Hong Kong, as a small and open economy, has been adversely affected by the global trade slowdown. Exports of services (i.e. transport, travel, finance), which account for 31% of GDP, grew by a mere 0.2% y/y in 2Q, from 0.8% y/y in 1Q and 5% last year. Hong Kong economic activity remains under pressure from ongoing Sino-US trade tensions and domestic uncertainties.
Trade downswings and poor sentiment are not new to Hong Kong, but not all slumps are born equal. From an economic angle, this economic slump resembles the one in 2015–16 (caused by CNY weakness). But the added social tensions risk dragging retail spending lower – which might produce a sharper downturn in GDP growth, like in 2003.
The HKD has fallen toward the 7.85 convertibility undertaking limit. This means that by design capital outflows would trigger official intervention, which in turn would tighten local conditions and push up HIBOR. In these circumstances, there may be an uncomfortable wait for borrowers while investors return to bid down elevated HIBOR yields.
Importantly, the HKD linked exchange rate system is solid, more than fully backed, highly transparent and working normally as an anchor for monetary policy. It has survived worse crises and we expect it to weather current conditions unchanged.
We expect the HIBOR-LIBOR spread to trade in and out of a modest premium of up to 50bps through 2H before settling to parity or below in the following 12 months (see "Asia Pacific economy: Macro monthly: Hong Kong," published 19 August). Despite slower economic growth, Hong Kong retains many aspects of resilience that do not argue for significant and extended upward pressure on USDHKD (and therefore a significant HIBORLIBOR premium), such as large current account and fiscal surpluses as well as a well-capitalized banking system.
Philip Wyatt, Economist, UBS AG