Hong Kong Budget 2021/22 – Is the glass half full or half empty?
In the last week of February, Hong Kong’s Financial Secretary, Paul Chan announced the city’s 2021-22 budget. With the city recording a second year of negative growth and deficits mounting, there was significant interest in the government’s economic forecasts and their plans to support the recovery while reducing their revenue shortfall. Although there were a few specific implications for short-term interest rates, the budget and the government’s economic plans will have significant longer term implications for HKD cash investors.
During 2020, the Hong Kong government accelerated spending to help local businesses and households weather the challenges caused by the Covid-19 outbreak. This pushed the fiscal deficit (Fig. 1) to a record high of HKD257.6bn (USD33.2bn), equivalent to 9.4% of GDP in the financial year ending March 2021. While this year’s budget is still expansionary, Secretary Chan forecasted the deficit will narrow to HKD101.6bn (USD13.1bn; 3.6% of GDP) as the government continues to support the economy.
The budget includes several measures (totaling HKD120bn), designed to stabilize the economy – which is still suffering from the impact of the Covid-19 outbreak and the political instability since 2019. These include consumption vouchers, salary tax rebates, as well as lower profit taxes and registration fees for businesses.
However, the announced benefits were less generous than last year’s budget – cash payments to residents and salary tax rebates were halved, no new public housing rent waivers were announced, first registration tax on cars was increased, and the trading tax on stocks was increased from 0.10% to 0.13%.
Despite 2020’s GDP plunging to a record low of 6.1%y/y (Fig. 3) and unemployment hitting almost a 17-year high of 7.0% (Fig. 4), Secretary Chan was optimistic, forecasting 2021 GDP would grow by 3.5% to 5.5% as the economy rebounded. The government’s positive outlook is based on the vaccine rollout, reopening of borders and recovery in tourism. However, many economists are less optimistic, with consensus predicting a more modest 4.3% growth in 2021.
Secretary Chan also indicated the government would generate deficits for the next five years; and Hong Kong’s fiscal reserves, which declined from HKD1.2trn at the start of 2020 to HKD900bn by January 2021, are expected to grind even lower towards HKD770bn by 2026 (Fig. 2).
These continued fiscal deficits underline Hong Kong’s narrow tax base – which is primarily dependent on land premiums, salaries taxes and profit taxes. The combination of slower economic growth and the need for continued fiscal support suggests the government may not be able to rapidly replenish their fiscal reserves. Secretary Chan also hinted at the possibility of tax reform, but ruled out any short term changes.
STILL HIGHLY RATED
Historically, Hong Kong’s strong fiscal reserves, robust economy and conservative government merited high credit ratings. As recently as 2017, the city was rated AAA by Standard & Poor’s, Aa1 by Moody’s and AA+ by Fitch Ratings. However, a deteriorating financial position and closer integrations with mainland China are some of the key concerns which triggered downgrades – although Hong Kong’s credit ratings remain strong by regional standards.
All three rating agencies currently maintain a stable outlook on the city’s credit rating. Although with Standard and Poor’s rating (AA+) two notches higher than Moody’s (Aa3) and Fitch (AA-), the former may appear to have enhanced risk of being downgraded to be more in-line with the latter two rating agencies (Fig. 5). While this is unlikely in the near term, any further weakening of local financial conditions would trigger concerns.
With a deteriorating fiscal reserve, a slower than expected economic recovery would put further pressure on the government’s spending commitments – especially as the city’s working age population continues to decline, while its retired population increases with health, housing and education costs spiral higher. Meanwhile, the government’s narrow tax base and heavy reliance on land related premiums as part of their revenue sources (Fig. 6) limit their options to stimulate new drivers of economic growth.
In an attempt to minimize the ongoing, high operating expenditures, the government has already transferred a total of HKD48bn from the Future Fund and the Housing Reserve into the latest budget. Nonetheless, given the government’s tight revenue base – the recent, minor adjustments to car registration taxes and stock trading stamp duty are unlikely to help the government to balance its fiscal deficit in the short to medium term.
INTEREST RATE AND MARKET OUTLOOK
Although the trading tax hike stole the headlines – with Hong Kong exchange (HKEX) and the wider equity market selling off – the longer term impact is likely to be minimal given the city’s pool of capital remains deep and the bourse will remain the default choice for Chinese companies looking to tap into international investors.
The HKD peg has proven resilient, and the currency is expected to remain stable and on the strong side of convertibility. The Hong Kong Monetary Authority’s reserves are ample, and large south-bound flows into property and stocks are likely to continue as more mainland Chinese companies list on the HKEX.
However, if Hong Kong’s fiscal reserve continues to grind lower, this may require additional borrowing and trigger a sovereign rating downgrade. Both of which would impact the city’s credibility and credit spreads.
Fortunately, with ample liquidity in the banking system combined with the Federal Reserve’s recent commitment to keeping rates low, HIBOR levels are also expected to remain close to record lows for the foreseeable future.