Moody's Investors Service has affirmed Hong Kong's government bond rating at Aa1 and changed the outlook to stable from positive. The outlook change was made in conjunction with a change in the outlook for China's Aa3 rating to stable from positive.
Hong Kong's Aaa country ceilings for domestic debt and bank deposits, the Aaa/Prime 1 ceiling for foreign currency bank deposits, and the Aa1/Prime-1 country ceiling for foreign currency bank deposits were also affirmed.
Moody's says Hong Kong's Aa1 government bond rating reflects a strong, competitive economy, very high institutional strength, very high government financial strength, and considerable resilience to shocks. However, the Special Administrative Region's (SAR's) risk profile is adversely affected by its vulnerability to credit shocks that might emanate from China.
Hong Kong's credit strengths were demonstrated during the global financial crisis.
Real GDP declined in 2009, but the government budget remained in surplus. Moreover, although Hong Kong is an international financial center, the banking system did not experience significant stress.
Hong Kong's economic strength is evident from its growth record. Although the pattern of growth is somewhat volatile, real GDP increased by an average of 4.5% annually during the past decade. Underpinning this growth have been Hong Kong's role as an international financial center and strong increases in international trade and related activities. Much of this activity is focused on China, supporting strong growth in Hong Kong.
The government's financial position is also among the strongest of any government rated by Moody's and strengthened further in the last fiscal year. The budget has been in surplus for the last nine consecutive years, allowing the government to build up large fiscal reserves that are now equivalent to almost two years of expenditures or 36% of GDP. These reserves far exceed the very low level of government debt.
The SAR as a whole also has a very large net international asset position. External assets exceed liabilities by an amount equivalent to 278% of GDP, the largest such position of any country rated by Moody's. The significant build-up of assets has resulted from continuous current account surpluses over a long period of time.
A final factor supporting the rating is the strength of the banking system, which carries an average Moody's Bank Financial Strength Rating that is among the strongest in the world. Unlike banking systems in many other countries, Hong Kong's banks did not exhibit significant stress during the global financial crisis. At some time in the next few years, they may face the prospect of a decline in the housing market, but the last time that occurred around the turn of the century the banks were able to manage this without seriously affecting their financial strength.
Despite these demonstrated strengths, Moody's Aa1 rating for Hong Kong also incorporates an element of China risk because of the significant, and increasing, interconnections.
Politically, Hong Kong is a Special Administrative Region of China. Economically, Hong Kong companies derive a significant portion of their revenues from activities elsewhere in China and are major investors there.
The financial markets have also become interconnected to a significant degree, with Chinese companies making up the majority of the market value of the Hong Kong stock exchange, Chinese banks having significant market share in Hong Kong, and Hong Kong banks having increasing exposure to China.
While this degree of interconnectedness leaves Hong Kong vulnerable to developments in the Mainland, Moody's Aa3 rating of China indicates a low probability of adverse developments that would affect Hong Kong's ratings.
As a result of the SAR's status as part of China and the interconnections, Hong Kong cannot be completely insulated from developments in the rest of China. Therefore, the ratings of Hong Kong and of China are linked, but not necessarily the same. Hong Kong's significant buffers against any potential shocks and its strong institutional framework indicate that it can be rated more highly than China. Moody's believes a two notch differential appropriately reflects the differing credit profiles of the two entities.