OREANDA-NEWS. Macao's 2Q GDP quarter-on-quarter decline of 6.4%, following a 12.4% fall in 1Q, is a larger move than that factored into Fitch Ratings' forecast. Fitch expects Macao's economy to shrink by 16% year-on-year in real terms in 2015.The contraction underscores the risks to Macao's economy from its heavy reliance on gaming revenues from Chinese visitors, and its vulnerability to shifts in mainland government policy. Gaming revenues have begun to stabilise in recent months, but the potential remains for substantial shifts to our forecasts - both on the upside and downside - with the evolving economic and policy conditions in China.

Fitch expects Macao's gaming revenues to drop by about 30% in 2015, and the rapid pace of economic contraction thus far has been linked directly to the falling top line at casinos. The feedthrough to the broader domestic economy has been limited, though, as the impact has mostly been absorbed by casino operators through narrowing margins. All major casinos have nevertheless remained profitable, and unemployment has stayed low as hotels have sought to retain staff in advance of new casino resort openings in 2016-2017.

That said, there have been some signs that the domestic economy is beginning to slow. Household consumption and capital investment growth have fallen, albeit from a high base. Government has also announced measures to tighten spending, which will help to mitigate the impact on the fiscal account but may squeeze domestic demand. Risks are also growing to income growth and to Macao banks' loan growth, which could feed through to a further slowdown in the domestic property market.

Yet Fitch maintains a Stable Outlook on Macao's AA- rating, reflecting the territory's exceptionally strong sovereign balance sheet and external position. It has no debt liabilities, and retains fiscal reserves and accumulated surpluses in excess of 100% of GDP - enough to almost cover six years of expenditures at the 2015 level projected by government. This gives the territory significant policy space to accommodate a structural shift in the economy and support diversification away from the current reliance on VIP gaming. Notably, new resorts due to open on the Cotai strip in the next few years could boost mass-market arrivals to enhance Macao's attractiveness to a wider tourist market.

Furthermore, Macao's banking sector benefits from conservative underwriting standards, which supports asset quality and relatively healthy capitalisation. Institutional support from mainland Chinese parents in terms of capital, funding, and operations also provides a buffer to mitigate unexpected shocks.

Fitch expects gaming revenues to continue to stabilise in 2H15, but recovery could be slowed by a number of policy measures. These include a full smoking ban at casinos, restrictions on mainland visitor arrivals, and a continued slowdown in the Chinese economy. As such, there remains the potential for the outlook on Macao to change rapidly and significantly. An economic/policy scenario which could reduce Macao's vast fiscal reserves and weaken its balance-sheet buffer remains a tail risk.