Protectionism is a bigger risk to Hong Kong than currency peg collapse

Flapping in the wind: the risk of investors taking flight is more trade than currency related

Hong Kong’s risk score has stabilized at around 78 points from a maximum 100 based on preliminary data from Euromoney’s first-quarter country risk survey as experts take a sanguine view of the latest financial market turbulence spurred by rising US interest rates.

The survey will be officially released next month.

Typically, the Hong Kong Monetary Authority has intervened in the forex market to defend the pegged exchange rate linking the local dollar to its US equivalent, as the Federal Reserve’s tightening of monetary policy has precipitated soaring US-dollar Libor rates.

The risk of capital flight is underlined by the currency falling to a three-decade low, to the lower end of the band surrounding the central target of HK$7.80, within the range of HK$7.75 and HK$7.85.

But country risk experts are unperturbed by the chatter of an impending crisis.

Hong Kong’s global risk ranking remains well supported by strong economic factors linked to the robust outlook for mainland China, which fuels local trade and tourism, while the survey's monetary policy/currency stability indicator is holding firm.

The Special Administrative Region (SAR) ranks 14th globally, at the top of the second of five tiered categories Euromoney divides all its 186 sovereign credits into.

The ranking broadly indicates a low level of risk. The SAR is sandwiched between Austria and Chile in the country risk guide.

Meanwhile, the IMF is predicting 2.8% GDP growth for Hong Kong this year (close to potential), an unemployment rate of 3.2%, inflation of 1.8%, a budget surplus with robust fiscal reserves and a current-account surplus close to 3% of GDP.

The HKMA has ample reserves to defend the peg, including a stockpile of US dollar assets that exceeds the SAR’s liabilities. Real estate is also strong: the local property market has plenty of liquidity, underpinned by low mortgage rates.

“As the US interest rate has risen in recent months, higher interest rates in Hong Kong are widely expected,” says survey expert Andy Chui, an associate professor at the Hong Kong Polytechnic University.

“Furthermore, there is no sign of a surge in capital outflow”.

Hong Kong interbank rates will naturally rise thanks to arbitrage and HK-dollar borrowings for large IPOs, which surged in the first quarter.

There are more potential listings, including one from the Xiaomi Corporation, a smartphone manufacturer, valued at $100 billion.

Risky picture

Still, Hong Kong’s risk score has been on a slow decline since 2010, shedding more than five points in Euromoney’s crowd-sourced survey.

This reflects concern about China’s long-term financial health and its impact on Hong Kong’s growth prospects, as well as worries over political meddling from Beijing that has thwarted pro-democracy protests, in turn weighing down political risk scores.

Markets have also been unnerved by the prospect of president Donald Trump’s America First policy creating a global trade war.

In Hong Kong, the outlook for economic growth, employment and government finances has deteriorated modestly over time but this would become a good deal worse if the trade war intensifies in the wake of the US decision to impose tariffs on Chinese imports.

The American measures – still to be reviewed and implemented – will only have a modest impact on China’s GDP, assuming that the introduction of tit-for-tat barriers does not escalate.

“The likelihood of a full-blown and protracted trade war between the US and China is still low,” state BBVA economists.

“Much would depend on China’s retaliatory response to US’s planned tariff package and potential investment restrictions. Also, both sides are well-aware of the spill over effects of such a ‘lose-lose’ trade war”.

For now, Hong Kong is a shining star, but forget the peg, just keep an eye on the trade war.