While political tensions in Hong Kong escalate, the city has not yet witnessed large-scale capital outflows. But market analysts warn the city’s business environment and credit rating may be downgraded if the chaos persists
There has been no sign of capital exodus from Hong Kong’s financial system in spite of the social chaos in the city resulted from the persistent protests. But it is widely ackowledged that the unstable situtation would threaten Hong Kong’s status as an international financial center and affect the overseas investors’ confidence in local investment market. (EDMOND TANG / CHINA DAILY)
Hong Kong politics became unsettled in June when protests erupted against the proposed amendments to the city’s extradition law. Numerous political protests took place in the city in June and July, and signs are pointing to more protests for the time being.
The financial market started to worry that if the political protests drag on, capital outflows from Hong Kong’s financial system may become more evident.
Immune to adverse effect
However, Financial Secretary Paul Chan Mo-po said that Hong Kong’s financial system is operating orderly and smoothly, and the system is resilient to recent external shocks in the global financial market.
“We have monitored the market to gauge whether there are speculators selling short the Hong Kong dollar, and so far, there has been no such short selling. We believe financial risks are manageable despite recent social unrest,” the finance chief said at the Wednesday Financial Leaders Forum.
The worst-case scenario would be highly negative for Hong Kong’s economy and its status as an international financial center. It is also highly unpalatable for an international financial center to implement a state of emergency, and there is unlikely to be an easy exit once implemented. A lot of capital and talent may also have exited Hong Kong
Kevin Lai, analyst at Daiwa Capital Markets
In Chan’s view, the Hong Kong banking system is well positioned against market volatility. The liquidity coverage ratio and capital adequacy ratio of Hong Kong banks are 160 percent and over 20 percent respectively, higher than the international standards of 100 percent and 8 percent. In addition, the bad-debt provision of local banks stood at 0.6 percent at the end of 2018, indicting that the banks’ asset quality is good.
The Hong Kong Monetary Authority (HKMA), the city’s de facto central bank, has offered reassurances that there has been no evident capital exodus out of Hong Kong.
“There are possibilities that the Hong Kong dollar may be tested. We have witnessed several large-scale capital outflows in the last 36 years, when the dollar-peg system was instituted, and the system is still operating properly,” HKMA Deputy Chief Executive Arthur Yuen Kwok-hang said after the forum.
According to the HKMA, the city’s monetary base, comprising certificates of indebtedness, government notes and coins in circulation, the aggregate balance, and outstanding Exchange Fund Bills and Notes, reached HK$1.631 trillion (US$207.97 billion) on July 29, compared with HK$1.625 trillion on June 28, after political protests happened in the middle of the month.
Though the aggregate balance has dwindled from the peak of HK$180 billion in April 2018 to HK$54.4 billion in July, the financial sector is holding a vast amount of outstanding Exchange Fund Bills and Notes amounting to HK$1.069 trillion, which is a huge boost of liquidity in the city’s financial system.
In addition, the HK$4.137 trillion Exchange Fund at the end of June is a huge financial arsenal that the city can leverage to defend the Hong Kong dollar. The city’s foreign currency reserve assets represented over twice the monetary base, and this figure also far outweighs the estimated HK$1.014 trillion in capital inflows into Hong Kong since the global financial crises of 2008.
“We have noticed that in the last few months, including the end-of-June deposit figures that have just been published, the level of HK dollar or US dollar deposits in Hong Kong have remained stable. There was no noticeable outflow of funds from Hong Kong dollar or from the banking system,” HKMA Chief Executive Norman Chan Tak-lam said on Aug 1.
OCBC Wing Hang Bank Economist Carie Li Roufan agreed, saying in a report, “As massive capital outflows have not been seen so far (Hong Kong’s monetary base remains sizeable and USD/HKD stays away from 7.85) and the renminbi stabilizes, the chance of HIBOR (Hong Kong Interbank Offered Rate) testing July’s high look slim, especially in the absence of huge dividend payments and large initial public offerings.”
Some feeling the pinch
The Hong Kong IPO market is the one financial sector that has felt the chill of possible capital outflows, when the city’s stock exchange market lost an estimated HK$90 billion in IPO fundraising business in June and July.
Global brewer Budweiser Asia Pacific, tycoon Li Ka-shing’s biopharmaceutical company Hutchison China Meditech, and logistics real estate developer ESR Cayman all have scrapped their listing plans in the past two months. It is possible that more companies will shelve or put off their listing plans until the political and social situation improves.
This probably will dethrone Hong Kong as the top IPO listing destination this year when the city was the world’s first top IPO listing venue in 2018, raising a total of HK$288 billion last year.
“A stable stock market and favorable valuations are essential for these big offerings. Support from cornerstone investors is also critical. Market dynamics will be driven by several macroeconomic and geopolitical events. These factors will affect the timetable and final amount of funds raised in these larger deals,” Deloitte China National Public Offering Group Co-Leader Edward Au told China Daily.
Some investment banks are less optimistic, predicting some sort of the worst scenarios may happen, leading to a capital exodus.
Daiwa Capital Markets analyst Kevin Lai cautioned that there is 40 percent chances that the worst-scenario will happen, in which the government will adopt a moreforceful approach against political protests.
“The worst-case scenario would be highly negative for Hong Kong’s economy and its status as an international financial center. It is also highly unpalatable for an international financial center to implement a state of emergency, and there is unlikely to be an easy exit once implemented. A lot of capital and talent may also have exited Hong Kong,” Lai warned.
Braced for the worst
Credit rating companies warn that if the political crisis continues, Hong Kong’s credit rating may be downgraded, making the city’s stock and bond market less attractive, exacerbating the concerns of capital flight.
Although Fitch Ratings affirmed Hong Kong’s AA+ sovereign credit rating on June 11 before political protests erupted, the US-based credit rating agency nevertheless warned that some of the assumptions underpinning the rating are currently being tested, including the effectiveness of the city’s governance and its rule of law. Another additional factor that could affect credit assessment would be the international response to recent events in Hong Kong.
It argued that “the unrest and apparent rising distrust in government runs the risk of damaging business confidence and eroding the quality and effectiveness of governance, which supports Hong Kong’s three-notch positive sovereign rating differential with the Chinese mainland.”
HONG KONG NEWS