The Deloitte Research Monthly Outlook and Perspectives


The Deloitte Research Monthly Outlook and Perspectives


3 July 2020

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HKD peg – no better alternatives in foreseeable future

Why concerns over HKD peg again?

The issue of the HKD peg comes up every now and then when the Hong Kong market experiences significant jitters, causing short-run capital outflows. In early June this year, it was reported that Singapore has seen foreign-currency deposits at local banks almost quadrupling from a year earlier to a record S$27 billion in April, and deposits from non-residents surging by 44% to S$62 billion, allegedly from Hong Kong. The rivalry between Hong Kong and Singapore in juggling the position of the leading regional financial center has existed for years. Hong Kong, which boasts a far deeper capital market and enjoys close proximity to mainland China, a fast growing economy, has got the upper hand. Meanwhile, Singapore has carved out a few niches such as forex/commodities trading and wealth management. Of late, the key question confronted by investment community is whether Hong Kong's role as one of the three global financial centers (New York and London are widely viewed as the other two), would be diminished due to a prolonged protest (since last June) and forceful measures taken by the Central Government of China in an effort to restore social stability. The concerns over the HKD peg have stemmed from the hypothesis that potentially persistent capital outflows would deplete Hong Kong's forex reserves, and eventually cause the peg to crack. In our views, such fears are unfounded. The HKD peg remains rock solid.

What's our baseline scenario on the peg?

Our baseline scenario on the HKD peg boils down to the fact that capital outflows which Hong Kong has experienced last month are unlikely to be significant enough to drive HKD interest rates much higher than corresponding USD rates. US-China trade war, which has made Hong Kong a collateral damage, is also making some of Hong Kong's comparative advantages (the prime stock exchange for Chinese companies' listings) even more pronounced. As Chinese companies are flocking to the Hong Kong Stock Exchange for listings, demand for HKDs could easily offset capital outflows. In fact, HKD interests (HIBORs throughout tenors) have not seen significant deviation from the USD rates, suggesting that the market has largely dismissed the risk of a de-peg.

Table: Recent returns of China Concepts Stocks to HK


Listing date in HK

IPO fundraising (HKD, bn)

Alibaba Group Holding Limited

Nov 26, 2019


NetEase, Inc.

Jun 11, 2020

24.3, Inc.

Jun 18, 2020


Source: Wind

Chart: HKD's risk premium is negligible 


What can be done to ensure the sustainability of the HKD peg?

Would the HKD peg stay perpetually? No one could answer this question because no economy should be committed to a particular exchange rate regime forever. A more fitting question is whether the HKD peg has outlived its usefulness. The answer is a resounding no. Rightly or wrongly, the HKD peg has been viewed as a cornerstone of Hong Kong's financial system.

In order to understand such entrenched view from investment community towards the peg, it is important to refresh the history of the HKD peg. In Hong Kong's case, the very reason for the territory to adopt a hard peg to the USD, or an orthodox peg through a so-called currency board system in October 1983, was to ensure the market that there would be little political interference in exchange rate management. HKMA is a monetary authority not a central bank. HKDs are "printed" by three commercial banks who automatically convert USDs into HKDs at 7.8. Net capital outflows will force HKD rates to rise until such excess demand for the USD is fulfilled, as is the case with surging inflows into Singapore's wealth management. And net capital inflows will cause HKD rates to fall until excess demand for the HKD is satisfied, as is the case with investors buying local listings of late.

The chief reason for Hong Kong to adopt such a hard peg is to maintain fiscal prudence which is often missing in most emerging economies. So far, Hong Kong's fiscal war chest is immense (with fiscal reserves of HKD1.12trn in May) and the territory would be unlikely to repeat its previous fiscal slippage as in late 90s (fiscal deficit/GDP was 3% in 1999). 3% of deficit/GDP should not be viewed as an alarming threshold per se but currency board and territory's heavy reliance on retail and tourism meant property related levies and fees have accounted for the lion's share of fiscal revenue. And asset deflation coupled with a "strong" HKD dried up fiscal revenue then. Today, an expected deep recession caused by protests and worsened by Covid-19 has prompted the HKSAR to run a large fiscal deficit this year in order to support local economies (retail and hospitality mainly) and consumers (cash handout of HKD10000 per adult). We think such fiscal expansion is one-off. As covid-19 fears subside, HKSAR Government is expected to recoup its fiscal stimulus through a recovering economy over time.

