Fitch Ratings has affirmed the Long-term foreign and local currency Issuer Default Ratings (IDRs) of the Hong Kong Special Administrative Region, People's Republic of China, at 'AA' and 'AA+', respectively.
At the same time, the agency has affirmed the Short-term foreign currency IDR at 'F1+' and the Country Ceiling at 'AAA'. The Outlook on the ratings remains Stable.
According to Fitch, Hong Kong's sovereign credit fundamentals are underpinned by its strong external financial position, improving public finances, a credible linked exchange rate system, a sound and robust banking system and a stable political and social environment.
"The 'one country, two systems' governing principle has now been applied for more than a decade, and Hong Kong retains considerable autonomy with respect to economic and financial policies," commented Vincent Ho, Associate Director with Fitch's Asia Sovereign ratings team in Hong Kong, adding:
"But, economic and political developments in the Mainland remain important considerations in our assessment of Hong Kong's creditworthiness."
Hong Kong's external financial position continues to strengthen on the back of a continuous accumulation of official foreign exchange reserves.
In 2007, its current account surplus widened to 13.5% of GDP (one of the highest in the 'AA' peer group) and international reserves (including gold) increased by 15% yoy to USD153bn.
Fitch expects the pace of reserve accumulation to slow in 2008, but they are still expected to reach an all-time high of USD164bn at year-end (equivalent to 3.5% of current external payments and 18.3% of broad money).
In addition, the agency forecasts Hong Kong's international liquidity ratio to be steady at 175% and the gross external financing requirement to be just 7.5% of reserves; all these ratios are stronger than the 'AA' peer group medians.
Meanwhile, Hong Kong's gross external debt (GXD) of 313% of GDP in 2007 and short-term external debt of 74% of GXD were high, but not when compared to other international banking centres. Gross public external debt is also extremely low, at less than 1% of GDP.
Fitch notes that Hong Kong's net external creditor position remains one of the strongest among all its rated sovereigns despite Hong Kong's high private-sector external debt ratios.
In the fiscal year that ended on 31 March 2008 (FY2007/08), Hong Kong's fiscal surplus widened significantly to 7.5% of GDP and its fiscal reserves surged to 30% of GDP. Government debt was 1.1% of GDP, the lowest in the 'AA' peer group.
Nevertheless, Fitch expects sizable one-off measures to substantially affect this year's fiscal performance, with the surplus declining to 1% of GDP and fiscal reserves falling to 28% of GDP.
The agency forecasts a slowdown in economic growth to 5.3% in 2008, but an increase in average inflation to 5.5% based on higher import prices, such as food and energy.
In the medium term, Fitch expects the fiscal balance to be in surpluses despite the government's commitment to healthcare reform and the 10 announced major infrastructure projects.
These infrastructure projects are not expected to have a substantial fiscal impact, as there will be considerable private-sector participation.
Moreover, sizable fiscal reserves are necessary to cushion against negative fiscal shocks, especially given Hong Kong's structural fiscal challenges, such as the narrow tax base and volatile land revenue.
The demonstrated credibility of the linked exchange rate system is a rating strength for Hong Kong, but the system does not allow for flexibility in monetary and exchange rate policies in response to external and domestic challenges.
As a small open economy, Hong Kong is vulnerable to external shocks, which can, with a fixed exchange rate, lead to deep and prolonged economic adjustments, as evidenced by the period of deflation during 1999-2004.
In addition to fiscal prudence, a sound banking system underpins the credibility of the linked exchange rate system.
In terms of Fitch's Banking System Indicator and Macro-Prudential Indicator, Hong Kong's high-quality banking system and low risk exposure to potential systemic stress are comparable to other highly rated sovereigns, such as Austria ('AAA'), Bermuda ('AA+'), Germany ('AAA'), Japan ('AA') and Singapore ('AAA').
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