Hong Kong Still Will Roar

The restoration of Hong Kong to China at midnight on June 30 makes investing in the territory a much riskier venture, right?

As the old Gershwin song goes, "It Ain't Necessarily So."

For months now, the future of Hong Kong under Chinese leadership has been hotly debated. Some believe China will use its power to trample on human rights, curtail freedom of the press, and threaten the stability of the Hong Kong dollar. On Capitol Hill there are calls for economic sanctions against Hong Kong and denial of "most favored nation" (MFN) trade status to China if a crackdown occurs. "Most members of Congress would deem it absurd to contemplate investing in Hong Kong on the eve of Communist rule," New York Times columnist Floyd Norris wrote.

Yet, as the date approaches, it's a good time to look beyond the ballyhoo and see what economic and political forces really are at work and whether they'll make investment in Hong Kong "risky business."

Not so risky

First, it's important to realize how strong the incentives are for China to permit Hong Kong the high degree of autonomy it has promised in the Basic Law of the Hong Kong Special Administrative Region. One-half of China's foreign trade is with the territory, and Hong Kong is the source of 60 percent of its foreign investment. Hong Kong also is a major provider of financial and management services vital for the mainland's economic development.

Second, Hong Kong's wealthy, dynamic economy shows no signs of slowing down. Thousands of foreign companies continue to use Hong Kong as a base for their East Asian commerce. With a per capita income of about $27,000, gross domestic product growth averaging more than 5 percent annually in the past five years, low debt, and high fiscal reserves, Hong Kong is a success story that China wants to "capitalize" on.

Third, Hong Kong's continued prosperity is key to the success of China's "one country, two systems" policy, under which it hopes ultimately to reestablish ties with Taiwan. China's desire for a peaceful reunion with Taiwan would be dashed if Hong Kong suffered under its rule.

In view of this, Standard & Poor's was comfortable in upgrading Hong Kong's credit rating from "A" to "A+" last month, 40 days prior to the return of the territory to China. (See chart.)

This reflects our analysis that Hong Kong's economy is strong and improving and that China will continue to respect the territory's financial autonomy. Our rating isn't an endorsement of any form of government or political ideology. It is an opinion based on an independent assessment of current financial conditions and prospects for the future. In that light, an "A+" rating is a signal to investors around the world that Hong Kong will maintain a strong capacity to meet its financial obligations.

At the same time we raised Hong Kong's rating, we also upgraded China, in recognition of that nation's economic growth, manageable inflation, high savings and investment rates, and continuing financial liberalization. But, consistent with the view that China and Hong Kong are one country with two systems, they are one country with two credit ratings. China's "BBB+" rating is three notches below that of Hong Kong, reflecting its own incomplete fiscal and monetary reforms and inflexible political system. We do remind the investing public, however, that Hong Kong's "A+" rating is still shy of our highest rating ("AAA"), in part because there is some risk that misgovernance by Beijing could erode over time the pillars of Hong Kong's creditworthiness, including its conservative financial management, the rule of law, and an efficient and impartial civil service.

A word of caution

Moreover, despite the margin of safety that the financial profile of Hong Kong provides, we recognize that, owing to the territory's economic and political integration with China, a severe deterioration in the mainland's economic and social situation could eventually impair Hong Kong's credit standing.

But the generally strong financial posture of Hong Kong remains in place. Things can go wrong after the Union Jack is lowered on June 30, but it is unlikely given the strong economic and political incentives China has to let this roaring tiger continue to make noise.

The flags flying over the Government House in Hong Kong will be different, but there is good reason to believe that it will be "business as usual" on the streets and in the skyscrapers. The risk of investing in this freewheeling, bustling territory of China will not be higher than when it was a freewheeling, bustling colony of the United Kingdom.

* Leo C. O'Neill is president and chief ratings officer of Standard & Poor's Ratings Services.