Hong Kong economic bounce back feared to be hollow

The picture remains weak due to falling consumer confidence.

Hong Kong may see its economic activity show signs of life in the short-term but economists are saying it isn’t time to celebrate just yet. With the slowing global economy and a soft demand for Hong Kong’s exports to boot, the perfect storm might still be brewing for the territory. According to Thomas Shik, acting chief economist at Hang Seng Bank, retail sales of consumer durables fell by almost 21% in May, its largest fall since February.

Shik notes that this reflects the adverse impact of the persistent global economic uncertainty and financial market volatility on household spending activity.

“In addition, the slowing pace of economic growth in mainland China has resulted in the number of visitors from the mainland to Hong Kong dropping by an annual rate of 8.3% in May after a 4% decline in April, pointing to a continued slowdown in tourist spending,” Shik says.

Julia Wang, an economist for HSBC concurs, saying “Weak global demand, especially from mainland China, has been a major drag on Hong Kong’s economy and remains a key downside risk.” Wang adds export growth registered the 13th straight month of contraction in May although the pace of contraction slowed from April. “Exports were down 0.1% y-o-y in May, compared with a fall of 2.3% in April,” she says.

Meanwhile, Silvia Liu, an economist for UBS says consumption is expected to stabilise in 2016, and a slower pace of US rate hikes and headline growth, could be marginally better in 2017. However, Adrienne Lui from Citi Hong Kong begs to differ, saying that consumption weakness has further to run. “We think the weak consumption trend is well established, and the rate of y-o-y declines will likely remain in the high single digits throughout the summer, which will have lagging effects on hiring (9.2% of total employment is retail-related and 7.6% is accommodation and food services-related) and shop rentals,” Lui says.

“Aside from our above-mentioned concern about a possible further slowdown in tourism receipts in the summer, we do not see th e light at the end of the tunnel for local consumers.”

Trade flows an illusion

Additionally, Shik implies an illusion in the recent improvement in trade flows, as they appear to have been more related to higher commodity prices than to a robust global economic growth. “The Commodity Research Bureau (CRB)
commodity price index, a basket of key commodities, has risen by about 10% in 2016 to date, but growth in advanced economies, in particular the US and the Eurozone, has remained moderate,” Shik says.

“Without a pickup in growth in these economies, which are the leading markets for Asian exports, Hong Kong’s trade growth is unlikely to be sustainable,” he adds. According to OCBC Research, in comparison, growth in China’s imports from Hong Kong jumped 242.6% y-o-y after increasing 203.5% in the previous month. “Nonetheless, the persistent mismatch in data prints continues to signal that fake invoicing activities continue to support capital outflow from the onshore market,” OCBC Research noted.

Waves of Brexit on HK shores

Meanwhile, while the United Kingdom may be 9,600 kilometers away from Hong Kong, waves of its referendum to leave the European Union may affect the territory’s economy significantly. Hang Seng’s Shik says while Hong Kong’s exposure to the UK may be low, there’s no discounting the territory’s dependence on the temperature of the global
economy. “Although Hong Kong’s direct trade exposure to the UK is limited, with goods exports to the nation accounting for about 1.5% of total goods exports and 6.6% of total services exports, Hong Kong’s trade could still be adversely affected if the world economy slows in response to the UK’s ‘Leave’ vote,” Shik says.

On the other hand, UBS’ Liu expects Hong Kong to be less bad next year. “Lower rates for longer and the potential peak in USD should more than offset a moderately weaker DM. We reiterate our real GDP projection at 1.2%y-o-y for 2017, up from an estimated 0.6% y-o-y in 2016, and expect Hong Kong to temporarily stabilise under this muddling-through scenario,” Liu predicts.

Liu explains that UBS now forecasts a total of 75bps Fed rate hikes by 2017, a reduction of 75bps from the old projection. “This is significant for Hong Kong, where private leverage is high and the economy is sensitive to interest rates. Lower rates will be constructive in the following ways. First, the expected debt service burden will now rise much more gradually. A 75bps reduction in rate increase could translate into interest savings of up to 1.0% of nominal GDP by end-2017,” she says.

Not that big a deal?

She adds that while the overall debt service burden will remain relatively high, the incremental drag from the rising interest cost will not be as big as what was previously predicted. “Second, outflows pressures from the HKD should be more moderate under the new US rate forecasts, and the tail risks of substantial and disorderly outflows have also somewhat eased,” Liu says. “Therefore, if the USD has peaked, even if it continues to hover at a high level, the incremental drag from the currency should start to taper off in 2H16. This is a key reason why we believe Hong Kong’s retail sector might stabilise next year.”

However, Liu explains that it’s too early to tell if Hong Kong will be affected by Brexit lightly, moderately or greatly. “Under the current baseline muddling-through scenario, DM growth will only be moderately trimmed, so the direct negative impact on Hong Kong through the trade linkages will be small. But given heightened uncertainty there could be big downsides to this optimistic view,” she says.

Brexit gives Hong Kongers chills

Meanwhile, Shik adds that the uncertainty generated by Brexit will also make Hong Kong business and households sweat about their investments and consumption, which are undeniably already showing some signs of weakness. “Gross
domestic fixed capital, a proxy of Gross domestic fixed capital, a proxy of business investment, has recorded three
consecutive quarters of annual decline and private consumption expenditure annual growth has slowed to 0.7%.

Domestic economy showing

Exports business investment, has recorded three consecutive quarters of annual decline and private consumption expenditure annual growth has slowed to 0.7%, a level not since the third quarter of 2009,” Shik says. As a result, Shik says investors have sought safe-haven assets, notably the US dollar, after the Brexit vote. “Following the US dollar’s strong run, the Hong Kong dollar has also strengthened, representing an additional factor weighing on the city’s trade and investment,” Shik adds.

Investment contracts for Hong Kong

Investment also contracted for Hong Kong, according to UBS’ Liu, widening by 10%. “Weak outlook is undermining private sector facilities investment, while the delay in funding approval by the legislative council has also temporarily slowed public infrastructure investment to a standstill,” Liu says. “The government’s commitment to increase housing supply should continue to support construction investment. But weak outlook and the delay in government funding approval will continue to undermine investment,” she adds.

Liu also notes how Hong Kong’s CPI picked up to 2.9%. “Hong Kong occasionally experiences persistent, negative real interest rates that over-stimulate the domestic economy. We expect the CPI (excluding the one-off government measures) to moderate to 1.8%y/y in 2016 from 2.5% in 2015,” she explains.