Hong Kong’s sovereign ratings raised to AA by Capital Intelligence

Capital Intelligence (CI), the international rating agency, has raised Hong Kong’s long-term foreign currency rating to ‘AA’ from ‘A+’ and its short-term foreign currency rating to ‘A1+’ from ‘A1’. The outlook on the ratings is stable.

The adjustment reflects the continued improvement in the government’s balance sheet and CI’s expectation that the gap between the government’s financial assets and its debt liabilities will continue to grow over the medium term. The ratings also reflect Hong Kong’s robust balance of payments performance and the continued accumulation of official foreign assets which, combined with a low level of public external debt, help to insulate it from external economic shocks. The ratings upgrade also takes into account CI’s recent adjustment in China‘s ratings (to A/A1/Stable) and the reduced likelihood of direct intervention from Beijing.

The government budget has been in surplus for the past three years and is likely to remain so over the coming years, supported by prudent expenditure management and robust GDP growth.

Government debt is estimated at just 1.3% of GDP in 2007 while government guaranteed debt is equivalent to about 0.3% of GDP and is linked to various business finance schemes. Fiscal flexibility is enhanced by the government’s longstanding policy of maintaining a prudential level of fiscal reserves as a buffer against shocks. Fiscal reserves are currently in the region of 24% of GDP and are expected by CI to continue increasing over the medium term.

Hong Kong’s external finances are very strong. Consecutive current account surpluses since 1998 have further strengthened its net international investment position and CI estimates that the combined foreign assets of the Hong Kong Monetary Authority and banking institutions are almost one-and-a-half times as large as the external debt stock, almost all of which is owed by private sector entities. Official foreign exchange reserves, at USD 142 bln at the end of October, are the ninth largest in the world.

Volatile budget revenues remain the principal constraint on Hong Kong‘s ratings. This volatility is due to a narrow tax base and a heavy dependence on non-tax sources of revenue such as investment income and the land premium. Although large fluctuations in revenue can complicate fiscal management, fiscal risks are greatly mitigated by the high level of government financial assets. CI notes that there is growing recognition of the need to strengthen the tax system, but as yet there is no clear consensus on the way forward.