Hong Kong: Risk Assessment
Country Risk Rating
Business Climate Rating
- Open economy
- High-quality infrastructure
- Top-class global financial center, airlock between China and the rest of the world
- Healthy banking system
- Anchoring of the currency to the U.S. dollar
- Lack of innovation and diversification of the economy
- Exposure to slowdown in mainland China
- Mismatch between business cycles in the United States and China, as the HKD is pegged to the USD
- Real estate sector risks and housing affordability
- Rising income inequality and social discontent
- Industry has fully relocated to mainland China
- Caught in between rising U.S.- China tensions
Downside pressures on growth to linger into 2021
GDP growth is likely to remain weak in 2021, as a new wave of COVID-19 infections prompted the government to tighten containment measures once again in November 2020. This will continue to weigh on private consumption and investment. Private consumption (65% of GDP) has suffered from the social unrest that started in June 2019 and from the pandemic over the first half of 2020. That said, since the National Security Law was enacted in June 2020, the resurgence of protests should be occasional and the impact on private consumption would ease in 2021. The services sector relies on tourism, of which arrivals dropped by -92.4% as of September 2020 as international borders remain shut. Inflation should increase from a low base in 2020 but would remain weaker than before the pandemic, while the labor market should only partly absorb the rise in unemployment triggered by the pandemic (6.4% in October), which would drag on disposable income in 2021.
Investment (21% of GDP) growth is expected to recover but could be pressured by political uncertainties surrounding the National Security Law and Hong Kong’s autonomy from western countries. Credit conditions have eased, in line with the zero-rate policy undertaken by the U.S. Federal Reserve (Fed) since March 2020 because of the pandemic. The Hong Kong Monetary Authority (HKMA) follows the monetary policy moves of the Fed since the currency is pegged to the U.S. dollar. With a housing shortage, excess liquidity, and the Fed unlikely to raise interest rates any time soon, housing prices had hardly experienced a drop and should correct further in 2021, which would drag on consumption through wealth effects. In July 2020, the government unveiled a USD 124 billion fiscal stimuli (9.5% of GDP) package in the 2020-21 budget. This gave little relief to the economy, as only half of it is allocated to employees and businesses.
Large budget deficit ahead, albeit cushioned by large reserves
Hong Kong is set to register the largest budget deficit ever recorded in the financial year ending March 2021. This is mainly due to the pandemic, which urged the government to undertake policies prioritizing economic recovery and employment, with a package of relief measures amounting to 4.3% of GDP. That being said, the prudent policymaking approach over the years has led to large reserves, accumulated for rainy days, which represent 22 months of expenditure. The trade balance surplus should pick up slightly, as exports should increase faster than imports since these largely dominated by re-exports (54% of total exports) to and from China, which is recovering.
Financial services should remain dynamic despite pressures on capital inflows because of geopolitical uncertainties. Banks’ balance sheets, which saw a slight deterioration in 2020, as well as a deterioration in credit quality, are still resilient and should remain so in 2021 thanks to strong capital and liquidity positions. Furthermore, Hong Kong is a top global Initial Public Offering (IPO) center and the largest financial hub in the region, with assets under management (AUMs) far exceeding those of regional competitors such as Singapore and Tokyo.
Further integration into mainland China
Chief Executive Carrie Lam’s pro-Beijing establishment coalition lost the majority in the Legislative Council (Legco) in 2019. Her popularity has plummeted since the Extradition bill and even worsened with the National Security law that China passed on 30 June 2020. This law stipulated four offenses - secession, subversion, terrorism, and collusion with foreign forces - and granted broader powers to the Hong Kong police. Critics from western countries saw this move as an attempt to curtail protests and freedom of speech. In response to this, the Trump administration put an end to Hong Kong’s special status with the U.S. through a call to label imports from Hong Kong as ‘Made in China’ from September 2020 onwards and restricting visas for Chinese officials. That said, the impact could be somehow limited, as more than 80% of Hong Kong exports consisted of re-exports from China to the U.S., while only 1.2% were domestic exports.
In her annual policy address in November 2020, Carrie Lam continued to stress the importance of the National Security law and said that she had no plans for Hong Kong’s democratic reform until the end of her term. Further integration of the city within mainland China in the future, especially through the Greater Bay Area concept, was at the heart of her policy address. She promoted programs that would boost employment opportunities, particularly among the youth in China, through wage subsidies for tech companies that would send staff in China.