Singapore, March 12, 2016 -- Moody's Investors Service has today affirmed the government of Hong Kong's long-term debt and issuer ratings at Aa1 and changed the outlook to negative from stable.

The announcement follows Moody's outlook change on China's Aa3 rating to negative from stable. The revision in Hong Kong's rating outlook reflects Moody's view that trends in Hong Kong's credit profile will continue to track those in China, due to its tightening political, economic and financial linkages with the Mainland.

In particular, increasing political linkages are likely to weigh on Hong Kong's institutional strength. In addition, the risks to China's economic and financial stability may also undermine Hong Kong's own economic and financial outlook.

Moody's has also affirmed Hong Kong's Aa1 senior unsecured rating.

In a related rating action, Moody's has affirmed the Aa1 ratings of the Trust Certificates issued by Hong Kong Sukuk 2014 Limited and Hong Kong Sukuk 2015 Limited, special purpose vehicles established by the Government of Hong Kong. The payment obligations associated with these certificates are direct obligations of the Government of Hong Kong, and their ratings automatically reflect changes to Hong Kong's sovereign ratings.

RATINGS RATIONALE

RATIONALE FOR ASSIGNING A NEGATIVE OUTLOOK

The principal driver of the negative outlook on Hong Kong's rating is the tight linkage between the credit profiles of the Special Administrative Region and China. That linkage manifests itself in the economy, given the very strong trade links between the two; in the financial system, given Hong Kong's banking system's involvement in the Mainland; and ultimately in the political and institutional arena, given the tensions inherent in the "One Country, Two Systems" policy.

Accordingly, while Hong Kong possesses credit strengths -- principally in the form of fiscal buffers -- that continue to support a higher rating than China's, the close and enduring linkage between the two issuers' credit profiles suggests that the pressures currently facing the Chinese authorities have implications, over both the near and longer term, for Hong Kong's own economic, financial and institutional strength.

POLITICAL LINKAGES WITH CHINA RISK WEIGHING ON HONG KONG'S INSTITUTIONAL STRENGTH

The tight political linkages between the Special Administrative Region and China have the potential to adversely affect Hong Kong's policy credibility and effectiveness over both the near and longer term.

Political risk has risen in Hong Kong in light of ongoing tensions over the implementation of the "One Country, Two systems" policy. In the near term, tensions could rise further, in particular ahead of the 2017 election for Hong Kong's Chief Executive, and impair the effectiveness of government policies.

Over the medium term, the strong political linkage embedded in the "One Country, Two Systems" policy -- which was re-asserted in "The Practice of the 'One Country, Two Systems' Policy in the Hong Kong Special Administrative Region" June 2014 White Paper from China's State Council -- creates the risk that Hong Kong's institutions will lose some of their independence over time as China's influence grows. This would negatively affect policy effectiveness and credibility in Hong Kong and weaken its institutional strength relative to China's.

ECONOMIC AND FINANCIAL LINKAGES WITH CHINA TURN FROM POSITIVE TO NEGATIVE SPILLOVERS

Hong Kong's economic and financial linkages with China also give rise to potential negative spillovers from China in case of a rise in financial stress and, ultimately weaker growth, as such developments could adversely affect Hong Kong's economy and financial sector. In turn, weaker growth and rising losses in Hong Kong's banking sector would erode the government's fiscal buffers, as support to the economy and the banking sector leads to a rise in public spending.

In 2015, 43.6% of Hong Kong's exports of domestically-produced goods and 53.8% of its re-exports were shipped to China. In addition, 77.3% of tourist arrivals were from China, up from 63% five years ago.

The importance of China for Hong Kong's trade sector and the dependence of Hong Kong's economy on trade imply that weaker economic growth in China -- as a result of rising financial stress -- would significantly dampen Hong Kong's economic performance, both directly through bilateral trade channels and indirectly through China's impact on global trade. Already, in light of the sharp slowdown in exports to China, combined with unfavorable demographic trends, we forecast only muted GDP growth in Hong Kong over the next five years.

