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Jackit Wong
Headwinds and
Hong Kong’s
Economic Outlook
November 2015
• External economic headwinds have
been growing stronger, due mainly to
the uncertainty over US monetary
policy normalisation and growth
prospects for mainland China as the
economy continues with structural
reforms.
• Looking ahead, these headwinds may
create greater global market volatility,
slightly higher borrowing costs, and
weaker external demand.
• These developments are moderating
external demand which, in turn, is
cutting into the impact of resilient
domestic demand. As a result, we have
cut our 2015 full-year GDP growth
forecast to 2.3%, with risk tilted
towards the downside.
• In 2016, Hong Kong’s economy is
expected to expand at a broadly similar
pace to that in experienced in 2015,
with cyclical headwinds likely to persist
into early next year.
Senior Economist
Thomas Shik
Acting Chief Economist
Headwinds and Hong Kong’s Economic Outlook
Hong Kong’s economy recorded moderate growth for the first half of 2015, with
gross domestic product (GDP) increasing by 2.6% in real terms compared with a
year earlier, due mainly to resilient domestic demand which bolstered the economy
against effects of the rather weak external sector.
With renewed concerns over the Greek crisis in July, followed by external
headwinds being generated by economic concerns in the US and mainland China,
global market volatility increased sharply. Global volatility indices jumped in the
third quarter of 2015, although these have come down moderately since the release
of the 3Q figures (Exhibit 1).
Hong Kong’s latest economic figures suggest a poorer-than-expected growth
outlook for the local economy in the second half of the year (Exhibit 2). For the
period covering July to September, the performance of retail sales weakened in
terms of both volume and value, compared to the average performance of the first
half of 2015, while merchandise exports and imports deteriorated at a faster pace in
the third quarter this year, compared to the first half of 2015. Signs of economic
activity softening were reflected in the Nikkei Hong Kong Purchasing Manager’s
Index (PMI), a leading business sentiment indicator, which, despite already being
below 501, further weakened in the third quarter.
Exhibit 1: Volatility Indices
Source: Bloomberg
Exhibit 2: Hong Kong’s Monthly Economic Figures
yoy: year-on-year; s.a.: seasonally adjusted
Source: Census and Statistics Department, Bloomberg,
CEIC, Hang Seng Bank
November 2015 2
Jan - Jun
(Average) Jul Aug Sep
Retail Sales
(Volume, yoy) 2.8% 1.8% -0.1% -3.1%
Retail Sales (Value,
yoy) -0.9% -2.9% -5.4% -6.4%
Merchandise
Exports (yoy) 0.4% -1.6% -6.1% -4.6%
Merchandise
Imports (yoy) -0.9% -5.2% -7.4% -7.6%
Nikkei PMI (s.a.) 49.2 48.2 44.4 45.7
1 The Nikkei Hong Kong Purchasing Managers’ Index measures the performance of the private sector and is derived from a
survey of 300 companies. A reading above 50 indicates an expansion, compared to the previous month; below 50 represents a
contraction; while 50 indicates no change.
Headwinds
The headwinds that are currently hindering Hong Kong are external in nature. They
originate mainly from the US and the Mainland, due to uncertainty over monetary
policy normalisation and softening economic growth respectively.
US monetary policy normalisation
The timetable for and pace of monetary policy normalisation in the US remains
unclear. Some members of the Federal Reserve’s Federal Open Market Committee
(FOMC) are continuing to talk about the interest rate hike cycle beginning this year,
while others have started to suggest it may be postponed to next year. The
markets are currently leaning towards the latter scenario as being more likely. After
the FOMC meeting on 27-28 October, the futures implied probability of the status
quo was 50% for the FOMX meeting held on 15-16 December and 43% for that to
be held on 26-27 January next year (Exhibit 3), suggesting that the markets believe
there is a 50% chance of the Fed maintaining the Fed funds target rate range at the
current 0 to 0.25% by the end of 2015 and a 57% chance of the Fed hiking the Fed
funds target rate range early next year at the first 2016 FOMC meeting on 26-27
January.