Ultimately, what would have broken the HKD peg is persistent rising HKD rates in relation to the USD rates. Why? Again, the answer lies in the mechanism of the currency board system where economic adjustment could only be achieved through asset prices and labor cost, not through exchange rate. During economic booms, asset inflation and salary increases are the norm while economic slumps would result in asset deflation and salary reduction (or higher unemployment rate). But this is how a currency board system is supposed to operate – to maintain investors' confidence by depriving policymakers' discretion to adjust exchange rate. Needless to say, a prolonged asset deflation can be painful. The case of the Asian Financial Crisis in 1997 was a case in point.  HKD peg was under severe attack when short-term interest rates surged to double-digit. Meanwhile, almost 50% of residential property prices have put a significant number of mortgage holders in negative equity class. To compound the problem, regional economies have adopted competitive devaluation policy in order to export their way out. Was the cost of maintaining the peg overweighing its benefit? For argument sake, if Hong Kong had switched to a perfectly flexible exchange rate regime during the height of the Asian Financial Crisis, interest rates would have plummeted when the HKD was viewed as undervalued, capital inflows would resume, while unemployment rate would fall. The challenge would be how to convince the market that the government would stick to its fiscal prudence after deflation subsided. In the end, the choice made by Hong Kong was to strengthen the currency board with seven measures. The crux of these measures was to reinforce HKSAR's commitment to the peg with an implicit pledge of dollarizing the HKD. Speculators have not amounted to any meaningful attack against the peg since late 1998. The market essentially views the HKD as an almost perfect substitute for the USD under "convertibility undertaking". In short, the peg is rock solid.


Gas to bridge transition to greener power

The goal of replacing coal with renewables seems to be receding in China. This year there will be a marked slowdown in the transition to green energy, thanks mainly (but not only) to the lockdown-induced reduction in demand for electricity and the fact that, in order to stimulate the economy, more coal plants are on the anvil. Subsidy cuts on renewable energy that were announced in 2018 have also made a dent in new renewable energy installations, casting a cloud over the ongoing clean energy transition in the power sector. But, given that tackling pollution remains high on the government’s agenda, gas will most probably have to step into the breach. Given its relatively low-carbon footprint, its ability to provide flexible generation to meet the grid's peak-shaving and load leveling needs, and the current record-low gas prices, natural gas is the obvious choice to serve as a bridge fuel to a greener future for China.

Renewables stutter, coal sees sudden surge in project approvals 

A few years ago China committed to reducing the predominance of coal in its energy mix and began to encourage the creation of renewable energy installations, starting a trend of reduced dependence on coal and greater integration of renewables into the grid. But economic distress in the wake of COVID-19 seems to have turned that trend on its head. In an attempt to bring back confidence and jumpstart the economy, the country approved 48 GW of new coal-fired power projects in the first five months of the year, roughly 2.8 times the amount approved for all of 2019. The sudden surge in project approvals runs counter to the government's stated policy intention of scaling back and even halting new coal-fired power projects given air pollution concerns and attempts to balance excess coal power supply. Local state-owned companies, mostly in Shaanxi, Guangdong, and Shanxi, and even some private enterprises have led the renewed investment in coal. Of course, not all approved and planned projects will translate into real installed capacity. Some will simply be taking the place of old coal-fired capacity that was retired over the past few years. To find out whether the short-term additions will actually move the needle, it would be important to monitor the pace of new projects approvals for the rest of the year, and it remains to be seen whether such a reverse in policy is temporary or structural.

