Dark clouds are gathering over Hong Kong's economy as the city braces for projected severe downside risks that could jeopardize economic growth this year. Oswald Chan reports from the frontlines.

Hong Kong's economic growth in the last decade was supported in the main by an inflow of mainland tourists that spurred retail sales, a booming home market fuelled by a loose monetary policy, and the city's strategic position as a re-exporter to the Chinese mainland.

However, there is growing evidence that these external factors might not be sustained and the situation could potentially be reversed in the near term.

The downward trajectory is only too apparent. From 2004 to 2008, average gross domestic product (GDP) growth for Hong Kong was 6.3 percent. But from 2009 to 2013, the figure fell to less than half at 2.8 percent, according to government data. Last year, growth further slowed to 2.5 percent.

"In 2015, positive impact from mainland tourist arrivals could soften as more travelers choose other destinations over Hong Kong and visitor spending drops. The wealth effect could negatively impact local demand if the upward trend in property prices ends. Meanwhile, re-exports could face increased risk if there are more free-trade agreements between the Chinese mainland and other economies," a forecast from UBS last December summarized in indicating how these three potential risks could impede economic growth in the SAR in 2015.

The Swiss investment bank warned of a likely 2 percent contraction in the event of a worst-case scenario where the three primary pillars suffer more setbacks than anticipated.

On Aug 14, the Hong Kong government revised its economic growth forecast for 2015 upward to 2 to 3 percent, from 1 to 3 percent earlier, citing resilient domestic demand and financial and business services exports as supporting factors despite the effects of faltering inbound tourism and sluggish mercantile exports.

First love loses charm

The first pillar of economic growth - positive impact from the inflow of mainland tourists - is a sector expected to decelerate, with a direct effect on the retail industry.

The decline in mainland visitor arrivals outpaced the drop in total visitor arrivals in August, continuing the trend from July. In August, mainland visitor arrivals in Hong Kong shed 7.1 percent to reach 4.55 million, from 4.89 million a year earlier. During the same time, total visitor arrivals slumped 6.6 percent to 5.61 million, from 6 million a year earlier. In July, mainland tourist arrivals plunged 9.8 percent, 1.4 percentage points more than the decline in total visitor arrivals in the same month.

But according to data for the first eight months of 2015, total visitor arrivals edged 0.1 percent lower while mainland tourist arrivals in fact trended up 0.8 percent.

The dip in mainland tourist data comes as relaxation of travel visa application requirements by other governments, as well as a stronger Hong Kong dollar vis--vis other regional currencies such as the Japanese yen, coupled with yuan depreciation in August, have seen many mainland travelers head elsewhere for their holidays or spend less even if they did visit the SAR.

Further, a change in the shopping habits of mainland visitors, away from luxury items to daily necessities, has also led to a fall in their overall spending levels in Hong Kong.

Hong Kong retail sales fell for sixth months on the trot and weakened further in August as the double whammy of inbound tourism slowdown and stock market volatility dented consumer sentiment. The value of retail sales in August fell 5.4 percent to HK$37.9 billion, after dropping 2.9 percent in July. In the first eight months of 2015, retail sales value slipped 2.2 percent compared with the same period last year, according to Census and Statistics Department data.

"We have revised downward our 2015 GDP forecast to 1.8 percent due to the continued decline in retail sales and tourist arrivals, and a weaker-than-expected growth outlook for Hong Kong's major trading partners, especially the Chinese mainland," said Chang Jian, an economist at UK investment bank Barclays.

UBS in its research report had cautioned: "Loss of higher-spending mainland tourists, inflow of lower-spending mainland tourists and the scheduled opening of Shanghai Disneyland in 2016 would weaken the positive impact from the inflow of mainland tourists in terms of retail sales volume and tourist spending."

John Zhu, economist at HSBC, warned: "Growth in tourist arrivals has continued to slow and this will be a drag on both retail and exports of services such as travel and transportation, both of which have been significant contributors to Hong Kong's services trade surplus in recent years."

