The Impact of China’s Slowdown on Hong Kong

China’s economy is slowing down, as its GDP grew at 7.4% in the first quarter this year, a level below the 7.7% growth last year and the double-digit growth many years ago.

Relatively, many people are concerned about the prosperity of Hong Kong, whose economy is heavily tied to China through trade, tourism, foreign direct investment, and financial channels. In my observation, there are two main risks for Hong Kong—export growth and credit quality.

China’s growth momentum has long been exports and government-led investment projects. Meanwhile, the country as the world’s second largest economy is also a significant importer due to its huge domestic market of 1.35 billion people. Therefore, many Asian economies, including Singapore, Taiwan, South Korea, and Vietnam, have heavy export exposure to China. In particular, Hong Kong appears to among the most exposed with almost 30% of its exports to China. Since domestic consumption is weakening on the overall economic slowdown and potential risk of a housing bubble, Hong Kong’s exports are highly likely to slide, dragging down the special region’s GDP growth.

Besides, surging loans to Chinese borrowers by banks in Hong Kong triggered concerns on the city’s financial stability. It is due to tight credit in China and lower interest rates in Hong Kong that lending to mainland businesses by all authorized institutions has increased from about 5% of total banking sector assets in 2007 to nearly 20% today, according to the Hong Kong Monetary Authority. As a result, total mainland-related exposure amounts to 165% of Hong Kong GDP, despite that 43% of the outstanding loans come from foreign banks operating in Hong Kong, rendering a comparison to the city’s GDP less relevant.

The worry is that the booming lending might increase uncertainties in Hong Kong’s banking sector and result in overwhelming integration with the Chinese economy. There are signals of credit quality deterioration in China, as the non-performing ratio of Chinese banks rose to 1% at the end of the fourth quarter from 0.97% at the end of the third quarter last year, which is the highest since the end of 2011. Many loans were made on the expectation of higher growth rate and the slowdown could lead to serious default issues.

In response to the higher risk of cross-border leverage, the HKMA decided to regularly conduct on-site examinations of banks’ credit-underwriting processes, as well as regular stress tests to assess banks’ resilience to credit shocks. Specifically, it said it has written to banks that have posted higher-than-average increases in total lending and asked them to make sure they have enough “stable” funds.