Hong Kong SAR: Moderating recovery

Real GDP decelerated from 2.9% YoY in 1Q to 1.5% YoY in 2Q23.
Group Research, Chris Leung, Samuel Tse01 Aug 2023
  • The recovery was driven by buoyant consumption and the tourism sector.
  • Yet, the weak merchandise trade sector dragged overall growth momentum.
  • Investment sentiment remained tepid amid elevated interest rates.
  • We downgraded our GDP forecast from 6.5% to 4.8% for 2023.
  • 1M HIBORs to stay elevated at around 5.23% for the rest of the year.
Photo credit: Adobe Stock Photo

Real GDP decelerated from 2.9% YoY in 1Q to 1.5% YoY in 2Q23. On a sequential basis, it contracted by 1.3 % QoQ. The ongoing improvement in domestic economy was offset by the weakness in external sector and government spending.  We have downgraded our GDP forecast from 6.5% to 4.8% for 2023.

Favourable consumption and tourism recovery

Private consumption expenditure growth (60% of GDP) eased from 13.0 %YoY in 1Q23 to 8.5% in 2Q from dissipating low base effect. Monthly retail sales data suggested ongoing buoyancy of consumption sentiment. Retail sales and restaurant receipts returned to 90% of the pre-covid levels. Durable goods such as automobiles, an anchor of longer-term consumer confidence, registered more apparent YoY rebound of 41.7% YTD in May, compared against headline of 21.0%. 

Looking ahead, the recovering labour market will support domestic consumption. The jobless rate fell to 2.9% in 2Q, lower than the pre-COVID level of 3.3% in 4Q19. The labour force recorded the third YoY increase of 1.4% in 2Q.

Inbound tourism also improved markedly, with exports of services advancing further from 16.6% YoY in 1Q to 22.6% in 2Q.  In July, visitor arrivals were equivalent to around 80% of the pre-pandemic level, up from 50% in February-March.  Accordingly, sales of jewellery and cosmetics soared by 76.6% YoY YTD and 37.4% as of May, respectively.

Risks to retail sales

However, the negative wealth effect from a sluggish asset market limits the further upside of consumption.  The Hang Seng Index was one of the worst performers in the global equity market this year. It plunged by 11.5% from its year-high in Jan despite the 7.6% rebound since last week. Likewise, Centaline Leading Index also retreated by 2.5% from its 2023 peak in Mar. The recent weakness of the RMB may also weigh on tourist arrivals. The correlation between YoY change of USD/CNY against retail sales and Mainland visitor arrivals was -68.9 and -39.5 during 2011-2019. A weaker RMB also encourages Hong Kong consumers to spend in Mainland China instead. Note that the advancement of imports of services soared from 20.7% YoY in 1Q23 to 30.2% in 2Q23. On a side note, the weaker stimulus could have curbed consumption sentiment. Cash voucher issuance fell from HKD10,000 per citizen in 2022 to HKD5,000 in 2023. There is also a decrease in ceiling of the income and profit tax reduction.

Government spending declined

Government consumption recorded the first YoY contraction of 9.6% since 2006. However, this could be good news to the economy. The drag should be attributed to falling purchase of goods and services component (detailed data are not included in this advanced release) amid removal of COVID restriction. In fact, the health care spending soared by 54.7% during 2019-2022. Its share in GDP rose from 2.9% to 4.5%. According to government budget, it is expected to retreat to 3.4% of GDP in the current fiscal year. This represents a 17.8% YoY decline. 

External sector is dragging the overall growth

Goods exports declined slightly from 18.9% in 1Q23 to 15.3% in 2Q23. External demand from both Mainland China (around 60% of Hong Kong's exports) and the rest of the world continued to abate. In particular, machinery and transport equipment, which account for over 75% of Hong Kong exports, contracted by 17.8% YoY.

As major central banks such as Federal Reserve and ECB are likely to keep the policy rates elevated for extended periods, the outlook of the global economy has remained cautious with a downward bias.   Likewise, China's second half is, at best, cautiously optimistic under the assumption of deploying a stimulus package and further rate/reserve requirement ratio cuts. The situation calls for a reassessment of net exports of goods and services' contribution to HK GDP.

