How will Greece's crisis affect Hong Kong?

Its economic and financial links are limited.

Greece’s direct economic and financial links to the world at large are highly limited. It has been noted that the core question is — how much contagion will result from the recent turmoil in Greece?

According to a research note from Hang Seng Bank, specifically, what impact is the Greek turmoil to have on the Hong Kong economic outlook, and how significant could it become?

There is currently no conclusive answer as the situation is still highly fluid, the research note said.

Here's more from Hang Seng Bank:

Our aim here is to provide some insight into potential spillovers as manifested through three main transmission channels: 1) trade, 2) bank lending, and 3) the financial market.

Since the odds of scenario 3 occuring are slim, our analysis concentrates on exploring the potential impacts under scenario 1 and scenario 2.

Weaker trade flows. For scenario 1, a new deal would represent a major leap forward in the integration of the euro area and would strengthen market confidence in other European countries. In light of this, we focused on developing analyses of the direct impact.

As Exhibit 1 demonstrates, goods exports destined for Greece from Hong Kong are insignificant – worth less than 0.1% of Hong Kong’s total exports. We have previously discussed3 that every 1% increase in GDP of Hong Kong’s trading partners brings about a 1.5% increase in its exports. So even a sharp contraction of 20% in the Greek economy would only take less than 0.1 percentage point off Hong Kong’s export growth. The bottom line is that the direct trade effects of a Greek import slump are likely to be so inconsequential that they can essentially be ignored.

Even a broader euro area slowdown — were scenario 2 to occur — would likely have a manageable impact on Hong Kong. About HKD343.2 billion of Hong Kong’s exports originate from EU demand. This makes up 9.3% of total exports. In this scenario, we assume a 7% decline in exports to the EU — similar to the fall recorded during the euro debt crisis in 2012 (Exhibit 2). Based on this assumption, the knock-on effect on other European countries would only drag Hong Kong’s exports down by 0.7% — a consequence that should provoke little cause for serious alarm.

Reduced credit availability. Another potential risk is that loan losses cause a downsizing of European banks’ balance sheets that meaningfully reduces the quantity of available credit. Delving into the details of banks’ lending positions, it appears that the spillover through this channel would be quite mild. As of the end of 2014, total Greek bank claims on Hong Kong accounted for a just 0.1% of Hong Kong GDP (Exhibit 3). Even including claims from banks originating from PIIGS4, the potential systemic risks appear to be well contained.

A more worrying situation could be where Hong Kong financial institutions are forced to liquidate loans to restore their capital positions. The good news is that Hong Kong banks’ exposure to debt-ridden European nations has declined since the turbulence of 2010. By the end of 2013, the aggregate exposure of Hong Kong’s banking sector to PIIGS was about 0.3% of the sector’s total assets.

Even if these holdings became worthless, Hong Kong banks should easily be able to cover their losses with annual profits. It is also worth noting that credit disbursals have delivered less of a growth dividend than before, a point we have made in previous research6. It now takes more than HKD3 of credit to generate HKD1 of additional GDP. That said, the potential disruption in credit
flows is not a serious worry.

Tighter liquidity conditions. Perhaps the most relevant challenge in connection with Grexit is related to financial contagion. Clearly, the impact of this is hard to gauge, but one way to approach it is to recognise the Greek shock on domestic liquidity conditions. More specifically, we looked at the impact of a rate spread between EUIBOR and EONIA, an indicator of perceived counterparty risk within the European banking system, on US dollar LIBOR and HIBOR during the European turmoil in 2010 and 2011.

The key takeaway of this study is that the liquidity conditions in Hong Kong are not particularly sensitive to spikes in European rates. Each 10 basis points widening in the spread between EUIBOR and EONIA only moves US dollar LIBOR up by less than 4 basis points. Its impact on HIBOR is even weaker. In fact, there is good reason for this different response in USD rates and HKD rates.

A large part of the hit from the European turmoil appeared to have been offset by capital inflows amid continued liberalisation of the Mainland’s capital account. If history is any guide, with a 2010/11-sized financial shock in Europe, the spread between EUIBOR and EONIA could drift up to 1% and push up HIBOR by 0.3 percentage points at most. The effect of financial contagion, while negative, is likely to be mild under scenario 1.

Extending our dataset back to 2008, another fact is that euro area financial shocks are not nearly as contagious as US ones (Exhibit 5). In other words, if US financial institutions suffer heavy losses as Greece heads towards default, the Greek crisis would be much more contagious.

The main concern remains the extent to which the US financial markets will be affected as the situation deteriorates in Greece. We believe there are reasons to be cautiously optimistic. US banks’ claims on Greece amounted to less than USD13 billion, or 0.7% of US GDP, by the end of 2014. US financial institutions could even benefit from global flight to safety, diluting the adverse impacts of Grexit. On balance, with the Greek crisis having limited spillover on the US financial system, the potential impact of financial contagion under the Grexit scenario should be similarly confined, though bouts of volatility would be expected.