The pitfalls of being flagged a political risk

PUBLISHED : Friday, 07 May, 2004, 12:00am
UPDATED : Friday, 07 May, 2004, 12:00am

Hong Kong is a city where making money matters more than idealistic notions of political principle. That oft-repeated refrain by proponents of the status quo has begun to look outdated in an era of heightened political consciousness, yet financial markets have barely registered a flicker of fear.

Over the years, investors have learned to discount political rumblings as background noise. That changed this week when two leading credit rating agencies flagged concerns over the budget deficit and the political impasse over constitutional reform.

Standard & Poor's maintained its currency rating, but offered a negative outlook.

Moody's Investors Service pointed to unsatisfied popular aspirations that could damage investor confidence.

The international arbiters of risk seem less focused on economic growth, predicted at 6 per cent this year, than a budget deficit expected to hit 6 per cent of gross domestic product.

Officials may disagree, but the agencies are important in setting a benchmark for the general cost of capital. 'Political risk' can sound like an abstract term, but it directly influences the holdings foreign funds commit to a market.

Some funds can hold Hong Kong shares, for example, but not riskier Indonesian ones. Investors price risk by applying a higher discount rate on earnings made by companies. A heavy dose of risk reduces valuations and pushes up the cost of raising fresh funds.

In its most naked form, political risk is manifested by cataclysmic societal developments - riots in Indonesia or a political coup in the Philippines. Asia is no stranger to such ructions and this year has seen uncertainty with varyingly controversial elections in India, Malaysia, the Philippines, South Korea, Sri Lanka and Taiwan.

Hong Kong's dissatisfied, although largely peaceful, polity would seem to offer no such peril. The population may be miserable, but there seems little prospect of a radical challenge to the status quo.

The trouble is that stability-at-all-costs can be a hindrance when your economy is crying out for transformational change.

Economic decision-making in Hong Kong has become hostage to special-interest pleading and an overwhelming need to divine consensus due to the government's lack of a mandate.

An escalation of popular unrest and another summer of discontent will inevitably focus markets on the lack of progress made in tackling festering sores like ineffectual industry policy, ad hoc regulation, perverse welfare incentives and most importantly the worsening shape of government finances.

The financial worry for Hong Kong is that its political system is choking change and providing mechanisms only for complaint. Markets may yet price that fear into our collective future.