The worries extend also to the second pillar of economic growth, the property market. A sizzling home market fuelled by ultra-low interest rates is about to reverse its upward trend, it is feared, given the looming prospect of a US interest rate hike at the upcoming US Federal Reserve meeting in December.

Trouble on homes front

Although local home prices reached historical highs recently, the hike is being increasingly decoupled from robust transactions. In other words, sales have fallen while prices have risen, and this indicates a strong signal that the local home market may be poised to see a significant downward correction.

According to local property agents, secondary home transactions have fallen to an unprecedented low, worse than even during the Severe Acute Respiratory Syndrome outbreak in 2003.

This is because of a stalemate, with home sellers still reluctant to trim offer prices, while potential home buyers are unwilling to accept the hefty price tags, leading to a sluggish trend in transactions.

"We see Hong Kong's home prices plummeting by between 25 and 30 percent in the next two years due to slowing economic growth, rising unemployment, falling inflation, an imminent US interest rate hike and a strong Hong Kong dollar," noted Eva Lee Chi-wan, head of Hong Kong-mainland property research at UBS.

Besides the dip in home prices, increased local mortgage rates in case of a US interest rate hike would make the repayment burden much heavier, which could in turn have serious consequences for local households.

According to Bank of America (BoA) Merrill Lynch, household debt in Hong Kong amounted to about HK$1.55 trillion, or 66.6 percent of GDP, in the second quarter this year. Of this, residential mortgage loans accounted for 70 percent, while credit card advances and loans for private purposes made up the rest.

"When real rates rise, Hong Kong's private sector balance sheets could come under pressure as their debt burden surges," said Marcella Chow, an analyst at BoA Merrill Lynch. "In the worst-case scenario, household and corporate defaults could rise amid financial hardship, with adverse effects on economic growth as well as disorderly consequences for some markets and asset classes in Hong Kong."

Exports hit doldrums

The third pillar of Hong Kong's economic growth, the re-export trade, is also on shaky ground. Merchandise exports declined further in August in tandem with regionwide subdued trading and production activities, due to sluggish global demand.

Total exports value decreased further, posting a 6.1 percent slump in August compared with a year earlier to HK$307.3 billion, following a year-on-year dip of 1.6 percent in July, Census and Statistics Department data showed.

In the eight months to August 31 this year, total goods exports value dropped 1 percent compared with the same period of 2014, with re-exports value and domestic exports falling 0.8 percent and 15 percent, respectively.

In September, the Hong Kong Trade Development Council in a shock declaration revised its export growth forecast for 2015 from 3 percent to zero, citing dented exporter confidence amid an uncertain global economic environment.

"We believe Hong Kong's private sector will contract in the near term as new business from the mainland at the city's private sector firms dropped at the sharpest rate since late 2008. We believe there is room for more accommodative fiscal policy (including infrastructure) to promote investment," Chang from Barclays added.

"Hong Kong's service sector continues to see deteriorating operating conditions, as output and total new work both declined at stronger rates, purchasing activity fell sharply and job shedding persists," said Adrienne Lui, an economic analyst at Citibank.

The Nikkei Hong Kong Purchasing Managers' Index in September signaled further deterioration in business operating conditions for the Hong Kong private sector. The index remained below the neutral 50 threshold at 45.7, though up from a 76-month low of 44.4 in August. The rate of decline was still one of the sharpest seen since early 2009.

"The external environment will continue to be relatively weak and net exports are expected to pose downside risks to growth. Import and export services will come under pressure in both the short and long term due to weaknesses in world trade and competition from other ports in the Chinese mainland," John Zhu at HSBC said. "In the medium term, Hong Kong's economy still needs to transition to new sources of growth."

Contact the writer at oswald@chinadailyhk.com

(HK Edition 10/09/2015 page8)