S&P’s Hong Kong credit downgrade to raise financing costs, say analysts

US rating agency Standard & Poor’s lowered its credit rating on Hong Kong to AA+ from AAA on Friday, a move set to raise financing costs for local businesses.

S&P said the rating cut for Hong Kong was related to its decision to downgrade China’s rating a day earlier.

The Hang Seng Index fell 0.84 per cent, or 235.69, to close the morning session at 27,874.64, as investors reacted to the S&P downgrade statement issued earlier in the day.

“The S&P decision to cut the credit rating of Hong Kong was an excuse for investors to take profit from the market,” said Louis Tse Ming-kwong, managing director of VC Asset Management.

“The rating cut is definitely bad news for Hong Kong companies planning to raise money by issuing bonds or other fixed income,” he said. That is because the bonds would be priced on the credit rating of the company, which would in turn be affected by the credit rating of Hong Kong, he explained.

“The lower the rating the higher the interest rate the company would need to pay,” Tse said.

S&P said in an emailed statement on Friday that its decision to cut Hong Kong rating was related to China.

“Strong institutional and political ties exist between China and Hong Kong, arising from the latter’s status as a special administrative region (SAR) of China,” S&P said.

“Consequently, we view a weakening of credit support for China as exerting a negative impact on the

ratings on Hong Kong beyond what is implied by the territory’s currently strong credit metrics.

“We are lowering the rating on Hong Kong to reflect potential spillover risks to the SAR should deleveraging in China prove to be more disruptive than we currently expect.”

Financial Secretary Paul Chan disagreed with S&P’s decision.

“We have built up robust markets and strong regulations over the years to safeguard against any spillover risk from mainland China as suggested by S&P,” Chan said. “Hong Kong banks have all along maintained prudent underwriting standards and the HKMA has put in place enhanced measures in respect of risk management for banks on mainland-related lending.”

Tse said the S&P decision showed that international rating agencies are putting Hong Kong and mainland China together due to the increasing economic interaction between the two. Two decades after Hong Kong’s handover to China, 60 per cent of the market capitalisation of the local stock market is from mainland Chinese companies, while there are two stock connects linking Hong Kong with the stock markets of Shanghai and Shenzhen to facilitate cross border trading.

“However, these rating agencies should note that the Hong Kong dollar is pegged to the US dollar which means Hong Kong monetary policies are affected more by the US than mainland China. The credit rating agencies should not believe that Hong Kong is only affected by mainland China policy,” Tse said.

S&P on Thursday cut the sovereign credit rating on China for the first time since 1999, lowering

it from AA- to A+, citing increased economic and financial risks in China after “a prolonged period of strong credit growth”.

It was the second China downgrade by an international rating agency this year.

In May Moody’s cut China’s rating for the first time since 1989. On the following day, Moody’s also lowered its rating on Hong Kong.

S&P on Thursday also lowered its ratings on three foreign banks that operate in China – HSBC China, Hang Seng China and DBS Bank China.

Horst Geicke, chairman of the European Chamber of Commerce in Hong Kong, said he was “shocked” at S&P’s Hong Kong downgrade.

“I didn’t expect this. Yesterday we had the downgrade for China from AA- to A+, which is a marginal downgrade. Justified? Probably yes because corporate finances in China are a little bit tighter than they were before,” he told the South China Morning Post.

“You see the big profits in the internet companies...but the core economy, which is employing most of the people...they have squeezed profits because the competition in China is quite strong.”

But Geicke said he was “totally surprised” that Hong Kong was downgraded as the city is sitting on a huge financial reserve.

The Chinese Ministry of Finance said in a statement posted on its website Friday that S&P’s downgrade on China was a “wrong decision”.

A ministry spokesman said it is “hard to understand” the rationale for the downgrade, given China’s economic fundamentals have become stronger as Beijing has strengthened its “supply side” structural economic reform to cut industry overcapacity.

A commentary piece from Xinhua News Agency late on Thursday quoted university public finance researchers as criticising S&P for using methodologies and theories that have “failed to keep up” with the changing global economy and that of China.

Ken Cheung Kin-tai, senior Asian foreign exchange strategist at Mizuho Bank’s Hong Kong treasury department, said in a note that the currency market had little reaction to the downgrade since China’s debt problem is well recognised.

“The S&P action was a catch-up downgrade with other two main rating agencies and it was backward looking,” he said.

“Market participants refrained from selling [the yuan in offshore markets] before the 19th Party Congress as the government could use aggressive action to curb such speculation. Some [yuan] bears should have learned the lesson after the Moody’s downgrade on China in May. Hence, the market broadly stayed calm to the China downgrade.”

Cheung noted that the Hong Kong dollar weakened slightly to near 7.81 per US dollar after the downgrade on the city’s rating, adding that the impact would be tiny because S&P’s AA+ rating for Hong Kong is still the highest among the three major international ratings agencies, that include Moody’s and Fitch.

S&P said it expects Hong Kong to maintain its “strong credit metrics across the board” in the next two to three years, adding its “predictable and effective policy framework supports healthy economic growth”.

Additional reporting by Phila Siu