Source: Bloomberg
Fed policymakers and the markets not only have different expectations about the
timing of the interest rate hike cycle, but also have divergent perceptions on the
pace of monetary policy normalisation (Exhibit 4). Should market observers
Exhibit 4: Market vs FOMC Policy Rate Expectations
(as of 30 October, 2015)
Source: Fed FOMC, Bloomberg
Exhibit 3: Futures Implied Probability
(as of 30 October, 2015)
FOMC
Meeting Calendar
Futures Implied Probability
of a Status Quo
15-16 Dec 2015 50.0%
26-27 Jan 2016 43.0%
15-16 Mar 2016 28.4%
26-27 Apr 2016 25.0%
14-15 Jun 2016 16.5%
November 2015 3
reassess their perceptions of growth and inflation, the resulting upturn in outlook
could trigger renewed global market volatility2.
Putting the risk of greater global market volatility aside, Hong Kong’s Linked
Exchange Rate System (the Link) – which officially pegs the Hong Kong dollar to
the US dollar at a fixed rate of HKD7.80 per US dollar (with a Convertibility Zone)3 –
means that US monetary policy normalisation will directly affect Hong Kong in
terms of capital flow and borrowing costs.
From a systems perspective, an interest rate hike in the US would result in capital
flowing out of Hong Kong and a decrease in demand for Hong Kong dollar assets.
Should the Hong Kong dollar exchange rate weaken to hit the weak-side
Convertibility Undertaking of HKD7.85 per US dollar, the Hong Kong Monetary
Authority (HKMA) would be ready to purchase Hong Kong dollars from banks,
leading to a monetary base contraction. Eventually, interest rates in Hong Kong
would rise (Exhibit 5), which would increase borrowing costs.
November 2015 4
3 On 18 May 2005, the HKMA introduced a strong-side Convertibility Undertaking to buy US dollars from licensed banks at
HKD7.75 to the US dollar, and announced the shifting of the existing weak-side Convertibility Undertaking from HKD7.80 to
HKD7.85, so as to achieve symmetry around the Linked Rate of HKD7.80. The Convertibility Zone lies between the two
Convertibility Undertakings.
Exhibit 5: How the Link Works
Source: HKMA
Capital outflow Capital inflow
Markets sell Hong Kong dollars Markets buy Hong Kong dollars
Downward pressure on the Hong
Kong dollar exchange rate
Upward pressure on the Hong
Kong dollar exchange rate
Monetary base contracts Monetary base expands
Interest rates rise Interest rates fall
Hong Kong dollar exchange rate stabilises
2 World Bank Group. 2015. Global Economic Prospects, June 2015: The Global Economy in Transition. Washington, DC: World
Bank. doi: 10.1596/978-1-4648-0483-0. License: Creative Commons Attribution CC BY 3.0 IGO
Previous monetary cycles also indicated a very close relationship between the one-
month Hong Kong Inter-bank Offered Rates (HIBOR) and the Fed funds target
rate’s mid-point of range (Exhibit 6).
That said, the accumulation of a huge monetary base – which, as of October, 2015,
stood at HKD1,579 billion (including the record high aggregate balance4 of HKD424
billion) – over the previous years (Exhibit 7) might delay the transmission of the
interest rate hike, especially for short-term HIBOR rates, from the US to Hong Kong.
Taken in conjunction with the possible delay in transmission time, we expect
borrowing costs to rise gradually in Hong Kong next year. Tightening financial
conditions amid capital outflow and higher borrowing costs, if not bolstered by an
improvement in external demand and/or resilient domestic demand, will weaken
growth prospects for Hong Kong’s small and open economy next year.
Slower pace of economic growth on the Mainland
As the Chinese government continues to move forward with structural reforms, the
pace of economic growth on the Mainland economy has been moderating. The
implementation of reforms and policies such as shifting the economy to be more
tertiary-sector focused, internationalising the renminbi, further relaxing capital
November 2015 5
Exhibit 7: Hong Kong’s Monetary Base
Source: Hong Kong Monetary Authority
Exhibit 6: HIBOR vs Fed Funds Target Rate
Source: Bloomberg
4 ‘Aggregate balance’ is the sum of balances of banks' clearing accounts maintained with the HKMA and varies in line with the
flow of funds into and out of the Hong Kong dollar.
controls and improving the efficiency of state-owned enterprises, is expected to put
the Mainland economy on a more sustainable and steady growth path in the longer
term.
