OREANDA-NEWS. The defeat of a proposed new electoral system in Hong Kong's Legislative Council is the latest stage in an intense political debate over the structure of chief executive elections in the territory. The ongoing debate, although heated, does not present near-term risks to Hong Kong's sovereign rating, says Fitch Ratings.

The proposed system failed to gain the necessary two-thirds majority in Thursday's vote. Opponents had attacked the proposal - based on universal suffrage but requiring candidates to get majority backing from a 1,200-strong nominating committee - as anti-democratic.

Fitch views the debate over how to select the territory's chief executive in 2017 as secondary in importance - from a sovereign credit perspective - to broader economic and financial factors. Last year's protests could recur, and are estimated to have involved more than 100,000 pro-democracy and pro-establishment participants. But the protests were not sustained or sufficiently disruptive to inflict lasting damage on the economy.

Greater economic vulnerabilities stem from the Hong Kong banking system's rising exposures to mainland China; potential demand shocks; and US monetary tightening. Rising trade and financial links with the mainland bring economic and macro-prudential risks alongside their benefits. Hong Kong banks' gross mainland China exposure (MCE) was USD869bn at end-2014, or around 300% of GDP. China's stop-start move towards less credit-driven growth is not without risks, as the authorities attempt to unwind the debt and property booms of 2009-2014.

Hong Kong, being a small, open economy, is exposed to lacklustre external demand globally as well as the slowdown in China's growth to below 7.0%. Weak external demand contributed to Hong Kong real GDP growth edging down to 2.1% in 1Q15, from 2.4% in the preceding quarter. Spill-over from Fed tightening (which we expect by year-end, and which Hong Kong would import via the currency board regime) may dampen growth further.

Hong Kong's sovereign credit profile is cushioned from China risk and potential growth shocks by its resilient and flexible economy, high income levels, and strong public and external finances (including fiscal reserves amounting to 36% of GDP and a large net international investment surplus equivalent to 285% of GDP). Hong Kong's economy and credit profile benefit from institutional strengths, including the rule of law and strong core public institutions. The balance of risks and buffers is reflected in Fitch's Stable Outlook on Hong Kong's 'AA+' sovereign rating.

The territory faces its share of longer-term issues, though. These include the impact of population ageing and provision of housing and infrastructure, as well as social questions connected with inequality and some perception of a rising "nativist" or anti-mainland sentiment. Social and political tensions could become more salient as a credit issue if they were to undermine the government's ability to draw up and implement policies to tackle Hong Kong's long-term economic challenges. Any erosion of the high standards of governance and favourable business environment would also be credit negative.