Hong Kong economy seen to grow by 5.7%

Yet growth expected to ease on as global economy decelerates while assets will heat up.

The Hong Kong government is set to release its third quarter GDP report on November 12.

The upcoming GDP figure is likely to be quite strong, as recent economic releases have been unexpectedly robust, according to the Hang Seng’s Hong Kong Economic Monitor. Exports and retail sales expanded at a double-digit pace and unemployment dropped to a 20-month low.

Thus, Hang Seng sees a solid growth of 5.7% for the third quarter, only slightly slower than the 6.5% in the second. If our estimate is correct, the growth in the first three quarters could average 6.7%. As such, the bank has revised up this year’s GDP forecast to 6.0%, from an initial estimate of 5.0%.

Going forward, the growth momentum for the externally oriented Hong Kong economy looks set to cool off, as the global economy is showing clear signs of moderating. The IMF also projects the growth of world trade volume to ease sharply to 7% next year, from an estimated 11.4% this year. That may explain why the US Federal Reserve decided to go for further monetary easing to stimulate growth.

Risk seems to arise more from the asset markets, as new injections by the Fed have reinforced expectations of a prolonged low interest rate environment, fueling an overheating local asset markets.

Third Quarter Data Stay Strong
The Hong Kong economy has appeared strong so far, with exports expanding at double digit pace. The value of total exports surged 27.8% in the third quarter, after growing 24.3% in the second.

Consumer demand also strengthened on the back of improving labour market conditions. The value of retail sales grew 17.8% in the third quarter after rising 16.9% in the second, as unemployment rate dropped to a 20-month low of 4.2% in the third quarter. Wealth effects from soaring property prices might have also played a role. Residential property prices climbed 26% in the first eight months.

Hang Seng sees a solid third quarter growth of 5.7%, slightly slower than the 6.5% growth in the previous quarter. If the bank’s estimate is correct, the growth in the first three quarters will turn out to be 6.7%. The economic reports have appeared stronger than expected so far. As such, Hang Seng has revised up this year’s GDP forecast to 6.0%, from an initial estimate of 5.0%.

Clear Signs of Global Deceleration
The outlook is more uncertain. External demand looks set to cool, as the global economy is showing clear signs of moderating in the third quarter.

The US GDP growth hovered around low levels and unemployment stayed at high levels. That may explain why the US Fed decided to go for further monetary easing to stimulate growth, although the US National Bureau of Economic Research declared that the US recession had ended in June 2009.

In Europe, negative credit news from time to time also remind investors that the sovereign debt crisis has not gone away. The planned budget cuts and austerity measures would also crimp demand.

In Asia, South Korea and Japan’s exports cooled sharply in September. Japan’s Nomura/JMMA Manufacturing Purchasing Manager Index, a leading economic indicator, dipped below the 50 expansion threshold for the second month, signaling continuous contraction of manufacturing activities ahead. Mainland China’s real GDP growth also decelerated to single-digit in the third quarter under the government’s cooling measures.

What does that mean for Hong Kong?

Weaker export outlook for Hong Kong
High government deficits and high unemployment in advanced countries and a softening global recovery would mean a weaker outlook for Hong Kong’s exports.

The IMF projected the growth of world trade volume to drop sharply next year.

Sustained funds inflows
It may also mean sustained funds inflows and climbing banking liquidity. Hong Kong has experienced strong inflows of capital to bet on mainland China’s better economic prospects and in search of higher yielding assets, as evidenced by the rise in the aggregate balance of the banking sector and the issuance of additional Exchange Fund Bills.

Between August 2008 and September 2009, the aggregate banking balance and value of outstanding Exchange Fund paper increased by over HKD620 billion, equivalent to about 38% of nominal GDP in 2009. The aggregate banking balance and value of outstanding Exchange Fund paper have stayed at high level of around HKD800 billion since then.

Surging loan demand
Bank deposits slow and loan demand surges on negative real interest rates. Loan demand has been rising sharply since the third quarter of 2009 amidst an economic recovery. Between September 2009 and September 2010, total loans expanded 25.9% but total deposits grew merely 8.5%. Thus, the total loan-to-deposit ratio jumped from 50% in to 61%. Similarly, the Hong Kong dollar loan-to-deposit ratio also surged from 70% to 78% during the same period.

The excess liquidity has found its way to the asset markets. The Hang Seng Index, an indicator of stock prices in Hong Kong, has jumped over 20% in the past five months. Similarly, local property prices are close to their record highs and the share of property related loans now stand at a four-year high. As of September 2010, property related loans account for 52% of the total (residential property related loans was 37%).

Economic Forecast
The Hong Kong economy has appeared stronger than expected so far. As such, Hang Seng has revised up this year’s real GDP forecast to 6.0%, from an initial estimate of 5.0%.

Growth looks set to ease on cooling external demand, but the new injections by the Fed and augmented expectation of a prolonged low interest rate environment, fueling an overheating local asset markets.