Tepid investment and loan recovery

Growth of Gross Domestic Fixed Capital Formation (investment) reversed from an advancement of 7.9% YoY in 1Q23 to a contraction of 1.0% in 2Q23. This marked the 14th YoY decline in the past 5 years. In 1Q (latest data), machine, equipment & computer software investment rebounded by 24.0%. However, recovery was dragged by the real estate sector amid ongoing rate hikes. This mirrors the very weak credit data. Total loans and advances fell 4.2% YoY in June while loans for use in Hong Kong grew mildly by 0.4%. Real estate-related loans accounted for 23.1% of these domestically used loans.

Outlook for credit growth is mired too. Loans used outside Hong Kong declined by 12.0%, consistent with 14.1% plunge in foreign currency loans. This is largely a result of soaring USD and HKD rates. Short-end HIBORs or SOFRs are now even higher than CNY rates. Mainland corporates tend to borrow onshore loans. The moderating recovery momentum of the Chinese economy also added downward pressure to Hong Kong’s banking sector performance. Meanwhile, trade finance plummeted by 22.6% alongside very weak international trade flows. 

HKD rates to stay elevated

HIBORs have eventually caught up with USD counterparts in 2Q after rounds of HKMA intervention. 1M HIBOR reached 5.29%, with the spread against 1M SOFR narrowed from over 200 bps in April to just 4bps as of today. The Aggregate Balance has fallen to around HKD50bn, the level last seen during the previous rate hike cycle in 2019. Looking ahead, demand for HKD liquidity will remain tight, and there has been a couple of instances of large usage of HKMA's Discount Window in July. Aside from the usual seasonal demand for dividend payments, improving demand for equity trading lately could put significant pressure on liquidity. As such, we expect 1M HIBOR to stay around 5.23% in the rest of the year.

Stronger pressure on property market

Against this backdrop, home prices should ease further in the near term. Centaline Leading Index fell by 1.9% in the past four weeks. Weekly property market transactions (primary + secondary) fell from 1,686 in March to 806 in July.

Prevailing negative rental yield will continue to suppress investment demand from investors. The prime rate is now set at 5.875%, with the new effective mortgage rate staying elevated at 3.625%. This is much higher than the rental yield of 2.0-2.8% across all residential property classes.

Capital inflows from Mainland investors were also nuanced. The purchasing power is restrained by the depreciating CNY. Weak economic fundamentals and income growth also clouded the investment sentiment in offshore markets like Hong Kong. Even the onshore real estate market is stagnant. Weekly primary market transactions in Mainland China are 30% below 2021 levels.

Meanwhile, developers will continue to adopt defensive pricing strategies amid high funding costs (opportunity costs). For instance, yields of 2Y and 10Y USD IG grade bonds reached 5.4% and 7.1% respectively. Therefore, developers have a stronger incentive to cash out from unsold inventories. In fact, unsold inventories reached a 20-year high of 19,085, capping home and property prices.

Outlook for office buildings is cloudy. Overall vacancy rates reached a post-GFC high of 12.6% as of Jun. Even that of Central rose to 9.2%. Demand for offices will continue to be curbed by (1) work-from-home arrangements and (2) decreasing number of foreign companies. The number of regional headquarters of foreign companies fell by 8.4% during 2019-2022. The expansion plan of foreign companies may ease further amid the global economic slowdown. Hopefully, the recovering domestic economy could stimulate the demand going forward. The increasing presence of Mainland companies will also fill up some of the vacancies.  

Consumer prices to stay moderate

The composite CPI registered 1.9% YoY advancement in Jun, inched lower from 2.0% from the previous month. The drag primarily comes from the housing component (40.3% of CPI), which registered a 0.6% increment given the ongoing downturn of the local property market.  Durable goods such as electrical appliances, video & sound equipment, and computers & telecom equipment fell 3.7% YoY. That said, overall consumer confidence remains weak and there could be a permanent change in consumer behavior after 3 years of COVID. 

To read the full report, click here to Download the PDF

Chris Leung

Chief China Economist - China & Hong Kong 首席中國經濟學家 - 中國及香港


Samuel Tse 謝家曦

Economist - China & Hong Kong 經濟學家 - 中國及香港

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