HK caught between investors' greed and policy-makers' fear
Fears of a double-dip recession haunt investors in developed markets around the world. But here in Hong Kong, our policy-makers are suffering from the opposite anxiety: that economic and financial conditions in the city are getting too hot for comfort.
There is no shortage of evidence that the temperature is rising. Data published last week showed that Hong Kong's retail sales were up by a thumping 19 per cent in July compared with the year before, thanks in part to a 40 per cent rise in the number of mainland tourists visiting the city.
Meanwhile, survey results released on Wednesday showed that Hong Kong's purchasing managers' index - a key leading indicator of activity levels - was well above its trend level in August, with orders, prices, backlogs and staff costs all rising.
And just in case anyone was in danger of forgetting the extent to which Hong Kong's economy is being propelled by surging property prices, on Tuesday developer Kerry Properties outbid 15 rivals at a government land auction to pay a record HK$16,587 per square foot for a residential plot in Kowloon Tong.
The record price emphasised just how difficult the government will find it to cool the property market. Last week, the Centa-City leading index of home prices climbed to 83.61 - its highest since 1997 and up more than 150 per cent from the market's 2003 low - despite a series of tightening measures introduced in August (see the first chart).
The reason property prices have remained so buoyant is simple enough. With central banks around the world keeping interest rates low and continuing to print money in an attempt to support economic recovery, Hong Kong remains awash with liquidity.
According to Morgan Stanley, Hong Kong's financial system saw net inflows worth HK$79 billion in July, thanks largely to renewed interest in the prospect of yuan appreciation.
As a result, despite strong credit growth (see the second chart), loan-deposit ratios in the banking sector actually fell in July, which helped ensure that competition to lend remained strong and market interest rates stayed low.
That pushed the one-month Hibor rate back to 0.16 per cent from 0.52 per cent at the end of June. With almost 90 per cent of mortgages now priced against Hibor rather than the less volatile prime lending rate, the renewed fall has ensured that monthly mortgage service payments remain attractively affordable despite the recent increase in property prices.
Yet if plentiful liquidity and low interest rates have supported property prices, they have done surprisingly little for share prices in recent months. So far this year, the Hang Seng Index has fallen by a little over 4 per cent.
That may be about to change. Following a strong first-half earnings season, analysts have been racing to upgrade their corporate profit forecasts for both 2010 and 2011. Those upgrades have left the stock market looking relatively cheap, prompting Morgan Stanley strategists Jerry Lou and Corey Ng to predict that the Hang Seng Index will surge by 25 per cent before the end of the year to more than 26,000 points.
That forecast may well be overly bullish. Even so, with fears of a hard landing for the mainland economy receding, at least for the time being, any rise in expectations of yuan appreciation could see a significant increase in investors' risk appetite and an abrupt upward re-rating of Hong Kong equity prices.
That of course would make Hong Kong's policy-makers even more nervous about overheating. Rising stock prices and increasing risk appetites would only encourage fresh capital inflows into the Hong Kong market, further lifting liquidity levels and weighing on interest rates, which in turn would tend to push property prices even higher.
With no ability to raise interest rates to check the boom, the Hong Kong Monetary Authority would be likely to resort to additional counter-cyclical administrative restrictions in order to contain the amount of leverage in the banking system.
As HKMA researchers explained in June, in an asset-price boom and bust, 'the severity of fallout on the real economy depends very much on whether or not a banking crisis is triggered, and it is the economic and financial consequences of the crisis that should be the more relevant focus of policymakers, not whether asset bubbles exist'.
In other words, the HKMA is determined to be safe rather than sorry. It is not going to spend time debating whether rising stock and property prices are symptoms of a developing bubble or not. Instead, it is resolved to take pre-emptive action to reduce the banking system's exposure to rising asset prices, just in case there is a bubble.
We saw the first signs of that resolve last month when the HKMA reduced the permitted loan-value ratios for mortgages on luxury and investment properties and imposed a ceiling on mortgage service payments as a proportion of homebuyers' incomes.
How effective those measures will be at cooling prices remains to be seen. But if asset prices continue to climb, it is likely the HKMA will introduce further counter-cyclical tightening measures, possibly by further reducing permitted loan-value ratios or by raising bank capital requirements.
It is said that financial markets are locked in an eternal battle between greed and fear. Well in the case of Hong Kong, it is likely the battle to be fought out over coming months will be between investors' greed for higher returns and policy-makers' fear of overheating.
It will be interesting to see which proves the stronger.
