Rating agency Fitch Ratings announced today that it has revised the rating Outlook on Macau from Stable to Negative, citing its reason as the city’s ‘large and rising economic, financial, and socio-political linkages with mainland China’.

‘[These links] are consistent with a gradual convergence of their respective sovereign ratings. This was also among the drivers of Fitch’s downgrade of Hong Kong’s Long-Term Foreign-Currency IDR in September 2019,’ the company added.

The company has also affirmed the Long-Term Foreign-Currency Issuer Default Rating (IDR) for Macau at ‘AA’.

‘The agency’s ‘AA’ rating on Macau is currently two notches above that of mainland China (A+/Stable), and rests on the assumption that the territory’s governance, rule of law, economic policy framework, and business and regulatory environments remain distinct from that of the mainland,’ Fitch noted

The credit company then affirmed that these assumptions are now evolving, as both SARs become more closely integrated into the Chinese governance system, which has accelerated by the events in Hong Kong, as well as via policy initiatives such as the Greater Bay Area, which seek to enhance long-term regional growth opportunities by integrating the economies of southern China more closely.

Fitch also noted that Macau ratings are constrained by the city’s high GDP volatility and ‘narrow economic base’, which largely consists of gaming tourism from mainland China.

The company previously forecast that the local economy will contract by 2.5 per cent in 2019, due to a downturn in the gaming sector, and with slower economic growth in mainland China, which has contributed to the 2.4 per cent year-on-year drop to MOP269.6 billion between January and November of this year.

‘The VIP segment, which tends to be more sensitive to changing economic conditions on the mainland, is on track to record a double-digit contraction this year. The mass market, on the other hand, has continued to grow strongly at 17 per cent yoy during the nine months ended September 2019,’ the company noted.

Fitch also attributed the economic downturn to the completion of several major infrastructure projects last year, which implied weaker investment and construction activity during 2019, and anticipated that the subdued economic activity will continue into 2020, with a 0 per cent GDP growth estimated, based on the rating agency ‘assumption that gaming revenues will grow in the low single-digits next year’.

Chinese exposure

Interestingly, the company considered the mainland China exposure (MCE) of Macau banks as the single biggest financial sector risk, with estimates that Macau’s MCE had risen to 41 per cent of system assets by end-1H19, the highest in the Asia-Pacific region, and double its size at end-2015.

‘At the same time, Macau’s MCE has a low impaired-loan ratio of less than 0.2 per cent, with about 50 per cent of exposures backed by parental guarantees or guarantees from other mainland banks. Macau’s banks have also demonstrated resilience during previous downturns, such as during 2015, when gaming revenues and the economy as a whole contracted by 34 per cent and 22 per cent, respectively.

Fiscal buffers

Nevertheless, Fitch expects local fiscal performance to remain strong and maintains the city’s ‘fiscal buffers’ despite the economic downturn, with a fiscal surplus of about 11.5 per cent of GDP in 2019. A more optimistic view than the usual conservative estimates by local authorities.

‘The 2020 Policy Address targets a budget surplus of MOP21 billion (4.7 per cent of GDP) based on conservative assumptions. Fitch forecasts a 2020 surplus of roughly 11 per cent, reflective of Macau’s long-standing record of budget outperformance,’ the group added.

‘Macau is also the only entity in Fitch’s global sovereign portfolio without any outstanding government debt, a considerable rating strength.’

The agency also underlined that Macau’s external finances are equally robust, with the city being a large net external creditor (253 per cent of GDP) and holding considerable sovereign net foreign assets (180 per cent of GDP), both well above the ‘AA’ median and in the top 10 among Fitch-rated sovereigns.

‘We expect the current account surplus to exceed 30 per cent of GDP throughout 2019-2021, a metric high by any comparison,’ the company added.