Real interest rates leave loan costs at high levels
Things are obviously beginning to turn for the better in Hong Kong again with the stock market rocketing upwards. But recession still has a firm grip on interest rates.
The problem is that falling interest rates alone are not enough to stimulate an economy. There must be opportunity for putting credit to work.
Look at it in simple terms. People may be willing to pay a 20 per cent interest rate if they think they can turn a 40 per cent gain on the money they have borrowed. They may be unwilling, however, to pay a 5 per cent interest rate if they think they can earn only 2 per cent.
The key variable for Hong Kong here is real interest rates, in other words the level at which interest rates stand if you deduct inflation from them. There is no problem paying 20 per cent borrowing costs for something if inflation will make it worth 40 per cent when you sell it again.
This happened in Hong Kong. For almost eight years until the beginning of last year, the three-month interbank rate was less than consumer price inflation, at one point almost 7 per cent less.
It happened because HK interest rates were closely tied to US rates through the peg to the greenback while consumer prices were not closely tied. With a booming property market Hong Kong's consumer price inflation rate soared well above its US equivalent.
These negative real interest rates in fact contributed to the property boom over the eight-year period. They encouraged property speculators to borrow money to punt the market.
However, real interest rates are now near record high levels. The link with US interest rates snapped last year when people became worried that the peg might not hold and HK rates then went up. They have since come down again as confidence has returned but meanwhile consumer price inflation has also dropped sharply. The difference still leaves real interest rates high.
They are even higher if, instead of using the consumer price index, one contrasts the three-month interbank rate with producer prices or export prices, both of which are declining in real terms. The latest export price figure, for instance, shows not inflation but deflation of 3.4 per cent.
On this measure the real interest rate for exporters in July was a prohibitive 13.1 per cent. It may be lower now and one can also argue that exporters benefit from falling import prices but it does not materially change the fact that real borrowing costs in Hong Kong have risen and are high by the standards of recent years.
This makes recovery difficult for a sluggish economy. It's all very well for a stock market to take heart from a slight shaving of lending rates but most people are still going to find that there is not much they can do with borrowed money to make more than their cost of funds.
It's particularly notable because interest rates have been falling faster than inflation in most other Asian countries outside of the mainland. Hong Kong's real interest rates are rising.
In much of the rest of Asia they have been declining since the beginning of the year.