The Macroeconomic Impact on Hong Kong of Hypothetical Mainland Shocks

As the Hong Kong economy became increasingly integrated with that of Mainland China, it has benefited tremendously from the strong performance of the Mainland economy. At the same time, skilful macroeconomic management and sustained structural reforms on the Mainland have engendered a virtuous cycle, which reduces risks to Hong Kong from any potential adverse developments on the Mainland. Nevertheless, questions have been raised how Hong Kong will fare in the unlikely event that the Mainland is hit by economic shocks, which could cause the economy to deviate from its envisaged robust medium-term growth path. Shocks could be transmitted from the Mainland to Hong Kong through two main channels. First, Hong Kong¡¦s exports and imports are likely to be affected by sharp fluctuations in Mainland macroeconomic variables. Reduced export earnings and changes in terms of trade will then spill over to the Hong Kong domestic economy. Second, monetary and financial conditions in Hong Kong may be altered by changes in investor confidence and in fund flows as a result of Mainland shocks. The resulting change in Hong Kong dollar interest rates will impact asset prices and domestic demand. We use an econometric model to quantify the impact on Hong Kong of a range of Mainland macroeconomic shocks. Seven hypothetical scenarios are considered: external shocks include a large renminbi revaluation, a significant US economic slowdown, a trade war, and an oil price hike; domestic shocks include an investment retrenchment, a credit crunch, and financial instability. The magnitudes of the shocks are deliberately set to be large¡Xtypically taken as two standard deviations of the shock variable based on historical observations over a ten year period. Our simulation analysis suggests that Hong Kong is resilient against the shocks