S&P Upgrades Its Outlook On Hong Kong

by Mary Swire, Tax-News.com, Hong Kong

05 May 2005

International ratings body Standard & Poor’s has upgraded Hong Kong’s outlook to positive from stable whilst also affirming its currency ratings, reflecting the growing level of confidence in the Chinese territory’s financial sector and economy at large, although S&P echoed familiar warnings over the city's narrow tax base.

In a statement issued on Tuesday, Standard & Poor's announced that:

"Standard & Poor's Ratings Services today revised the outlook on its 'A+' long-term foreign currency rating on Hong Kong to positive from stable."

"The new outlook is aligned with that of mainland China (BBB+/Positive/A-2) and, with the consolidation of Hong Kong's public finances, is a reflection that the principal risk to Hong Kong's foreign currency credit rating relates to challenges that may potentially arise from its increasing economic integration with the lower-rated mainland."

At the same time, Standard & Poor's affirmed all the sovereign ratings on Hong Kong (foreign currency A+/Positive/A-1; local currency AA-/Stable/A-1+).

"The economic upturn, renewed buoyancy in the property market and return to inflation are boosting fiscal prospects for the government," said Standard & Poor's credit analyst Philippe Sachs."

Hong Kong's general government deficit improved significantly to an estimated 0.8% of GDP for the fiscal year ended March 31, 2005, compared with the 6% forecast. (Standard & Poor's excludes asset sales, securitization, and bond issuance proceeds when calculating general government balances.) Although a large part of the improvement can be chalked up to cyclical factors like rising land sales and improved economic growth, the return to inflation is also boosting revenues.

"In addition to higher revenue, the government spent HK$24 billion less than budgeted and is planning to maintain comparable spending levels through to 2009. If this expenditure constraint continues, it will represent a significant structural improvement to budget outcomes," added Mr.Sachs.

The S&P statement continued: "Despite these improvements, Hong Kong continues to suffer from a narrow revenue base, which is overly dependent on land and asset sales. As a result, government finances remain highly vulnerable to shocks and economic cycles. A goods-and-services tax (GST) or other broad-based tax would set public finances on firmer ground, but opposition to its introduction remains strong."

"Fortunately, Hong Kong remains one of the few net creditor governments globally, with net assets forecast at 20% of 2005 GDP. This affords Hong Kong substantial fiscal flexibility," noted Mr. Sachs.

China's continued strong economic performance, sustained structural reform and overall strengthening of its credit-worthiness reduce risks to Hong Kong from any potential adverse political and economic developments on the mainland. Despite controversy surrounding the replacement of former Chief Executive Tung Chee-hwa and the flexible interpretation of the Basic Law in appointing a new Chief Executive for only two years, as opposed to the stipulated five, domestic and international confidence in Hong Kong remains strong.

"Hong Kong's stability and autonomy as a financial center are integral to China's ability to raise and more effectively allocate capital," explained Mr Sachs. "Therefore, China is widely expected to continue respecting Hong Kong's economic, fiscal and monetary autonomy. The ratings on Hong Kong being three notches higher than the rating on the mainland reflect the considerable margin of safety that Hong Kong enjoys vis-à-vis the rest of China by virtue of its fiscal strength, mature institutions and holdings of foreign currencies."

The continued stabilization of Hong Kong's government finances coupled with an upgrade in China's ratings, could lead to a rating upgrade for Hong Kong, S&P revealed. Conversely, deterioration in China's creditworthiness could precipitate a downgrade in the ratings on Hong Kong. In addition, marked fiscal slippage or material erosion in Hong Kong's economic and monetary autonomy could place downward pressure on the ratings.

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