Soft landing, soft rebounding, soft risks

Hong Kong's economy is poised for a soft landing in 2024 as annual real GDP growth moderates to around 2% from 2023’s 3.5%. Ironing out base effect, estimated growth between 2023-2024 is 2.75%, nearing the average growth rate achieved in the decade prior to the pandemic's onset. Central to this recovery is mainland tourism revival, fortifying retail and catering sectors. This bodes well for tourism-reliant industries representing one-third of retail sales and 4.5% of GDP. Further tourism recovery will aid employment, especially the 15% workforce in retailers, hotels, and restaurants. Together, this should augment incomes and support domestic spending.

Lending growth remained subdued in 2023, with credit-to-GDP dipping to -4.7% in 1Q23 from a peak of 48.9% in 3Q20. Credit risk materialized from economic slowdown, lofty interest rates, and persistent stress in the mainland’s property sector. However, the worst may be over. Incremental stimulus should gradually lift Chinese consumer and business spending. Meanwhile, likely US tightening conclusion could alleviate Hong Kong dollar pressure, reducing HKMA intervention needs and bolstering liquidity.

Should the Fed commence monetary loosening in 2H24, Hong Kong rates will follow, easing strains in key sectors. We believe 3M HIBOR peaked at 5.7% and will retreat once seasonal effects dissipate, reaching 4.33%-4.7% in 2H24. After contracting ~20% in 2023, M1 may resume modest growth as households redirect funds to demand deposits amid lower cash holding costs.



Although domestic recovery is underway, slack persists with real GDP around 2% below 2018 levels. Output gaps and easing external price pressures are expected to offset inflationary forces from an improving labour market, keeping headline CPI steady at 2.0%. Prospects for private investment remain tepid amid restrained global economic expansion. Supportive policies are therefore imperative to maximize recovery potential. Initiatives stimulating investment and job growth remain crucial.

Downside risks include a pronounced global slowdown and regional conflicts capable of derailing recovery momentum. But such risks are soft, in our view, as indicated by the cautious optimism offered at the recent APEC summit. Enhanced cooperation promises from China and indications of eased bilateral tensions from the US signal a reduction in geopolitical risks, redirecting focus to bolster economic growth and reassure foreign investors navigating uncertainties in China and Hong Kong. Such developments may inject fresh momentum into the capital markets.

While overall external demand is expected to remain modest, prospects for Asian markets appear more promising. Evidence indicates the regional goods cycle downturn may have troughed. Given Hong Kong's electronics industry represents a whopping 70% of total exports, recoveries among key trading partners could strengthen the city’s role in regional supply chains through increased intra-regional trade. We expect headline export value growth to rebound by 7% in 2024 after two years of contraction.

HKD rate: Strain set to ease

Persistent interest rate hikes by the Fed over the past year widened the rate differential between the HKD and USD, fuelling speculative carry trades and putting downward pressure on the HKD. To defend the currency peg, the Hong Kong Monetary Authority has repeatedly intervened, draining interbank liquidity. The aggregate balance for Hong Kong banks consequently fell from over HK$400 billion in 2021 to around HK$48 billion currently—the lowest since 2008.

With a smaller liquidity pool, HIBOR has become more sensitive to fluctuations in HKD demand. 1M HIBOR spiked to 5.53% in early December from 0.18% in May 2022. Seasonal factors were also at play. Regulatory requirements and shifting liquidity profiles amongst banks systematically induced higher intermittent volatility in HIBORs approaching year-end.



Heading into 2024, further headroom appears limited. In the past five years, the degree of HIBOR increases leading up to December varied from 9bps-114bps. But rates consistently retreat once demand wanes in January. More importantly, the HIBOR-SOFR gap has essentially vanished after HIBOR caught up over the past year. As chart above shows, HIBOR tends to remain stable once differentials disappear, hinging future moves on the dynamics of the US counterparts.

Markets currently price in no additional Fed hikes in 1H2024 and around 100bps of cuts in 2H2024, reflecting expectations of economic softening due to strain on leveraged businesses after US rates climbed 525bps in the past year. Such expectations were reinforced by recent easing in CPI and jobs data. Under the currency peg, Hong Kong rates should follow suit, albeit with short-term volatility from transient forces. Our view aligns with IRS pricing lower funding costs across tenors versus one month ago.



Abundant domestic bank deposits are also expected to keep a lid on overall funding costs. Total deposit volumes have grown steadily this year at 3.3% as of October. Higher time deposit rates prompted fund rotation out of demand deposits and into higher-yielding time deposits. This led to a decline in the narrow money supply M1 while the broader M2 maintained expansion.



Robust deposit balances have thus far enabled banks to gradually absorb upward pressure on funding costs. This is reflected in the modest rise of local banks’ HKD composite interest rate - from 0.22% in March 2021 to 2.76% by November 2023 - notwithstanding sharp upticks in HIBOR. Absent acute liquidity stress, we anticipate the spread between HIBOR and the composite interest rate to narrow as their historical correlation suggests.



