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Mainland ties drag down Hong Kong credit score

Moody's cuts territory's issuer ratings to "Aa2" after hitting China

Moody's has downgraded Hong Kong's issuer ratings in conjunction with a similar move for mainland China. (Photo by Kenji Kawase)

HONG KONG - A day after China's sovereign debt rating downgrade, Hong Kong, by virtue of its links with the mainland, also saw its credit rating fall, despite robust fiscal strength.

Credit agency Moody's on Thursday cut the special administrative region's both local and foreign currency issuer ratings to "Aa2" from "Aa1," and changed its outlook to "stable" from "negative."

The move was triggered by a similar downgrade for the mainland to "A1" from "Aa3" on Wednesday, with its outlook going from "negative" to "stable."

The Hong Kong government immediately denounced the changes.

Local market reaction has been muted so far, with the benchmark stock indicator Hang Seng Index trading about 0.5% higher than Wednesday's close, hovering close to 25,550 at 11am local time. The Hong Kong dollar has been virtually flat versus the greenback at around 7.789 Hong Kong dollars, which is on the strong side of the limited trading band with the U.S. currency.

"Credit trends in China will continue to have a significant impact on Hong Kong's credit profile due to close and tightening economic, financial and political linkages with the mainland," said Moody's, noting that China accounts for more than 50% of the territory's goods exports, 40% of services exports, and 75% of tourist arrivals.

The connection was amplified in recent years given the mainland's rising importance in the world economy and share of global trade, and Hong Kong's reliance on re-export, which stands at almost 190% of its gross domestic product.

More worrying are the financial links between the territory and China, which Moody's said are "broad in nature" and "large in the size of the assets involved."

Total mainland-related lending among local banks surged to 3.6 trillion Hong Kong dollars ($460 billion) at the end of 2016, up 3.5% in six months; of which 0.8% is classified as "substandard," "doubtful" or "at loss," down 0.09 percentage points from September.

Other non-bank exposures rose faster, by 11.4% to HK$1.2 trillion in the same period.

This has yet to include potential spillovers through channels such as the Stock Connect framework with Shanghai and Shenzhen, as well as the soon-to-be implemented Bond Connect arrangement, which will only allow unilateral flows to the mainland.

"High capital and liquidity buffers and strong supervision mitigate but do not obviate the risks related to banks' mainland exposure," said the agency.

With strong land sales and stamp duties, both related to a red-hot property market fueled by local and mainland demand, the Hong Kong government booked a record surplus of HK$92.8 billion for the fiscal year ending in March. That boosted government coffers to HK$935.7 billion, or 24 months of its operating expenditure.

Hong Kong's first quarter GDP expanded at the fastest rate in six years, at 4.3% on the year and above trend growth. Unemployment remained at a subdued rate of 3.2% and inflation at a 7-month high of 2% as of April.

Apart from a pickup in trade, the upbeat performance was attributable to better consumption sentiment, thanks to the buoyant property and stock markets. The latter saw substantial inflows through Stock Connect channels as Beijing tightened capital control. The Hang Seng Index has surged over 16% year-to-date.

"Even in the absence of close contemporary economic and financial linkages, Hong Kong's status as a Special Administrative Region of China would imply close credit linkage and near proximity of ratings," said Moody's, highlighting currently it is the "One-Country, Two-Systems" institution that allows the former British colony to enjoy a higher rating than the mainland.

"Certainty regarding the legal and institutional arrangements that will apply post-2047 will increasingly influence Hong Kong's institutional strength and competitiveness," said Moody's.

Along with Standard & Poor's, Moody's lowered its outlook on Hong Kong's outstanding debt in March 2016 to "negative" from "stable." The moves mirrored identical cuts to its outlook for China's national debt due to worsening economic conditions.

The downgrade in turn dragged down credit outlooks for government-linked bond issuers, such as MTR, Airport Authority Hong Kong, Kowloon-Canton Railway and the Urban Renewal Authority.

Affected by the latest rating cut, some senior unsecured foreign bonds issued by the city's government such as the Sukuk offerings in 2014 and 2015 were rated a notch lower. But local currency bond and deposit ceilings remain at "Aaa."

Paul Chan, financial secretary of the territory, said in a statement on Thursday that the government "strongly disagrees with the assessment by Moody's" on its decision to "mechanically downgrade" Hong Kong's following the mainland's.

He said the credit agency "has overlooked the sound economic fundamentals, robust financial regulatory regime, resilient banking sector and strong fiscal position that Hong Kong has." Chan added that these elements will "continue to enable the economy to embrace the challenges ahead arising from the changing external environment."

Apart from the Hong Kong government and its affiliated companies, mainland companies -- mainly those backed by the state -- have also seen their ratings dragged down by China's sovereign debt downgrade.

The credit agency on Wednesday cut by one notch the ratings of 26 Chinese government-related bond issuers, including China Mobile, CNOOC, China Petroleum and Chemical Corp. (Sinopec), Dongfeng Motor Group, and China Shenhua Energy by one notch. It also trimmed the financial strength ratings of China Life Insurance.

State-owned banks were treated similarly. The three policy lenders -- Agricultural Development Bank of China, China Development Bank Corporation, and the Export-Import Bank of China -- saw their long-term issuer ratings skid in parallel with China's sovereign rating, while commercial lender Agricultural Bank of China (ABC), the country's third largest by assets, has had its long-term deposit rating cut to "A2" from "A1". Bank of Communications is on review for downgrade.

On the other hand, Moody's has affirmed Macau's local and foreign currency issuer ratings at "Aa3" and changed the outlook to "stable" from "negative." The agency pointed to factors such as strong fiscal and external buffers, and the ongoing progress of economic diversification from excessive reliance on gaming revenue. On the fiscal buffer, Macau's reserve stood at around 472 billion patacas ($59 billion) at the end of March, roughly equal to about six years' worth of public expenditure for 2016.

However, Moody's added that the former Portuguese colony is exposed to potential downgrade risks, "particularly those related to economic, financial and policy developments on the mainland."

Nikkei deputy editor Kenji Kawase in Hong Kong contributed to this report.

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