Fitch cites Hong Kong's increasing closeness to China as a reason for rating downgrade

• Ratings agency Fitch lowered Hong Kong's sovereign rating from AA to AA- with a stable outlook.
• The move was the agency's second downgrade of the city's rating in less than a year, and places Hong Kong just one notch above mainland China's A+ with a stable outlook.
• The linkages between Hong Kong and mainland China "economically, financially and from a sociopolitical perspective have continued to gradually rise over time," noted Andrew Fennell, senior director of APAC sovereigns at Fitch Ratings.

A woman wearing protective mask in Hong Kong.

Anthony Kwan l Getty Images

Hong Kong's increasing linkages to mainland China was a reason behind the downgrade of its credit rating by Fitch Ratings.

The ratings agency on Monday lowered Hong Kong's sovereign rating from AA to AA- with a stable outlook. The move was Fitch's second downgrade of the city's rating in less than a year, and places Hong Kong just one notch above mainland China's A+ rating with a stable outlook.

The linkages between Hong Kong and mainland China "economically, financially and from a sociopolitical perspective have continued to gradually rise over time," noted Andrew Fennell, senior director of Asia-Pacific sovereigns at Fitch Ratings.

"So, as a ratings agency, in thinking about where Hong Kong should sit in the rating relative to mainland China, we thought that that gradual integration means the ratings should be closer together," he told CNBC's "Capital Connection" on Wednesday.

"Now the ratings are just one notch apart and I think that makes sense ... because Hong Kong still does have some institutional differences with that of mainland China and in particular what we think is relevant is that it continues to maintain an open capital account, has its own currency, it independently manages its fiscal and external account," he added.

The Hong Kong government said in a statement on Monday that it was disappointed with Fitch's decision to downgrade its credit rating.

"The decision reflects a disproportionate emphasis on prevailing socio-political issues without giving due recognition to the strong fundamentals underpinning the local economy and financial market. The view that Hong Kong's rising economic and financial ties with the Mainland is credit negative is also ungrounded," the statement read.

Hong Kong could fall into a deeper recession

Economically, Hong Kong was at a weaker "starting point" before the hit from the ongoing coronavirus pandemic, said Fennell.

The Asian financial hub's economy was already in recession last year following widespread protests sparked by proposed changes to a law that would have allowed extradition to mainland China. Those protests dragged on for months and later morphed into broader anti-government demonstrations that sometimes turned violent, which badly damaged the city's image and businesses.

... this is the second major economic shock that Hong Kong is experiencing just in a matter of the last 12 months.

Andrew Fennell

senior director of Asia-Pacific sovereigns at Fitch Ratings

The months-long unrests were behind earlier downgrades in Hong Kong's sovereign ratings by both Fitch and Moody's.

For 2020, Fitch forecasts the Hong Kong economy to shrink by 5%.

"It's important to remember that the Covid-19 pandemic is inflicting economic shocks and reverberations across all of the world," said Fennell.

"However, Hong Kong is a bit of a different starting point because of the social unrest that it experienced last year, and so this is the second major economic shock that Hong Kong is experiencing just in a matter of the last 12 months."