HKMA chief's concerns sound like a massive understatement

If the US tapers its quantitative easing, the outflow of cash from the city could have a far greater impact than Norman Chan warns

PUBLISHED : Monday, 09 September, 2013, 12:00am
UPDATED : Monday, 09 September, 2013, 3:44am

Hong Kong Monetary Authority boss Norman Chan is a worried man.

On Friday he warned that Hong Kong's financial markets will suffer heightened volatility when the US Federal Reserve begins to scale back, or taper, its current programme of quantitative monetary easing.

Some HK$100 billion in liquidity has flowed into the city's banking system since the outbreak of the 2008 financial crisis, Chan said. When the US monetary cycle turns, that money will "inevitably" begin to flow out again, putting pressure on local asset prices.

"The market is filled with uncertainties and the investment environment is quite complicated," he commented.

You certainly can't accuse the Chan of scaremongering. If anything, he is playing down the scale of the potential outflows.

As head of the HKMA, Chan ought to have reliable numbers at his fingertips. But that figure of HK$100 billion in inflows he cited really does look like a gross understatement.

Between the summer of 2008 and the first quarter of this year, torrents of liquidity cascaded into Hong Kong. As a result, the banking system's aggregate balance - essentially its spare cash on deposit at the HKMA - has climbed from HK$5 billion to HK$164 billion; an increase of HK$159 billion.

But that's only part of the story. The HKMA has tried to mop up the inflows by massively stepping up the rate at which it issues exchange fund bills and notes. Add that issuance into the picture, and you find Hong Kong's overall monetary base has expanded by over HK$900 billion.

However, even that number doesn't capture the magnitude of the inflows. Analysts at Morgan Stanley also factor in the additional accumulation of the banking system's net domestic liabilities , which gives total liquidity inflows over the past five years of more than HK$1 trillion - 10 times the amount Chan cited last week.

Other methods give even more eye-popping sums. Using balance of payments data for portfolio investment flows, analysts at Goldman Sachs estimate that between 2010 and 2012 Hong Kong saw cumulative foreign inflows of HK$200 billion into the local bond market alone.

A further HK$390 billion flowed into Hong Kong's equity market. On top of that, they note that numbers from the Bank for International Settlements show an enormous HK$1.3 trillion of inflows in the form of cross-border loans.

As a result, Goldman estimates that total cumulative capital inflows into Hong Kong from 2010 to 2012 hit HK$1.89 trillion.

To put that amount into perspective, it's 50 per cent greater than capital inflows into India over the same period, and more money than flowed into either Australia or Brazil, despite those countries' mining investment booms.

Even if we take the lower estimate based on local banking system liquidity, it is clear that Hong Kong's asset prices will be highly vulnerable to any reversal in capital flows prompted by changes in US monetary policy.

Most exposed are local property prices, which have doubled with the doubling of the city's monetary base (see the second chart). Sizeable outflows now are likely to trigger a deep correction.

It may already be happening. As expectations of tapering have mounted over recent months, Hong Kong's monetary base has shrunk by almost HK$180 billion, and residential property prices have slipped by some 2.5 per cent from their March high.

Happily, the outlook is not entirely grim. Even if tapering does begin soon, it is likely to be a gradual process.

And there is the prospect that any further relaxation of China's yuan controls is likely to trigger inflows from the mainland that could cushion the ebbing tide of international capital.

Even so, you have to conclude that the mild concern Chan voiced last week sounded like a masterpiece of official understatement.