The recently released Mainland GDP figures for the third quarter of 2015 indicate
that the transformation of the economic growth model is already underway, with the
share of the tertiary industry sector to nominal GDP (Exhibit 8) continuing to rise
steadily. Tertiary industry’s share in the first nine months of 2015 was 51.4% – up
from 49.1% in the same period in 2014, and from 43.1% a decade ago. The share
of the secondary industry sector was 40.6% in the first nine months of 2015, down
from 42.7% in 2014 and 47.3% a decade ago.
In addition, recent significant progress with the liberalisation of interest rates has
kicked off a new era of a more market-based interest rate regime. After the
abolishing the deposit-rate ceiling for deposits with a maturity of more than one
year on 25 August this year, in late October the People’s Bank of China (PBOC)
announced the scrapping of the deposit-rate ceiling, saying that the move was
made possible by a decline in market-based interest rates5.
November 2015 6
5 In the same statement, the PBOC also announced that it would cut interest rates by 25 basis points, lowering the 1-year lending
rate to 4.35% from 4.60%, and 1-year deposit rate to 1.50% from 1.75%, with effect from 24 October 2015. The reserve
requirement ratio (RRR) for all banks was lowered by 50 basis points, with an extra 50-basis-point reduction for some institutions
that meet macro-prudential requirements and make certain level of micro and rural loans.
PBOC’s official statement (23 October 2015) : http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/2968725/index.html
PBOC’s Q&A press release1 (23 October 2015): http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/2968751/index.html
PBOC’s Q&A press release 2 (26 October 2015): http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/2968759/index.html
Exhibit 8: China’s Percentage Share of Nominal
GDP by Sector
Source: CEIC
The PBOC explained that it will continue to set the benchmark savings and lending
rates for a period of time and will eventually use short-term repo and its Standing
Lending Facility (SLF) to guide short-term market rates, and its Medium-Term
Lending Facility (MLF), Pledged Supplementary Lending (PSL), etc, to guide mid
and long-term market rates.
Given the complexity of the reforms, it is reasonable to have expected some
moderation in the pace of economic growth on the Mainland (Exhibit 9). Unlike in
the past when the Mainland was recording double-digit real GDP growth that
regularly exceeded the Government’s official growth target, the new ‘normal’ is
likely to be more ‘modest’ growth in the range of 6% to 7% and a softer growth
target, allowing scope for growth moderation amid the reform implementation.
With the continued and growing economic integration between Hong Kong and the
Mainland, it is widely expected that any economic ‘shock’ on the Mainland would
have some level of impact on Hong Kong’s economic growth.
A HKMA research study on Hong Kong’s growth synchronisation with the Mainland
and the US6 may provide some indication to the possible extent of the impact. The
study examined how economic shocks on the Mainland have previously affected
November 2015 7
6 HKMA, Half-Yearly Monetary and Financial Stability Report, September 2014.
Exhibit 9: China’s Real GDP growth vs.
Government Growth Target
Source: CEIC
the economic cycle and trend of Hong Kong. Mainland shocks were found to
account for only 8.6% and 18.0% of Hong Kong’s cyclical fluctuations at a 1-quarter
and 4-quarter horizon respectively in the period between the fourth quarter of 2003
and the second quarter of 2013, while the long-run five-year impact of the
Mainland’s permanent economic shocks on Hong Kong’s trend growth was about
65.3%. In other words, the study results indicate that that Mainland shocks affect
Hong Kong’s cyclical fluctuation relatively mildly in the short term, but more
significantly in the longer term.
Based on the results of the study and our previous estimates7, we expect that the
impact of the Mainland growth moderation on Hong Kong will be manageable in the
short and medium term. Further, if the implementation of the reforms proves
successful, it appears likely that Hong Kong will benefit from more sustainable and
steady Mainland economic growth in the longer term.
