HK SAR: Zero-COVID policy with rising rates


Hong Kong SAR economic outlook is clouded by both rising rates and renewed COVID outbreak.
Samuel Tse18 Jan 2022
  • Re-opening of border will likely postpone to end-2Q Flight ban will further stress the supply chain
  • The shrinking labour force is alarming
  • Investment outlook is cloudy given rising rates and a weakening economy
  • The GDP growth forecast for 2022 is adjusted downward to 2.4% from 3.0%
  • There are upside risks to our 0.92% 1M HIBOR and 1.75% end-22 forecasts
Photo credit: AFP Photo


The new year kicked off with a new round of lockdown. With the Zero-COVID policy at play, the Hong Kong authorities imposed bans on social activities ranging from in-restaurant dinning after 6pm to in-person schoolings. Also, flights from 8 countries are banned. Re-opening of border will likely postpone to end-2Q given it take times to reach herd immunity (with booster shots) and enforce the use of new Health Code System. As a result, GDP growth forecast for 2022 is adjusted downward to 2.4% from 3.0%. We have also laid out the potential downside risks to our forecasts if the border is re-opened in 3Q/4Q instead.

Retail sales will take the hardest hit. Even without the Omicron outbreak, retail sales growth slowed to 7.1% YoY in Nov from 12.1% in Oct as impact of cash voucher dissipated. That of big-ticket items such as durable goods plunged to 1.2% from 30.0%. With the delay in border re-opening, 2022 retail sales growth projection is down from 15.0 to 10.0%. Afterall, tourist spending accounts for around 30% of Hong Kong’s total retail sales.

On external front, flight ban and removal of aircrews quarantine exemption will stress the supply chain. Reportedly, one of the giant airlines’ cargo capacity will drop to around 20% of its pre-pandemic numbers in Jan, down from 71% in Nov due to removal of aircrew quarantine exemption. Logistics costs may surge by 40% within three weeks and CPI is expected to surge to 2.2% in 2022, up from the projected 1.5% of 2021. This is consistent with the widening spread between trade growth in value terms and volume terms. Also, cargo fell by 11.9% YoY in 3Q21 versus 6.1% advancement of nominal GDP (18% points differences). This is in stark contrast to previous recoveries.

The slowdown in Mainland China’s export-led production will also dampen Hong Kong SAR’s re-exports. The recovering advanced economies are now regaining market share from Chinese factories (see “China 2022: The State asserts”). Meanwhile, China’s domestic demand is weakening due to property market correction and renewed COVID outbreak. These also point to softer import demand from Hong Kong SAR.

Recovery in job market will likely pause. Although unemployment rate dropped drastically from 7.2% in Dec20-Feb21 to 4.1% in Sep-Nov21, the pace had started slowing down since 3Q. In our best case, it will only drop to 3.3% by end-2022, which is higher than the pre-social unrest level of 2.8%.

The shrinking labour force is even more alarming. Typically, the workforce should expand during recovery as the rising salary should lure economically inactive person back to work. Instead, it recorded on year decreases since mid-2019. It fell further by 1.1% YoY in Sep-Nov21. This translated into a loss of 143,000 workforce in the past 1.5 years. This largely match with the net departure figure (departure – arrivals) through Hong Kong International Airport since Apr 2020 (197,000).

Interest rates and investment

Rising interest rate alongside a weakening economy will dampen investment sentiment. Gross Domestic Fixed Capital Formation already decelerated from 23.9% YoY in 2Q to 10.8% in 3Q.

Given six US Fed Fund Rate hikes are likely in 2022 and 2023 (see “USD Rates: The Fed’s speed limit”), Hong Kong’s liquidity will be tightened. In response to the accelerating tapering, HKMA has issued HKD80bn of Exchange Fund Bills and Notes to extract liquidity in the banking system. Aggregate Balance (AB) dropped from HKD458bn to HKD368bn of late. This is in contrast to the 2013-14 tapering because commencement of Stock Connect jet up the AB. Although GBA Wealth Connect has commenced in Oct last year, capital inflow was limited amid subdued investment demand. Absence of giant IPOs since the regulatory crackdown of various sectors started in Jun notably depressed capital inflow through Southbound Stock Connect. M2 growth was a meagre 1.9% YoY in Nov YTD, compared to 6.1% of nominal GDP growth.

The Aggregate Balance will drop to HKD200bn by end of this year and HKD50bn by 3Q23 when rate hike cycle ends. Against this backdrop, deposit is likely to grow slower than loan in 2022. 1M HIBOR is thereby expected to rose to 0.92% by end-22 and upside risk is warranted. Yet, Prime Rate will stay unchanged this year. Given the experience from last rate hike cycle, Prime rate only rose by 0.125% when the Fed target rate hit 2.50%.

To encounter such headwinds, timely and targeted stimulus such as cash vouchers are needed in the first half of 2022. As the fiscal reserve already fell by 28.8% to HKD862bn from its peak in 2019, the government will have to consider more bond issuance. In fact, it already surged to 1.2% of GDP in FY21/22 after 15 years long of fiscal neutrality. Over the weekend, the government proposed HKD3.57bn subsidies to support the retail sector heavy affected by the lockdown imposed lately, which accounts to 1.1% of total stimulus in the past two years. We expect more to come.

There is upshot in government bond yields as fiscal spending may return alongside tightening liquidity condition. In fact, the spread between Hong Kong and US 10Y govies yields have narrowed to around 20-30bps lately. Compare to the last rate hike cycle, the spread could be widened to -120bps. Going forward, the spread will be largely neturalized and we think there is upside risk on our end-22 10Y HKD govies forecast of 1.75%. Yield of shorter tenors will rise even more aggressively as structural flattening will continue.

Property market

We expect stronger selling pressure ahead on residential properties, particularly in the first half of the year due to absence of investors from Mainland China. Prices on the secondary market has already fallen by 2.8% since the peak in September due to government’s plans to increase land supply. Purchasing power of residents are likely to retreat after a 21-month long bull market. There is also negative spillover from the recessed stock market onto the property sector. Business owners may also liquidate their properties in view of business difficulties. In fact, developers have slowed down the weekend sales. Yet, we do not see the price will drop significantly given the lingering land demand-supply imbalance. Land supply for the next 4 years stays at 94,000. Private properties completed also dropped by 30% in Nov YTD over a year earlier. Leveraging indicators such as loan-to-value ratio stayed low at 54.6 in Nov21, compared to historical high of 68.9 in 2022, also suggested the risk of property market is largely manageable. We think property prices will stay flat this year.


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Samuel Tse 謝家曦

Economist - China & Hong Kong 經濟學家 - 中國及香港
samueltse@dbs.com


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