HKSAR: Sagging fundamentals and asset prices

Assuming international border remains partially opened in 4Q (0+3days quarantine), real GDP will likely contract by 1.1% YoY in 4Q, with the full year at -2.5% YoY.
Group Research, Samuel Tse01 Nov 2022
  • Hong Kong’s real GDP contracted by 4.5%yoy in 3Q, the deepest contraction since the 2020 pandemic
  • Improving jobless rate does not render support to consumption as workforce continued to shrink
  • Asset market outlook remains gloomy due to rate hikes
  • GDP will fall by 2.5% in 2022 and rebound by 3.8% in 2023
  • 1M-HIBOR will reach 3.88% and 4.28% by the end of 4Q22 and 1Q23 respectively
Photo credit: AFP Photo

Real GDP registered the deepest contraction (minus 4.5% YoY in 3Q) since 2Q20. On sequential basis, it decreased by 2.6%. Assuming international border remains partially opened in 4Q (0+3days quarantine), real GDP will likely contract by 1.1% YoY in 4Q, with the full year at -2.5% YoY. For 2023, we maintain our forecast at 3.8% growth due to a low base.

Tepid consumption sentiment

Private consumption expenditure (PCE) stayed flat comparing to a year earlier in 3Q. Effectiveness of cash vouchers was less apparent comparing to last year. Retail sales dropped by 0.1% YoY in August, down from advancement of 4.1% in July. Consumers front-loaded cash vouchers on big-ticket items such as jewelleries. Partial relaxation of border reopening (3+4 in August-September and 0+3 in October) poses positive impact on outbound tourism than inbound tourism, thereby undermining retail sales performance. Negative wealth effect from asset prices consolidation also translated into subdued spending power.

Shrinking labour force restrained consumption power

The seemingly improving labour market can barely rescue the lacklustre retail sector. Although jobless rate fell from the peak of 5.4% in Feb-Apr to 3.9% in 3Q22, labour force dropped by 2.3% YoY. That said, the decline of jobless rate is reflecting human capital outflow. Amongst all, the drop of younger prime working aged workforce, i.e. aged 25-44, was more noticeable at 3.9%. This accounted for 81% of the shrink in total workforce. This explains why PCE did not recover alongside decreasing unemployment rate. Reflecting the poor economic situation, elderly labour force rose by 19.0% YoY. Such structural change in workforce will dampen the consumption power over the long-run.

Inflationary pressure is severe for lower income group

CPI surged from 1.9% in August to 4.4% YoY in September. Housing, which accounts for 40.3% of the CPI, soared by 6.4% YoY as low base of comparison resulted from the waiver of public housing rentals dissipated. Meanwhile, food prices advanced by 3.8% YoY.  Overall inflation for the year should conclude 2022 at 2.2%. However, living costs for higher income groups remain modest compared to general public. CPI B and CPI C, which denote the price levels of middle and high expenditure range, grew by 2.4% and 1.9% respectively in September, versus CPI A advancing by 8.9%. This implies disposable income of lower income population is shrinking.

Strong external headwinds

Contraction of goods exports extended from 8.4%yoy in 2Q to 15.5% in 3Q amid lingering Zero-COVID policy of China. Shipment to Mainland dropped by 12.9% in 3Q and 8.5% in September in value terms. Exports to US, EU and UK also plunged by double-digit amid elevated inflation and aggressive rate hikes. Meanwhile, logistic costs stayed elevated comparing to the rest of the world. Although Baltic Dry Index had retreated recently to early 2022 level, the spread between value and volume keeps widening. The air/shipment capacity could gradually normalize on relaxation of quarantine policy. The number of flights of one of the major airlines rose by 76.9% in September comparing from the trough in February. Meanwhile, imports fell further from contraction of 5.9% YoY in 2Q to 16.0% in 3Q. 

Sluggish investment, asset prices correction and capital outflow

Contraction of GDP was mainly attributed to the deep fall of Gross Domestic Fixed Capital Formation (investment). The decline extended from 2.1% YoY in 2Q to 14.3% in 3Q. Machinery & equipment and real estate investment were weak amid gloomy outlooks, notwithstanding the sharp fall of Hang Seng Index plunging to post-Global Financial Crisis low.