All told, the 3M HIBOR rate is believed to have peaked at 5.7% in December and expected to retreat as seasonal factors dissipate, settling at 4.33%-4.7% in 2H24. Receding domestic interest rates synergized with Fed moves should anchor local money market stability, buttressing both the value and supply of Hong Kong dollars in the period ahead. This will lead to impacts on both the price and quantity of Hong Kong dollars. In terms of price effects, the HKD versus the USD will tend to appreciate, with our model pointing to the USD/HKD rate reaching 7.78 by 4Q24. In quantitative terms, net Hong Kong dollar liabilities of Hong Kong banks (or net spot foreign currency positions) is expected to rebound after contracting 45% from the February 2021 high.

M1 may resume modest growth as households redirect more funds into demand deposits, driven by the reduced opportunity cost of holding onto cash. This trend could become more pronounced on the back of buoyant asset market performances. Our equity strategist anticipates the Hang Seng Index lifting approximately 15% to around 19,500 by end-2024. A turning equity market may attract capital inflows. Over the past year, Hong Kong's non-reserve financial account recorded unprecedented private fund outflows of HKD510 billion, mostly from portfolio and other investments. Stabilizing economic conditions and moderating funding costs could reverse this trend.



Credit growth: potential lift from rate cut

Economic activity remained lacklustre in 2023, contributing to subdued credit growth. Bank lending for use inside Hong Kong SAR flattened during Jan-Sep. The credit-to-GDP gap dipped to -4.7% as of 1Q23, down from the peak of 48.9% in 3Q20. Most economic segments registered credit contraction. Adversely affected by sluggish external trade, trade finance declined 19.2% while loans to manufacturing, wholesale and retail trade shrank by 12-13%. Loans to building, construction, property development and investment contracted by 1.9% as Hong Kong developers grappled with 16-year high inventories, elevated interest rates and China slowdown.



Businesses’ cautious outlook is likely to restrain credit demand in 1H24. The S&P Hong Kong SAR PMI declined to 48.9 in October 2023 from 49.6 the prior month, marking the fourth consecutive monthly decline and steepest drop since November 2022. According to the HKMA survey, the proportion of SMEs reporting "tighter" bank credit lines surged to 34% in 3Q from 18% previously. Potential monetary easing by the Fed in 2H24 might prompt a downward shift in Hong Kong's rates, strengthening borrowing and lending. Incremental stimulus from the Chinese authorities could further support Hong Kong banks, given their exposures to mainland nonbanks are sizeable at about 24% of banking sector assets (or 225% of GDP).

Meanwhile, Hong Kong's commitment to sustainability and robust green finance framework will propel its advancement. China's 14^th Five-Year Plan endorses Hong Kong's role in green finance for the Greater Bay Area. Policy measures like the Green and Sustainable Finance Grant Scheme will help to reinvigorate progress after a slowdown in 2023. Use of green loan proceeds is expected to diversify beyond real estate given property softness. By instrument, a more meaningful resurgence is anticipated for “sustainability-linked loans” as their viability depends less on specific investments and instead incentivizes broader performance targets.



Trade: Asia the beacon

Total exports witnessed a sizable drop of 11% y/y during January-October owing to weak global demand. The recovery in cross-border land transport capacity also lagged expectations early this year, contributing further to declining exports. Dwindling domestic demand in China weighed particularly hard given 60% of Hong Kong’s exports go to the mainland led by electronics (-13.5%), clothing (-7.6%), textile yarn and fabrics (-25.9%) and toys (-23.6%).

The current account surplus narrowed to 9.32% of GDP in 2Q23 from 12.6% in 1Q22. Weaker merchandise exports alongside stabilizing domestic demand caused the trade deficit to widen noticeably. This overshadowed the services surplus, which received a lift from reopening borders and the tourism recovery.

After two years of contraction, we forecast exports to stage a 7% year-over-year rebound in 2024, underpinned partly by base effects. Shipments beyond Asia are expected to see tempered expansion as demand cools in advanced and other emerging markets. Specifically, shipments to the US - which proved more resilient than anticipated in 2022 - are projected to lose momentum, in part reflecting the lagged effects of Fed tightening. Additionally, while excess pandemic-era savings of around USD2.1 trn helped the US economy defy downturn expectations hitherto, such savings are likely to have depleted in 3Q-4Q23. With household purchasing power declining alongside the run-down of savings, US consumption and import demand from China will soften.



By contrast, shipments to other Asian economies are projected to be the primary driver of growth, building on ongoing regional recoveries and integration trends. Evidence indicates goods cycle downturns across Asia may have bottomed out. South Korea witnessed memory chip exports rebound in October after 16 consecutive months of declines. Taiwan exhibited year-over-year growth in tech exports during Q3, reversing prior contraction. Its inventory-to-shipment ratio of electronic components has also eased from its peak of 2.0 in February to 1.4 in September, implying a pickup in demand. Given Hong Kong's electronics industry represents a whopping 70% of total exports, a recovery across key Asian trading partners could augment Hong Kong's position in regional supply chains through expanded intra-Asian trade. Our view is consistent with HKTDC’s latest 3Q Export Index signalling relative optimism for Asian markets such as ASEAN, Japan and mainland China.


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