Markets remain confident about Hong Kong’s future, even though poor leadership is undermining it

Despite the unrest and Fitch’s downgrade, markets do not believe Hong Kong’s special status as a financial centre is in danger. Rather, it is Hong Kong’s own government that has done more to sow uncertainty about the city’s stability

Nicholas Spiro

Published: 7:00am, 10 Sep 2019

Why you can trust SCMP

Financial markets are notoriously poor at assessing and pricing “tail risks”, improbable yet dramatic events that spread panic across asset classes and often pose a systemic risk.

The threat of military intervention to quell the protests that have wracked Hong Kong for the last three months is one of several tail risks investors are having to contend with. A crackdown would put an end to the “one country, two systems” arrangement, affecting the safe haven status that underpins the city’s role as Asia’s premier financial centre.

Mounting concerns about the impact of the political crisis on Hong Kong’s distinct system of governance led to last Thursday’s move by Fitch Ratings to lower its credit rating on the territory the first time since it reverted to Chinese sovereignty in 1997.

Fitch said the unrest had “inflicted long-lasting damage to international perceptions of the quality and effectiveness of Hong Kong's governance system and rule of law” and was “testing the perimeters and pliability of the ‘one country, two systems’ framework”. More ominously, it warned that Hong Kong’s institutions and creditworthiness are likely to come under greater strain as the city’s integration with the mainland gains momentum.

However, markets’ reaction to the downgrade was muted, a function of both the lack of new information to trade on and the usual divergence of views between credit rating agencies and investors.

Indeed, ever since the anti-government protests began in early June, there have been scant signs of panic. The Hang Seng Index has been down just 1 per cent since June 6, having already lost 10.5 per cent since its peak on April 9.

Although stock analysts have slashed their profit forecasts for this year and are expecting the sharpest earnings contraction since the 2008 financial crisis, data from Bloomberg show this is mostly due to the intensification of the trade war and the recent plunge in the yuan. About two-thirds of Hang Seng members’ revenue comes from the mainland.

Hong Kong is irreplaceable. That’s why the PLA hasn’t rolled in yet

What is more, there have been no significant capital outflows. The city’s monetary base has remained stable, Hong Kong dollar deposits are close to a record high and the exchange-rate peg to the American dollar has held firm, backed by Hong Kong’s huge war chest of foreign reserves.

All this indicates markets attach a very low probability to the threat of military action, and do not believe Hong Kong’s special status is severely endangered. The sharp fall in the Hang Seng last month reflected increasing concerns about Hong Kong’s economy – which is on the brink of recession – rather than a loss of confidence in the territory’s institutions and governance.

Indeed, Hong Kong’s own government has done more to sow uncertainty about the economic and political underpinnings of Asia’s premier financial hub. The actions of Chief Executive Carrie Lam Cheng Yuet-ngor’s administration since the crisis erupted have been a near-textbook example of how not to restore investor confidence.

Aside from the fact that Lam herself has proved incredibly tone-deaf and obstinate when it comes to dealing with the protesters’ demands, her government’s rhetoric and strategy have been counterproductive.

There was little to be gained, for instance, by claiming, as Lam did early last month, that the unrest was likely to prove more damaging to Hong Kong’s economy than both the severe acute respiratory syndrome outbreak and the global financial crisis, and was “like a tsunami”. It was equally unnecessary for her to warn the protests were “pushing our city … to the verge of a very dangerous situation”.

Has China forgotten how order was restored to Hong Kong in 2003?

Investors were given additional reasons to worry about the governance of Hong Kong when the administration changed tack last week by placing full-page advertisements in international newspapers, including the Financial Times, to highlight the resilience of the city’s economy.

Just as the Federal Reserve’s recent decision to start cutting interest rates has exacerbated concerns about the health of America’s economy, the Lam administration’s campaign to convince investors that the “one country, two systems” framework is sustainable only serves to accentuate the problematic status of Hong Kong. That the advertisement itself described the protests as “just one piece of a complex social, economic and political jigsaw puzzle” was hardly reassuring.

Luckily for the government, markets continue to be in a forgiving mood.

Markets still believe in ‘one country, two systems’

The deterioration in sentiment towards Hong Kong is being held in check by the outbreak of dovishness among the world’s major central banks and, just as importantly, hopes that Beijing and Washington will eventually strike a trade deal.

Most crucially, markets are correct in their assumption that China has little appetite for military intervention in Hong Kong – an assessment that was given added credence by last week’s leaked audio recording of Lam’s remarks to a group of businesspeople.

Markets still believe in “one country, two systems”. How the government intends to safeguard the arrangement in the face of continued unrest is another matter.

Nicholas Spiro is a partner at Lauressa Advisory

Post