial centre. The main factors that could lead to positive action, individually or collectively, are: - Confirmation that the economies of both Hong Kong and mainland China are resilient to China's transition away from debt-fuelled growth or resilient to a full economic cycle. KEY ASSUMPTIONS - China avoids a 'hard landing' or banking sector crisis. - Hong Kong maintains the present Linked Exchange Rate System with the US dollar. The full list of rating actions is as follows: Long-Term Foreign-Currency IDR affirmed at 'AA+'; Outlook Stable Long-Term Local-Currency IDR affirmed at 'AA+'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'F1+' Short-Term Local-Currency IDR affirmed at 'F1+' Country Ceiling affirmed at 'AAA' Issue ratings on long-term senior-unsecured local-currency bonds affirmed at 'AA+' Issue ratings on short-term senior-unsecured local-currency bonds affirmed at 'F1+' Issue ratings on global sukuk trust certificates affirmed at 'AA+' Contact: Primary Analyst Andrew Fennell Director +852 2263 9925 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Hong Kong Secondary Analyst Ed Parker Managing Director +44 20 3530 1176 Committee Chairperson James McCormack Managing Director +44 20 3530 1286 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email:; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: Additional information is available on Applicable Criteria Country Ceilings Criteria (pub. 21 Jul 2017) here Sovereign Rating Criteria (pub. 21 Jul 2017) here Sukuk Rating Criteria (pub. 14 Aug 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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