In our view, the Fed Fund Target rate will rise further from 3.25% to 4.50% by the end of 2022 and 5.00% in 1Q23. In response, 1M HIBOR soared to 3.17%. Its spread against LIBOR rocketed from 10bps in 1Q22 to 50-100bps in October. Capital outflow will sustain until the spread is neutralized. HKMA will continue to defend the peg as HKD is under pressure. Foreign reserve has dropped from the peak of USD 499.4bn in Nov21 to USD419.2bn in September.

Balance of Payment data also confirms deficit (and drop in reserve asset) reached historical high of HKD159.8bn in 2Q. Aggregate balance, an indicator of Hong Kong’s banking system liquidity, narrowed from HKD458bn last year to HKD100bn as of yesterday. Accordingly, we expect 1M-HIBOR will reach 3.88% and 4.28% by the end of 4Q22 and 1Q23 respectively. In fact, 3M-HIBOR has already reached 4.63%, 16bps above its LIBOR counterpart. This reflected the investor’s concerns over the stressed asset market.

Total loans fell 1.8% YoY in September, while foreign currency loans dropped by 10.9%. Loans used in Hong Kong grew modestly at 1.7%, compared to a contraction of 2.3% in June. Amongst all sectors, loans for transportation plunged significantly by 14.2% as border is yet to be opened. That of funding costs sensitive sectors such as tech companies fell from advancement of 11.4% to a contraction of 0.6%. Credit demand from stockbrokers and investment companies plunged by 23.4% and 6.9% respectively. Loans for residential property development also fell from 6.5% in March to 1.5% in September.    

Mirroring depressed equity prices, the world’s most unaffordable housing market continued to consolidate. Headline price on the secondary market fell by 8.9% YTD. Centaline top 10 mass estates transactions stayed low at 164 in October. Reportedly, number of transactions in the primary market fell by 42% MoM in October. New mortgage application dropped by 20% in September. Valuation Diffusion Index from major banks fell to historical low of 4-6 in the past two months. Prime rate will likely reach 6.00% in 1Q23 in tandem with rising US rates. Effective mortgage rate could eventually reach 3.75%, much higher than rental yield of 2.0-2.6% across all residential property classes suppressing investment demand. Current wave of emigration further stressed home price as evidenced by the severe drop of medium & small units / mass estates relative to large units.

Yet, severe consolidation is not likely. In the past two months, HKMA has already relaxed the stress testing requirement from 3% to 2%. In the latest Policy Address, the Chief Executive (CE) John Lee also suggested to refund extra stamp duty for talents stayed in Hong Kong for over 7 years. The government could ease housing market policies further to arrest declining property price. Also, default risk remains low. Outstanding negative equity rose to HKD3bn in September which accounted merely 0.2% of total outstanding mortgage.

Fiscal constrain will kick-in

As such, the government will have to boost the economy by public investment rather than social welfare / sector specific subsidies. Government spending rose by 4.3% YoY in 3Q, down from 13.0% from 2Q due to high base effect from issuance of cash voucher. In the latest Policy Address, CE proposed a new form of public housing with simple design so as to increase public housing supply by 30,000 in the next 5 years.

Also, the government spares no effort in developing the New Territories North and West. Railway will be connected with Shenzhen to strengthen the connection with the Greater Bay Area. The government also pledges to implement the Lantau Tomorrow Project by 2025. According to the Financial Secretary, the deficit could reach HKD100bn or 3.3% of GDP for FY2022/23. Upcoming infrastructure will stress the government budget. Although the government has not revealed the proposed budget, the Lantau Tomorrow Project alone would cost the city over HKD624bn. More government bonds must be issued to finance them. Coupled with declining income tax revenue due to human capital outflow, the long-term fiscal situation of Hong Kong Government warrants concerns.

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Samuel Tse 謝家曦

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

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