Hang Seng Index

The reminders of 1997-98 get more and more scary

PUBLISHED : Friday, 21 November, 2008, 12:00am
UPDATED : Friday, 21 November, 2008, 12:00am

As Hong Kong's economy continues to deteriorate, parallels with conditions during the Asian crisis of 1997 and 1998 are becoming increasingly disturbing.

Not only have we slipped into recession, but the stock market is down, trade is slowing, the banks are getting increasingly reluctant to lend and job losses are mounting.

Then yesterday we had yet another reminder of 1997-98 when the government released consumer price index data for last month showing the annual inflation rate dipped to just 1.8 per cent.

On the face of it, the news seemed positive. After all it was only a few months ago that we were worried about rising prices, so a fall in inflation should appear to be a good thing.

But scratch beneath the surface and the picture is not so encouraging. According to the Census and Statistics Department, the actual level of the composite consumer price index came in at 108.1 last month, down from 110.9 in July, implying that prices in Hong Kong are now dropping.

Part of that decline is the result of government handouts earlier in the year. But even stripping out the effects of official largesse, inflation is fast disappearing from the economy as demand evaporates.

The fear now is that Hong Kong will once again slide into deflation, just as it did 10 years ago.

Inflation is nasty because it erodes the real values of people's incomes and savings. But deflation can be equally unpleasant, although in a different way.

If prices are falling, consumers tend to postpone big-ticket purchases. For companies, that means profits get harder to come by and debts more difficult to service. As a result, earnings drop, default rates go up and unemployment rises.

Even worse, because interest rates cannot go below zero, the real cost of borrowing gets more expensive, depressing corporate investment and further hammering consumer sentiment.

If you don't believe how grim it can get, just ask anyone who remembers 10 years ago.

Until now, most economists and investment analysts have dismissed comparisons with 10 years ago, arguing that this downturn will be shorter and not so deep.

They may be right. But although the causes of this slump are different, some of the effects are eerily similar.

That's not entirely discouraging.

The first of the two charts below compares the performance of the stock market now and then. The blue line shows the decline of the Hang Seng Index from its peak in August 1997 to its trough a year later. The red line depicts the Hang Seng's fall from its peak at the end of October last year to the present.

If this crisis were truly to mirror that one, then there would be reason to think that the worst of the stock market falls are already over and that this could be a good time to buy equities.

But don't get your hopes up. If parallels between today and 1997-1998 really were valid, then the implications for Hong Kong's property market would be disastrous.

Most analysts believe that falls in property prices this time around will be nothing like as severe as in 1997, explaining that then Hong Kong was at the height of a property bubble, while this time it is not.

The second chart below tells a different story. The blue line shows the performance of residential property prices over the whole cycle from 1992 to 2003, while the red line shows how prices have behaved since 2003.

The similarities are obvious. Between 1993 and the height of the market five years later, property prices rose by 123 per cent. From early 2003 to the peak of this cycle five years later, they climbed 132 per cent.

The trouble is that after its 1997 peak the property market fell by 69 per cent over the next six years. If the parallel with that cycle really is valid, it would imply that property prices could decline another 50 to 60 per cent from present levels.

Let's pray the comparison is spurious.