On the bright side, China's renewable energy generation plants have shown greater resilience than other sources of power, with output recovering fast in the wake of COVID-19.  However, renewable power producers will probably encounter supply chain disruptions, construction delays and rising risks in investment as they bring new projects online. Just as some countries have started to curtail subsidies on renewables or put them on the back burner, China too has set deadlines to phase out feed-in-tariffs for renewables in the next two years (removing subsidies on new capacities of onshore wind and utility-scale solar power from 2021, and offshore wind power from 2022). This will certainly put a brake on the development of new energy resources for not only has the country had a long history of subsidy payment delays but now, as the prospect of being unable to benefit from subsidies looms large, and with the Green Electricity Certificate (GEC) transaction scheme still very much in its infancy, there is a marked disinclination to invest in the renewable energy sector. Renewables have seen both project investment and new installed capacity declining since the government rolled out its "531 policy" in 2018.

Chart: Renewables exhibit resilience with faster recovery of output

Source: National Bureau of Statistics of China

Gas as "bridge energy" before renewables reach grid parity 

Given the return of coal and the decline in interest in renewable energy, yet with pollution reduction remain an important goal, the role of natural gas is bound to grow in importance. Natural gas has a relatively low-carbon content, a good peak-shaving capability and can easily accommodate increasing shares of variable renewables. Moreover, natural gas produces only half as much carbon dioxide per unit of energy compared with coal, making it the "greener" alternative to reduce CO2 emissions – especially as persistent global oversupply has made prices drop.

But far and away the greatest advantage that natural gas has over coal lies in the former’s capacity to fulfill peak-shaving needs. Costs and construction times have generally increased in recent years for coal power, reflecting, in part, larger plant sizes and more complex project designs. The relatively high capital investment and fixed operations and maintenance costs associated with keeping units online or compliant with more stringent environmental regulation can only be justified if operating hours are maintained. Coal power is less cost efficient at low utilization due to higher fixed capital costs vis-à-vis gas. In addition, coal power plants tend to have longer start-up times, anything from 80 minutes to 6 hours, whereas gas turbines only take 5 minutes to 3 hours to reach full load. Options for flexible sourcing are also limited as pumped storage is restricted to a certain fixed location, and wide-scale battery storage is not expected to become cost effective until 2030. 

Chart:  Operation costs of gas turbines and coal-fired power plants

Source:EIA, Federal Energy Regulatory Commission

Moreover, with the persistent oversupply of natural gas, global gas benchmark prices are expected to fall to new lows. Asian LNG spot prices have tumbled to around $2/mmBtu. The bulk of import portfolios of China, Japan and Korea are oil-indexed LNG contracts. Impact from persistent low oil prices on oil-indexed LNG contract prices will be evident by Q3/Q4 of the year. And natural gas prices are expected to remain depressed in the medium term due to the weak demand forecast, high storage levels and continued growth in LNG supply from newly commissioned projects coming online. Therefore, low gas prices will accelerate the tilt in favor of gas.

Implications for power companies

Gas-fired power plants and their coal-fired counterparts tend to play different but complementary roles. Coal-fired generation more often serves the baseload, delivering a stable power supply to ensure grid security. Gas-fired combustion turbines, on the other hand, are better able to meet peak load needs as they are quick to start up, and provide cleaner, high-efficiency energy. In the short term, LNG import terminal operators in coastal areas such as Guangdong, Fujian, Zhejiang, Jiangsu, Beijing-Tianjin area, will start stockpiling low-cost seaborne gas to compete for market share, boosting gas-based generation along the coast. In the medium term, natural gas will play a more important role in meeting China's power demand. Some power companies and investors will seize this window of opportunity to invest in gas-fired power plants. As China pushes for power sector reform to have a pricing system reflective of market fundamentals, this will provide the right price signal to better compensate power generators for participating in grid peak-shaving services. Once fulfilled, gas-fired peaking plants are bound to experience a boom.


The cold chain for agricultural products is about to take off

The development of the logistics industry in China has always been government-led and not market driven. National policies have set the direction of development, from the national strategy of "new infrastructure" and "express delivery to villages" proposed at the Two Sessions in May 2020 to recent logistics policies and work plans. However, with COVID-19, there has been an acceleration in the development of cold chain logistics for agricultural products, and this has come about not because of government policy alone.

