Rating cut by Moody’s belies HK strength

Links with mainland cited for downgrade

Beijing/Hong Kong: Hong Kong’s increasingly tight embrace with China cost it a notch on the credit rating scale this week, but the move is at odds with signs of local economic and financial health that distinguish it from its neighbour. Hours after its surprise China cut, Moody’s Investors Service reduced Hong Kong’s local currency and foreign currency issuer ratings by one notch to Aa2 from Aa1 on Wednesday, citing the risk of contagion from the mainland, which is grappling with a record debt burden and an outlook for slower growth. But as these charts show, the city — which has seen its markets become steadily more integrated into China’s via investor connects — is on a pretty solid footing. “If you were looking at Hong Kong purely in isolation, you probably wouldn’t downgrade it,” said Mark McFarland, chief economist for Asia at Union Bancaire Privee. “But if you’re thinking of Hong Kong as part of a financial system in the Chinese geographical space, the reasons for downgrading China would also apply to Hong Kong, given the close nature of the links between the two.” While Beijing has made much of its campaign to reduce leverage over the past six months, Moody’s indicated it wasn’t enough. The ratings company zeroed in on the country’s hefty borrowing, which has surged to more than double gross domestic product since the global financial crisis. Hong Kong’s “close and tightening economic, financial and political linkages with the mainland” mean credit trends in China matter for the city, according to Moody’s. While Chinese stocks spiked lower on Wednesday’s downgrade — before rebounding amid speculation of intervention — equities in Hong Kong shrugged off the news, keeping to a trend that’s made the city’s stocks among the best performers in Asia this year. After two years of contraction, Asia’s second-biggest equity market, after mainland China’s, has seen its value jump by 12% in 2017. The MSCI Hong Kong Index, which only tracks companies based in the city of seven million people, is up 18% this year to near its highest level since June 2015. That compares with the 13% increase in MSCI’s broader Asia Pacific Index and the Shanghai Composite Index, which is little changed in 2017 after erasing gains over the past month on anxiety over the deleveraging drive. Property prices, too, reflect a certain resilience, setting fresh records despite concern over the potential fallout should Hong Kong see a market crash. Rock-bottom mortgage rates have f ueled t he boom, with l ocal banks reluctant to tighten because of intense competition. That’s resulted in the only real ripple in the Hong Kong investment landscape this year — the city’s dollar. The currency, which is pegged to the US dollar, has been tumbling, touching a 15-month low as the interest-rate differential with the US widens. Hong Kong banks’ declining to pass along the monetary authority’s rate increases has seen the premium on Libor — the one-month US interbank rate — over Hong Kong’s Hibor rate swell to the biggest since December 2008. The stock connect between Hong Kong and China, the forthcoming bond link, as well as the ever-closer ties between the two economies mean that the city is increasingly intertwined with the mainland, said McFarland at Union Bancaire in Hong Kong. “You have to remember — China’s the sovereign,” he said. “There are obviously going to be spillover implications for Hong Kong.” Moody’s rationale does raise the possibility that the cycle of downgrades will spread further, from Hong Kong companies to Taiwan and potentially even UK banks, according to Natixis chief wconomist for Asia-Pacific Alicia Garcia Herrero. “When push comes to shove, even the Taiwanese sovereign could be downgraded as its economy is still heavily reliant on the mainland in terms of exports,” she said in a report. “Hong Kong banks themselves also suffer from a direct exposure through cross-border lending, which for some is quite massive. This argument could even be made for HSBC and Standard Chartered Bank — whose revenues are heavily concentrated in greater China.”