Don’t be fooled by Hong Kong's strong sales growth in 2011

What stands out? We have finally seen some visible easing in Hong Kong’s retail sales. Yes, sales volume continued to grow at double-digit rate in 3Q11 (19.5%y/y versus 21.6% in 2Q11). However, sequential momentum has significantly slowed in the last few months. Sales volume grew 2.9%q/qsa in 3Q, still a healthy rate but this is well below the average 5%q/qsa (over 20% annualized growth) in the last four quarters. The slowdown in September (the last data point) was particularly sharp, with sales contracting 3%m/msa.

Is the slowdown just a blip? Well, the very strong sales during 3Q10-2Q11, to a large extent driven by Chinese tourist spending, looked more exceptional to us. 2011 is going to be remembered as a bumper year for the retail sector, with sales volume looking set to grow near a record 20%y/y. But for 2012, we are likely to see sales growth coming back to earth (we expect high single-digit growth of around 7-8%y/y) for the following reasons:

Chinese arrival to moderate. Hong Kong’s exceptional strong retail sales growth owes a great deal to the Chinese tourists, who are big spender here on basic necessities to luxury items. Chinese tourist arrivals have been growing on average 25%y/y since 2Q10, up from an average 8%y/y during 2005-09. A number of drivers for the surge in arrivals: visa relaxation; RMB appreciation; rising Chinese inflation and etc. Among these, the biggest driver, in our opinion, was visa relaxation. Two major changes on this since early 2010.

First, a year-round multiple entry visa arrangements for Shenzhen residents was launched in April 2010. Second, non-Guangdong residents in Shenzhen were allowed to apply for IVS (Individual Visitor Scheme) in December 2010. But absence any fresh policy initiative, the boosts to arrivals from these measures could taper off going forward, resulting in Chinese arrival to slow to a more moderate pace in 2012.

A global slowdown to crimp non-Chinese arrivals. Arrivals from the rest of the world will be negatively impacted by the global slowdown. This is particularly true for the European tourists (5% of the total arrivals into HK; the respective shares for the Chinese and America are 63% and 3%), as we are looking for Europe to slip into a recession in 1H12.

Discretionary spending by residents to slow. Until 2H11 spending by local residents was also boosted by a multitude of factors: an improving labour market, cheap and easy credit, positive wealth effects from rising asset prices, in particular property prices. But the external and domestic macro environments have deteriorated since 2H11. With unemployment rate likely to pick back up, we expect residents to turn more cautious on spending, particularly on discretionary items such as cars.