Investors in the week ahead will receive an update on Hong Kong’s economic growth rate, while ongoing protests and rising U.S.-China trade tensions have been generally taking their toll on the territory.

China’s central government has been recently applying more pressure on Hong Kong’s local authorities to stem the swelling wave of protests that, to date, have only intensified. The unrest has risen to the point where there have been reports of potential intervention by Beijing.

Against this backdrop, Hong Kong equities – as evidenced by the iShares MSCI Hong Kong ETF (NYSEARCA: EWH), which has among its top holdings life insurance giant AIA Group (OTCMKTS: AAGIY) and multinational conglomerate CK Hutchison (OTCMKTS: CKHUY) – have plunged more than 14.6% from their most recent 52-week high set in April 2019.

Since July 19, the ETF has fallen 12.3%.

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The protests, which were ignited in early June, were initially in response to Hong Kong’s proposed legislation earlier in 2019 to form legal extradition from Hong Kong to mainland China. While the Security Bureau’s plans have since been shelved, the movement has generally morphed into a groundswell of demands for broader democratic reforms.

Hong Kong has been operating as a semiautonomous territory of China under a “one country, two systems” principle, which had been established in connection with Britain’s handover, or return, of the land to China in 1997.

Economic Harm

Recent reports of clashes with police, along with a general strike that spurred massive flight cancellations and shuttered restaurants and other local businesses, has eaten away at critical parts of Hong Kong’s economy, including tourism and retail sales.

According to Hong Kong’s Census and Statistics Department, retail sales in June fell by 6.7% year-on-year, underscored by a 17.1% plunge in the purchases of jewelry, watches and clocks, and other valuable gifts.

The decline was accompanied by decreases in the sales of medicines and cosmetics (-4.1% in value); wearing apparel (-8.2%); commodities in department stores (-6.0%); food, alcoholic drinks and tobacco (-1.3%); electrical goods and other consumer durable goods (-16.1%); motor vehicles and parts (-9.1%); footwear, allied products and other clothing accessories (-1.4%); books, newspapers, stationery and gifts (-4.5%); Chinese drugs and herbs (-0.1%); and optical shops (-11.9%).

The activity, combined with intensified U.S.-China trade frictions, as well as the recent lowering of the Chinese yuan, does not bode well for Hong Kong’s rate of economic growth.

Investors will receive the final reading of Hong Kong’s second quarter of 2019 GDP on Friday, August 16, after a paltry uptick of 0.6% in Q1 2019. Earlier indications showed the pace of GDP in Q2 2019 was unchanged from the prior quarter.

Friday, Aug 16

• GDP (Q2 – Final)

Growth Prospects Dim, But Credit Reputation Remains Intact

Carrie Lam, Hong Kong’s chief executive, recently said that due to the China-U.S. trade friction and uncertainties in the external environment, Hong Kong’s economic momentum has weakened in recent months, with “no room for optimism for the second quarter and the entire year.”

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She continued that the HKSAR has been closely monitoring global and local economic situations and maintaining close contact with the business sector, including several local small- and medium-sized enterprises, to understand their needs.

Furthermore, Lam said that the disputes in society in recent months are not conducive to Hong Kong’s continued development and that she would spare no efforts to deal with them.

Meanwhile, it appears credit investors maintain a healthy view of Hong Kong’s ability to honor its debt obligations despite the rise in political risks and potential for slower economic growth.

Moody’s Investors Service, for example, recently affirmed its investment-grade ‘Aa2’ credit rating on the territory with a stable outlook in large part given the Hong Kong government’s fiscal surpluses.

Moody’s said these surpluses “span more than a decade and have been sustained through fluctuations in global growth that significantly influence Hong Kong’s economic environment.”

While Hong Kong’s budget surplus narrowed to nearly HKD68bn in fiscal 2018/19 (2.4% of GDP based on Moody’s estimates) from HKD149bn (5.5% of GDP) in the prior fiscal year, it was still higher than originally budgeted. In the next few years, Moody’s expects Hong Kong to continue to run small surpluses.

As a result, Moody’s said the government’s debt will remain “very low,” at 3.7% of GDP in 2018, which mainly reflects issuance to enhance market liquidity rather than finance the government’s budget.

Market participants’ perceptions of Hong Kong’s creditworthiness has generally remained stable, with spreads on its five-year credit default swaps (CDS) roughly 2.75 basis points tighter on the day Wednesday to nearly 29.5bps. Over the past three months, Hong Kong’s five-year CDS spreads have compressed by around 6bps.

However, the ratings agency noted that in the short-term, even in a status quo on U.S.-China trade relations, continued uncertainty over the trade dispute will “hurt Hong Kong directly through slower trade, and indirectly through lower business investment and consumer demand in Hong Kong.”

Moody’s added this will likely cause Hong Kong’s GDP growth rate to slow to 2.3% in 2019, before recovering modestly to 2.7% in 2020.

The figures are somewhat lower than the numbers the International Monetary Fund (IMF) published in its World Economic Outlook for April 2019, which pegged Hong Kong’s real GDP at 2.7% in 2019 and 3.0% in 2020.

Risks May Persist

Meanwhile, Hong Kong’s political risks and tenuous relationship with China may persist for an extended period before any stable resolution may be formed.

Neil Azous at Rareview Macro recently highlighted that “there is a growing acceptance that any U.S.-China trade truce is unlikely before the U.S. Presidential Election in late 2020. And, regardless of who is elected, it will not start to be dealt with until after the inauguration in 2021. This gives China’s leadership time to address their local issue of unrest in HK and establish the environment acceptable to the Politburo.”

In terms of global response to potential Chinese aggressive intervention in Hong Kong, Azous said he suspects the only action nations will take “will be to curtail investment and reduce current liquid investments.” He added that, in this case, the People’s Bank of China (PBoC) “will not hold the yuan stable.”

Investors will likely be keeping an eye on any further fluctuations in Hong Kong’s equity and currency markets, amid further developments in U.S.-China trade, protests, potential shifts in monetary policy, and other macro headwinds.

In the meantime, select the Event Calendar option in the IBKR Trader Workstation for a full list of the U.S. and global corporate events and earnings, dividend schedules, economic data, IPOs and more.