HK benefits from PRC’s bullish economy, clinches a ratings upgrade

Moody's has upgraded the government bond ratings of the Hong Kong Special Administrative Region to Aa1 from Aa2 and raised the foreign currency bank deposit ceiling to Aa1.

The foreign currency bond ceiling, meanwhile, was raised to Aaa. The agency also assigned a positive outlook to the ratings.

In a statement, Moody’s said the main driver for the upgrades and the outlook change was its upgrade of the Chinese government's bond rating to Aa3 and the positive outlook assigned to that rating. Also considered in the decision for Hong Kong were the following factors:

The prospects for continued and improving government financial strength, particularly in comparison to other sovereigns rated in the Aaa and Aa range;

The lessening vulnerability to external shocks, including any from mainland China, as demonstrated by the continued health of the financial sector through the global crisis, the increases in the Special Administrative Region's (SAR's) external financial assets, and the government's own very strong financial position;

(3) Favorable prospects for Chinese economic performance in the coming
few years, providing support to economic growth and financial
developments in Hong Kong.

“Moody's believes that, as a Special Administrative Region of China, Hong Kong's ratings should be linked to, although not necessarily the same as, China's. Unlike other subsovereigns, Hong Kong has a separate currency,international reserves, legal system, and foreign exchange regime. In addition, the central government does not collect taxes in Hong Kong, so there is no fiscal relationship between the two,” the ratings agency said.

On a stand-alone basis, Hong Kong's government financial strength, institutional strength, and economic strength are compatible with a Aaa rating, according to Moody's sovereign rating methodology. However, because of the SAR's legal status as a part of China and because of increasing financial and economic linkages with the rest of China, there is also an element of China risk inherent in Hong Kong's rating. Although China's economic performance has been positive for Hong Kong's economy since the 1997 return to Chinese sovereignty, any negative scenario for China in the future would also have consequences for Hong Kong. Moody's does not believe that such a scenario is likely, as indicated by China's high rating and positive outlook. However, the linkages between Hong Kong and the mainland do influence Hong Kong's rating level.

"Hong Kong's fiscal indicators are among the strongest of the countries and regions rated by Moody's, notwithstanding some revenue volatility," according to Hess. "The global financial crisis affected the government's finances, but the government has maintained a budget surplus despite a decrease in revenues and some increase in spending." Hong Kong's government has only a minimal amount of debt, and the budget is expected to remain in surplus this fiscal year, even though the original budget showed a deficit. Furthermore, the government's large fiscal reserves make it likely that, for the foreseeable future, potential budget deficits can be financed without debt issuance.

Although a number of highly rated countries experienced serious banking-sector difficulties as a result of the recent financial crisis, Hong Kong's banks proved comparatively resilient, and the Hong Kong government, although establishing a temporary facility to provide capital to the banks if needed, was not actually required to use this facility. "In addition, the government's fiscal reserves and the large foreign assets of both the government and the private sector provide Hong Kong with a cushion against potential external shocks," added Moody's Hess. "The prospects for further increases in the SAR's net foreign assets are positive."

Moody's last rating action concerning Hong Kong was on October 8, 2010, when the Aa2 government bond ratings were placed on review for possible upgrade.