Implications from the headwinds
To summarise, the current economic headwinds have three main potential
implications:
(1) Greater global market volatility based on the divergence in expectations over
the start of the US interest rate lift-off and pace of monetary policy
normalisation, exacerbated by market concerns about the growth outlook for
the Mainland economy.
(2) Slightly higher borrowing costs in Hong Kong amid the US interest rate lift-off
and the transmission mechanism of the Link.
(3) Weaker external demand due to changes in the US import demand pattern8
(despite the solid US recovery), industrial overcapacity 9 and slowing growth on
the Mainland.
8 HKMA, Half-Yearly Monetary and Financial Stability Report, Box 2 ‘Asian export performance amid changes in US import
demand pattern’, March 2015.
November 2015 8
7 Hang Seng Bank, Hong Kong Economic Monthly, Sep/Oct 2015.
9 China’s producer price index declined for the 44th consecutive month in October this year.
Hong Kong Economic Outlook
It appears that Hong Kong’s economic growth will soften more than was previously
expected in the second half of the year. Owing to the notable economic headwinds
originating from the US and the Mainland, external demand has been weaker than
expected and will probably remain weak for some time.
On a more positive note, although domestic demand will likely become slightly
weaker, it will continue to be a good driver of growth, supported by stable labour
market conditions (Exhibit 10), weak inflation (Exhibit 11) and infrastructure
investment. Hong Kong’s inflation is still largely contained, slowing to an average
of 2.3% in the third quarter of 2015 from 3.0% in the second quarter of the year.
Meanwhile, labour market conditions remain tight, as indicated by the steadily low
unemployment rate of 3.3% in the third quarter versus 3.2% in the second quarter,
and a high and stable participation rate of 61.5% in the third quarter versus 61.3%
in the second quarter.
With the stronger-than-expected impact of international economic headwinds on
external demand cutting into the positive effects of resilient domestic demand, we
have cut our 2015 full-year GDP growth forecast from 2.5% to 2.3%, with risk tilted
towards the downside. In 2016, Hong Kong’s economy is expected to expand at a
broadly similar pace to this year, with cyclical headwinds likely to persist into early
next year.
November 2015 9
Exhibit 11: Hong Kong’s Consumer Price Index
Source: CEIC
Exhibit 10: Hong Kong’s Labour Market
Source: CEIC
November 2015 Hong Kong Economic Monitor Statistics
November 2015 10
Nominal Real Value Volume
HKD bn yoy (%) yoy (%) yoy (%) HKD bn yoy (%) HKD bn yoy (%) HKD bn (%) yoy (%)
2010 1,776 6.8 18.3 15.4 3,033 22.7 3,368 25.0 -335 4.4 2.3
2011 1,934 4.8 24.9 18.4 3,341 10.2 3,767 11.9 -426 3.5 5.3
2012 2,037 1.7 9.8 7.2 3,437 2.9 3,915 3.9 -478 3.3 4.1
2013 2,139 3.1 11.0 10.6 3,562 3.6 4,065 3.8 -503 3.4 4.3
2014 2,256 2.5 -0.2 0.6 3,675 3.2 4,225 3.9 -550 3.2 4.4