The outbreak of COVID-19 has accelerated the reform of channels for fresh agricultural products.

During the epidemic prevention and control period, supply and demand imbalance of some agricultural products emerged due to the "broken chains" in the transportation sector. On the one hand, demand for fresh agricultural produce swelled, but on the other side, sales of agricultural products were sluggish due to the sharp decline in sales of physical stores. Ensuring ample food and fresh vegetable supply in a post epidemic world requires not only better e-commerce and logistics but also a build-up of cold chain logistics.

The structure of fresh goods retail channels has undergone critical changes against the backdrop of COVID-19. Consumption of fresh goods through e-commerce, community vegetable shops and community group-buying channels has surged while consumption in farmers' markets and physical stores saw a dramatic fall. The change in retail channel structure has led to an immediate shift from a centralized bulk agriculture transportation system to a mode of distribution of many small, individual orders. To get ahead of the competition, cold chain logistics enterprises must pay closer attention to the extension and expansion of the industrial chain, and fully tap the incremental market.

Figure: Changes in the purchase channels of agricultural products

Source: Circulation Industry Promotion Center of the Ministry of Commerce

Central government actively supports the development of agricultural produce logistics

In February 2020, the Central Document No. 1 which gave the CPC Central Committee and the State Council's Opinions related to the "Three Agro Issues”  work, stated expressly that “appropriation within the central budget will be made to support the construction of a number of backbone cold chain logistics bases”. It also highlighted the need for the promotion and application of modern information technologies such as the Internet of Things, big data, blockchain, artificial intelligence, the 5G mobile communication network, and smart weather to  the agricultural field. 

The Government Work Report 2020 also stated that "we will support e-commerce, express delivery services in rural areas, and expand rural consumption." Since the launch of the "Express Delivery to the Countryside" project in 2014, the coverage rate of China's express delivery service network in rural areas has increased from 50% to 96.6% by the end of 2019. More than 15 billion pieces of express mail were sent and delivered in rural areas, and more than RMB 870 billion were spent to support the circulation of industrial products and agriculture products between urban and rural areas. In recent years, accelerating the distribution and timeliness of logistics networks, especially promoting “express delivery to the villages”, is becoming an important measure to bolster consumption and the formation of a strong domestic market.

In the future, smart logistics will continue to go deep into rural areas, and then realize a diversified ecological deployment, and play a fundamental role in smart agriculture, poverty alleviation, and logistics inclusiveness.

The cold chain logistics of agricultural products ready for blossoming

At present, the Ministry of Agriculture and Rural Areas has comprehensively launched the construction of cold chain facilities for storage and preservation of agricultural products nationwide, focusing on the main production areas of fresh agricultural products, preferred areas of specialty agricultural products and poverty-stricken areas, and supporting family farms and farmers' cooperatives to build a number of cold chain facilities for storage and preservation of agricultural products closely linked to the market. The National Development and Reform Commission(NDRC) has also proposed in its recent work priorities to build a number of national backbone cold chain logistics bases for high value-added fresh agricultural products. There is no doubt that the cold chain logistics of agricultural products in China will enter a stage of rapid development.

For cold chain enterprises, many challenges remain, such as the continuous fragmentation of demand orders, the continuous augmentation of logistics efficiency requirements, and the increasing cost of labour. Cold chain enterprises need to take advantage of developments in information technology in order to achieve effective cost reduction and greater efficiency. At the same time, logistics enterprises also need to tap into new incremental markets, namely the supply chain market for agricultural products. They should pool together their resources in order to increase investment in cold chain infrastructure. This means investing in cold transport and warehousing, and using IT to create a public service platform for agricultural product sales. In future, logistics enterprises which can connect the whole industry chain from production to consumption will play a greater role.


