Hong Kong: More than just a technical recession

Hong Kong's economy contracted by 3.2% quarter-on-quarter in the third quarter of this year and is now in a technical recession. That's defined by two consecutive quarters of negative growth. It was widely expected due to the damage done by the trade war and anti-government protests. The economy shrank by 2.9% year-on-year in the third quarter after positive growth of 0.5% YoY in 2Q19.

As the trade war is expected to linger well into 2020, and there seems to be no end to the violent protests, for the time being, Hong Kong's economy will continue to suffer from negative quarterly growth going into 2020. More companies will close, leading to a deterioration in employment. Without the protests, those affected by the trade stand-off might be expected to find jobs in the retail sector. But retailers are suffering too given the demonstrations, with redundancies and no paid leave commonplace.

The downturn in the jobs market will put extra pressure on retail sales which are already under pressure because of the loss of tourism and a decline in local consumption. We're expecting, therefore, negative quarterly growth for each quarter of 2020. And that's a real recession, not just a technical one.

We believe it is more appropriate to compare the current situation with what happened with the SARS epidemic in the early 2000s than with financial crises, as the nature of the damage is more on consumption and tourism than on financial activities. What we're seeing is not worse than SARS, in the sense that people mostly stayed at home during the crisis in an attempt to avoid the deadly virus.

The difference is time-scale. The protests could inflict more damage to Hong Kong's GDP as they're likely to last longer than the acute SARS outbreak.

• Tourists will only return to Hong Kong when they see things have settled. However, we can't see yet how the protests will end. Mainland tourist arrivals decreased by 35%YoY, while overall tourist arrivals have declined by more than a third in September.
• Locals will continue to spend but only in their local areas to avoid not just the protestors but the traffic jams. Retail sales were down 23%YoY in August.

The Hong Kong government has been employing stimulus measures of some HKD21 billion (USD 2.7bn) in two tranches. That's not, however, expected to be a useful boost to GDP; the money has not been targeted at the most affected businesses. We think there's more stimulus to come, but some of the relief measures need to pass through the Legislative Council. And that might not be as easy as it once was so we're not expecting any quick fix.

The most talked-about topic given all this pressure is the HKD peg. Some market participants worry the peg could be under pressure if Hong Kong is no longer a place for tourists and expats. But so far, it seems that mainly only trade services and the retail sector are impacted. Financial services remain intact.

There is speculation that some people will emigrate. But let's face the fact that Hong Kong has a low tax regime. Even if some people do move away, their money is very likely to stay in Hong Kong. In short, we don't expect large capital outflows from Hong Kong.

This is an important reason why we see the HKD-linked exchange rate system as being solid, and USD/HKD will remain in the range of 7.75-7.85.