2015(F) NA 2.3 -3.2 0.3 3,610 -1.8 4,057 -4.0 -447 3.3 3.0
2016(F) NA 2.4 0.2 1.5 3683.2 2.0 4137.1 2.0 -454 3.7 2.5
Q1 2014 536 2.7 4.2 4.7 818 0.7 942 2.1 -124 3.1 4.1
Q2 526 2.0 -7.0 -7.3 901 4.8 1,042 4.6 -141 3.2 3.7
Q3 581 2.9 1.6 1.4 985 5.9 1,109 5.7 -124 3.3 4.8
Q4 613 2.4 0.2 3.1 971 1.2 1,133 3.3 -161 3.3 5.1
Q1 2015 574 2.4 -2.3 0.0 836 2.3 955 1.4 -119 3.3 4.4
Q2 566 2.8 -0.9 3.9 883 -2.0 1,008 -3.2 -125 3.2 3.0
Q3 NA NA -4.8 -0.5 945 -4.1 1,035 -6.7 -89.9 3.3 2.3
May 2015 NA NA -0.1 4.7 292 -4.6 332 -4.7 -40 3.2 3.0
Jun NA NA -0.4 4.4 300 -3.1 345 -2.0 -46 3.2 3.1
Jul NA NA -2.9 1.8 321 -1.6 349 -5.2 -28 3.3 2.5
Aug NA NA -5.3 -0.1 307 -6.1 332 -7.4 -25 3.3 2.4
Sep NA NA -6.4 -3.2 317 -4.6 353 -7.6 -36.4 3.3 2.0
YTD 1,140 2.6 -2.7 1.0 2,664 -1.5 2,999 -3.1 -334 3.3 3.2
HKD bn yoy (%) RMB bn yoy (%) HKD bn yoy (%) yoy (%) Index YTD(%) '000 yoy (%)
2010 6,862 7.5 315 402.1 4,228 28.6 8.0 163.0 21.0 36,030 21.8
2011 7,591 10.6 589 86.9 5,081 20.2 12.9 181.1 11.1 41,921 16.4
2012 8,296 9.3 603 2.5 5,567 9.6 11.0 227.6 25.7 48,615 16.0
2013 9,180 10.7 860 42.7 6,457 16.0 12.4 245.1 7.7 54,299 11.7
2014 10,073 9.7 1,004 16.6 7,276 12.7 9.6 278.3 13.5 60,839 12.0
Q1 2014 9,189 10.0 945 41.4 6,826 19.0 12.2 243.7 -0.6 14,698 15.3
Q2 9,612 13.3 926 32.7 7,074 16.0 15.0 250.3 2.1 13,831 9.6
Q3 9,920 11.4 944 29.4 7,210 12.7 12.3 266.3 8.6 16,130 11.2
Q4 10,073 9.7 1,004 16.6 7,276 12.7 9.6 278.3 13.5 16,180 12.1
Q1 2015 10,403 13.2 952 0.7 7,627 11.7 11.8 291.5 4.7 15,421 4.9
Q2 10,552 9.8 993 7.2 7,676 8.5 7.9 301.2 8.2 13,907 0.5
Q3 10,659 7.5 895 -5.2 7,560 4.9 4.9 NA NA 15,097 -6.4
May 2015 10,562 10.9 972 1.7 7,471 7.3 9.1 298.8 7.4 4,756 3.6
Jun 10,552 9.8 993 7.2 7,676 8.5 7.9 301.2 8.2 4,361 -2.9
Jul 10,534 7.0 994 6.1 7,630 6.9 5.0 303.9 9.2 4,923 -8.4
Aug 10,662 8.2 979 4.5 7,597 6.4 5.9 305.0 9.6 5,615 -6.6
Sep 10,659 7.5 895 -5.2 7,560 4.9 4.9 NA NA 4,559 -4.0
YTD 10,659 7.5 895 -5.2 7,560 4.9 4.9 305.0 9.6 44,424 -0.5
(F): HASE forecast; yoy: year-on-year; YTD: year-to-date; s.a.: seasonally adjusted; bn: billion; NA: not available
Source: Census and Statistics Department, Hong Kong Monetary Authority, Rating and Valuation Department, Hong Kong Tourism Board, Macrobond, CEIC, and Hang Seng Bank
Exports Imports
Unemploy-
ment Rate
(s.a.,
average)
Inflation
(average)
Tourist ArrivalsTotal Deposit
(period-end)
RMB Deposit
(period-end)
GDPExternal Merchandise Trade
Retail Sales
Residential Property Price
(period-end)
Trade
Balance
Total Loan
(period-end)
Money Supply
(M3, period-
end)
Source: Macrobond, Hang Seng Bank Source: Macrobond, Hang Seng Bank
Source: Macrobond, Hang Seng Bank Source: Macrobond, Hang Seng Bank
Source: Macrobond, Hang Seng Bank Source: Macrobond, Hang Seng Bank
GDP Growth
(yoy)
Consumer Price Index
(yoy)
Unemployment Rate
(s.a.)
Retail Sales Value
(yoy)
External Merchandise Trade
(yoy)
Residential Property Price Index
(1999 = 100)
November 2015 11
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November 2015 12