Embracing a smarter, greener retail under the COVID-19 ‘new normal’ 

Since the majority of China’s retail industry resumed their operations in March, the retail and consumer goods industry seems to be well on the way to recovery. In May, the year-on-year growth for total retail sales of social consumer goods narrowed to minus 2.8%, mainly thanks to the recovery of brick-and-mortar retail (including sales of physical stores and catering services), which, by all accounts, still dominates the consumer market. Online channels such as e-commerce also contributed mightily. A closer examination of consumption by category reveals that, except for clothing, shoes and hats, gold, silver and jewellery which remained stuck in a rut due to declining sales, most other consumer categories showed positive growth. Among them, daily necessities (excluding clothing, food and beverage, pharmacy products) and beverage products were the fastest growing categories, with a growth of 17.3% and 16.7%, respectively, on a year-on-year basis. Meanwhile, sales of cosmetics also rose rapidly in May, with a year-on-year growth rate of 12.9%. This was probably because cosmetics brands actively ramped up their online channels during the epidemic, introducing new channels such as "livestreaming ecommerce". In addition, cosmetics counters at department stores and cosmetics specialty stores expanded their online presence, and sales through shopping assistants. Livestreaming based on social media also boosted the sales of cosmetics in May. However, the restaurant industry continues to suffer. In May, catering revenue plunged 18.9% y-o-y. In addition, recent outbreaks of COVID-19 in Beijing is bound to dampen consumers' appetite to dine out, further depressing the catering industry.

Figure 1: Consumption is well on the way to recovery

Source: National Bureau of Statistics

During the delayed and much-shortened 2020 Two Sessions in late May, the central government proposed to "implement strategies for expanding domestic demand" and "promote the recovery of consumption". In response, the National Development and Reform Commission (NDRC) has formulated a number of measures to promote the recovery of consumption, covering multiple segments in the retail and consumer goods industries. Considering the changes experienced by consumers and industries since the outbreak of the pandemic, and the normalization of virus prevention measures’ impact, it is expected that in the future, the consumer market will show the following trends:

  • Online retail channels show strong resilience, and will become a key force for consumption expansion in the future. The NDRC proposes to accelerate the cultivation of online consumption. In the future, new retail formats such as "contactless" smart supermarket, livestreaming ecommerce, community group-buy, smart restaurant will get preferential policy support. According to the National Bureau of Statistics (NBS), the online retail sales of physical goods increased by 11.5% year-on-year from January to May. Apart from the traditional horizontal e-commerce platforms, new models such as fresh grocery e-commerce, live-streaming e-commerce and WeChat-based community group-buying developed rapidly after the outbreak. 

Figure 2: Online retail channels show strong resilience

Source: National Bureau of Statistics

  • The durable consumer goods industry such as home appliances and electronics will usher in new market opportunities under the policy of promoting green, healthy, energy-saving and environmentally sound consumption. For example, local governments have given out a large amount of consumption coupons in order to boost sales of household appliances, electronics and other durable consumer goods. NBS data shows that, in May 2020, retail sales of household appliances above the designated size increased by 4.3% y-o-y. In addition, data released by Jingdong on the 6.18 Shopping Festival show that sales of air conditioners went up by 200% y-o-y and the growth rate of refrigerators and washing machines reached 130% y-o-y.
  • Community based local life services will bring about new development opportunities. The NDRC has proposed that in order to improve the quality and expand the capacity of service consumption, the commission will vigorously support the consumption of culture, tourism, sports, nursing and housekeeping services. The local life service platforms that have the capability to integrate the above-mentioned community consumption services could well be rewarded with a new wave of policies and volume dividends. However, since the uncertainty of pandemic continues to pose a serious threat to the development of consumption of services in China, the ‘new normal’ virus prevention measures will affect consumer confidence in areas such as tourism, sports and housekeeping services.
  • New Infrastructure will speed up the digitalization of the retail and consumer goods industry. The NDRC has recommended the development of more intelligent infrastructure networks with greater interconnectedness of production and consumption systems. With the rapid implementation of 5G, data centers, industrial Internet of Things, artificial intelligence and other new infrastructure supporting systems, the connection between consumption and production will be further strengthened.  Flexible production will be promoted and expanded in such areas as intelligent terminal distribution facilities, intelligent vending machines, vending machines, intelligent micro vegetable farms, intelligent recycling stations and the like.

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