Beside economic linkages, Hong Kong's banking sector is significantly exposed to China. Bank lending to the Mainland accounted for 15.7% of total assets in Q3 2015. In a downside scenario of increasing leverage in China, Hong Kong's banks credit risk would in turn rise, given their loan books' exposure to Chinese corporates.

More generally, the elevated volatility in Hong Kong's financial markets in recent months has mirrored developments in China's markets, highlighting the strong transmission of changes in risk aversion from China to Hong Kong. Higher broad-based risk aversion -- vis-à-vis assets exposed to China -- could trigger a sharp correction in Hong Kong's financial sector. In particular, unfavorable developments in China could lead to a sharp correction in Hong Kong's elevated level of property prices.

Macro-prudential measures -- including tight loan-to-value ratios -- reduce the risk of financial stress for households. The absence of oversupply in the property market and room for fiscal policy action, such as government investment in housing also mitigate the risk of a sharp and extended fall in property prices. Nonetheless, the rapid pace of increases in property prices in recent years and stretched households' finances imply that this risks remains. A sharp property market correction would exacerbate the pressure on banks' asset quality and profitability.

Overall, Moody's assessment is that banking-sector risk for Hong Kong's government has increased.

RATIONALE FOR AFFIRMING HONG KONG'S Aa1 RATING

Hong Kong's Aa1 rating is supported by significant fiscal buffers, as evidenced in low government debt, sizeable fiscal reserves, and large foreign exchange reserves which lend credibility and stability to the linked exchange rate regime. In turn, the build-up of these fiscal and foreign exchange reserves in the past reveals the current strength of Hong Kong's institutions. Fiscal and institutional strengths are reflected in Hong Kong's rating being higher than China's.

WHAT COULD CHANGE THE RATING UP/DOWN

The negative outlook signals that an upgrade of the rating is unlikely. Moody's could revise the outlook to stable if we concluded that Hong Kong's institutions, economy, financial system and the government's finances were effectively and durably protected from changes in China's credit profile and from interference by China.

In the absence of such a conclusion, it is likely that further pressures on China's rating would be manifest in similar pressures on Hong Kong's. Specifically, evidence that domestic political tensions are likely to mount and undermine the effectiveness of policymakers, or evidence of interference from China in Hong Kong's policy formulation and implementation, would be consistent with a downgrade of the rating.

Similarly, evidence that unfavorable economic and financial developments in China lead to markedly weaker growth and higher financial stress in Hong Kong's banking sector would also put negative pressure on the rating.

COUNTRY CEILINGS

Hong Kong's local and foreign-currency bond ceilings remain at Aaa. Its local and foreign-currency deposit ceilings remain at Aaa and Aa1 respectively. Its short-term foreign-currency bond and bank deposit ceilings remain at Prime-1 (P-1).

GDP per capita (PPP basis, US$): 56,689 (2015 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 2.4% (2015 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 2.4% (2015 Actual)

Gen. Gov. Financial Balance/GDP: 1.3% (2015 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: 2.1% (2015 Estimate) (also known as External Balance)

External debt/GDP: 434.1% (2015 Estimate)

Level of economic development: Very High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 09 March 2016, a rating committee was called to discuss the rating of the Hong Kong, Government of. The main points raised during the discussion were: The issuer has become increasingly susceptible to event risks.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2015. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Marie Diron

Senior Vice President/Manager

Sovereign Risk Group

Moody's Investors Service Singapore Pte. Ltd.

50 Raffles Place #23-06

Singapore Land Tower

Singapore 48623

Singapore

JOURNALISTS: (852) 3758 -1350

SUBSCRIBERS: (852) 3551-3077



Anne Van Praagh

MD - Sovereign Risk

Sovereign Risk Group

JOURNALISTS: 212-553-0376

SUBSCRIBERS: 212-553-1653



Releasing Office:

Moody's Investors Service Singapore Pte. Ltd.

50 Raffles Place #23-06

Singapore Land Tower

Singapore 48623

Singapore

JOURNALISTS: (852) 3758 -1350

SUBSCRIBERS: (852) 3551-3077



Moody's changes outlook on Hong Kong's rating to negative from stable; affirms government bond rating at Aa1