16th September 2019 – (Hong Kong) Moody’s Investors Service has today changed the outlook on the Aa2 issuer rating of the Government of Hong Kong to negative from stable, and affirmed the Aa2 long-term issuer and senior unsecured ratings.
The change in outlook to negative reflects the rising risk that the ongoing protests reveal an erosion in the strength of Hong Kong’s institutions, with lower government and policy effectiveness than Moody’s had previously assessed, and undermine Hong Kong’s credit fundamentals by damaging its attractiveness as a trade and financial hub.
The affirmation of the Aa2 rating reflects, among other things, Hong Kong’s strong fiscal and external buffers, with a minimal government debt burden, large fiscal reserves and ample foreign exchange reserves, all of which offer resilience to shocks and negative long-term trends.
Moody’s has also affirmed the Aa2 senior unsecured foreign currency ratings of the Trust Certificates issued by Hong Kong Sukuk 2014 Limited and Hong Kong Sukuk 2015 Limited, special purpose vehicles established by the Government of Hong Kong. The payment obligations associated with these certificates are direct obligations of the government and rank pari passu with other senior unsecured debt of the government.
Hong Kong’s long-term foreign-currency bond ceiling and the local currency bond and deposits ceilings remain at Aaa, and the long-term foreign currency deposits ceiling remains at Aa2. Hong Kong’s short-term foreign currency bond and bank deposits ceilings remain unchanged at P-1.
RATIONALE FOR THE NEGATIVE OUTLOOK
Hong Kong’s Aa2 rating rests in part on the strength of its economy and institutions. The two are closely related, and the ongoing stalemate between the Hong Kong authorities and protestors has increased the downside risks to both since Moody’s last rating announcement on Hong Kong in July 2019. The longer the stalemate persists, the greater the risk that these strengths are revealed to be eroding.
Hong Kong’s economic strength reflects its competitive position as a trade and finance gateway between China (A1 stable), Asia Pacific and global markets. This position in turn reflects its economic proximity to China, but also the autonomy and predictability of its judicial and administrative institutions, including a strong rule of law and transparent and predictable regulatory regime. These qualities, along with its status as a Special Administrative Region (SAR), have allowed Hong Kong to enter into a number of treaties and arrangements that treat it as a distinct economic entity, subject to trade and investment policies that have allowed the territory to prosper.
The institutional features which grant Hong Kong a degree of political and economic autonomy — together with its intrinsic credit strengths — account for Hong Kong’s higher rating when compared with China. But the two ratings are clearly interrelated, and the closer the institutional and economic linkages between Hong Kong and China become, the more closely the two ratings will converge.
Closer linkages with China in Hong Kong’s institutional framework and policymaking would lead to an erosion in the currently very high strength of Hong Kong’s governing and judicial institutions, policy effectiveness and competitive advantage over large cities in the mainland and other international trade or financial hubs.
Consistent with this, Moody’s has previously noted that a downgrade could be triggered by a shift in the current equilibrium between the SAR’s economic proximity to and legal and regulatory distance from China. The decision to change Hong Kong’s outlook to negative signals rising concern that this shift is happening, notwithstanding recent moves by Hong Kong’s government to accommodate some of the demonstrators’ demands.
The longer the standoff continues, the greater the risk that disruption to the smooth functioning of the economy diminishes Hong Kong’s attractiveness as a global economic and financial centre. The weakening capacity of the Hong Kong government to implement policies to preserve living standards, competitiveness and financial buffers could in turn undermine key drivers of its competitiveness and macroeconomic stability.
Moreover, while the outcome of the standoff remains highly uncertain, the longer it persists, the greater the risk that it precipitates a response from the authorities, which would demonstrate a tightening in the institutional linkage to China and signifies a diminution of the predictability of Hong Kong’s own governing and judicial institutions. That situation would, in turn, exacerbate the damage to its near- and medium-term economic prospects. Any such erosion in Hong Kong’s comparative advantage would be accelerated by the change in its status in international trade and finance arrangements that could follow such a response.
RATIONALE FOR THE RATING AFFIRMATION
Hong Kong’s minimal debt burden and large fiscal reserves continue to imply strong resilience to economic and financial shocks and strengthen the SAR’s ability to address long-term structural challenges. Ample foreign exchange reserves also contribute to macroeconomic stability for a small, open economy and large financial centre. While government debt will likely rise modestly due to fiscal policy easing in the context of slowing economic growth, it will remain very low. Fiscal reserves of HKD1.2 trillion (around 40% of GDP) in fiscal 2019/20 represent a material buffer to address long-term structural issues.
A fast-ageing population continues to pose a major long-term challenge to Hong Kong’s policymakers, as the labour force shrinks and significantly raises ageing-related spending needs by the government and the entire population. In the absence of significant measures to mitigate these effects, Moody’s expects that population ageing will lead to a gradual reduction in fiscal reserves over time. However, the sustained record of budgetary prudence underscores the strength of Hong Kong’s fiscal and policy effectiveness, which in turn provides the SAR with more time to design and implement measures that will slow the rundown of its buffers.