Hong Kong protests highlight economic, governance risks
As protests in Hong Kong escalate, there is a growing risk of damaging business confidence and eroding governance, which are factors in territory's sovereign rating
Disruptions to economic activity from recurring protests in Hong Kong present a downside risk to our GDP growth forecasts, but are unlikely to undermine the territory's considerable financial buffers in the near term, Fitch Ratings says. However, the unrest and apparent rising distrust in government runs the risk of damaging business confidence and eroding the quality and effectiveness of governance, which supports Hong Kong's three-notch positive sovereign rating differential with mainland China.
Large demonstrations have been held regularly since early June, inspired initially by opposition against an extradition bill that would have provided for the transfer of suspects to mainland China and other jurisdictions with which Hong Kong does not already have an extradition treaty. The demonstrations escalated in the brief occupation of the Legislative Council by activists on July 1. Since then, protests have been increasingly marked by violence and clashes with the police.
The extradition bill was suspended on June 15 in response to the public outcry. Nevertheless, protests have continued featuring diverse groups, with widening demands that include the bill's formal withdrawal, retraction of the government's initial characterization of the protests as "riots", and the unconditional release of arrested protestors. Some factions are reigniting long-standing calls for deeper institutional changes, such as the implementation of universal suffrage.
The breadth of demands underscores the steady rise in social and political divisions in recent years, emanating from rising living costs, economic inequality and, above all, deep-seated apprehension over the perceived erosion of autonomy under "one country, two systems."
Growing discontent with the heavy-handed police response, public backlashes, and the government's seeming inability to address the public's concerns could cause long-lasting damage to business confidence. More broadly, the ongoing sensitivity of the relationship has likely heightened the risk of policy paralysis on economic integration initiatives with the mainland, such as the Greater Bay Area development plan.
Fitch affirmed Hong Kong's “AA+” rating on June 11. The affirmation reflected our view that any disruption from the protests, which had just begun, would not be sufficient to alter the territory's fundamental credit strengths, which include exceptionally strong public and external finances, high income levels, and a resilient and flexible economy.
These significant buffers and credit strengths are also reflected in the Stable Outlook on the rating. Nevertheless, some of the assumptions underpinning the rating are currently being tested, including the effectiveness of the territory's governance and its rule of law.
Fitch Ratings has long viewed Hong Kong's ongoing integration with mainland China as the territory's primary rating sensitivity. Hong Kong's three-notch positive rating differential rests on the assumption that the territory's governance standards, rule of law, policy framework, and business and regulatory environments remain distinct from those of mainland China (A+/Stable).
While further integration should enhance economic opportunities by removing supply-side constraints, it will also inevitably further entwine Hong Kong and mainland China's institutional and regulatory frameworks. On this basis their respective sovereign ratings should gradually converge over time.
An additional factor that could affect our credit assessment would be the international response to recent events, such as the possible termination of the US-Hong Kong Policy Act. Passed by the US Congress in 1992, the Act permits the US to treat Hong Kong as a separate customs regime from China based on the understanding that the latter would enjoy a high degree of autonomy following its handover to China in 1997.
While near-term termination of the Act appears unlikely, newly proposed legislation in the US Congress would require an annual certification of Hong Kong's autonomy. This underscores the potential for current tensions to erode international perceptions of Hong Kong as a stable business hub that enjoys a distinct economic and political environment from that of the mainland.
Hong Kong's World Bank Governance Indicators, which form a key input in Fitch's Sovereign Rating Model, have been broadly unchanged in recent years. But evidence of a permanent loss of confidence in public institutions or tangible reduction of the territory's semi-autonomy as granted under the Basic Law, would also be grounds to review the ratings.
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