• Thu
  • Jul 31, 2014
  • Updated: 11:36pm
Monitor
PUBLISHED : Thursday, 18 July, 2013, 12:00am
UPDATED : Thursday, 18 July, 2013, 4:17am

A property slump will affect the whole of Hong Kong's economy

Last week Monitor argued that the gradual tapering of quantitative easing and the eventual increase in American interest rates that will follow are likely to trigger a slump in Hong Kong property prices of 30 per cent or more.

That might sound like a good thing. Lots of families would like to buy. But with the minimum down-payment on a typical Hong Kong flat now equal to four years of median household income, many have been priced out of the market. To them, forecasts of a property slump are welcome.

But property prices do not fluctuate in isolation. In a city where the property market contributes a fifth of our gross domestic product, a big fall in prices will inevitably affect activity in all other sectors of Hong Kong's domestic economy.

First of all, a property bear market will erode consumer demand. With residential mortgage debt currently standing at 46 per cent of Hong Kong's GDP, a decline in the value of flats would have a big effect on household balance sheets.

For the hundreds of thousands of families paying off a mortgage on their flat, a fall in property prices would undermine the value of their assets relative to their liabilities, making them less inclined to go out and spend. That's not all. Falling property prices - and even the fear of falling property prices - will also affect the stock market, as the share prices of developers take a beating.

We've seen this factor at work recently. Even though home prices are up by 3 per cent over the last six months, the Hang Seng properties index of leading developers and landlords has dropped 15 per cent as investors anticipate falling profits over the next couple of years (see charts).

That hurts, because a weaker stock market makes investors feel less wealthy, adding to their reluctance to spend on big-ticket discretionary purchases.

Together, the direct impact of falling home prices and the indirect effect of a weak stock market can make a significant difference to consumer behaviour.

According to Marcella Chow at Bank of America Merrill Lynch, a 15 per cent decline in Hong Kong property prices relative to the prices of other goods and services knocks between 1 and 1.5 percentage points off the growth of private consumption spending.

A weak property market also hits investment. Most obviously, falling sale prices mean thinner margins for developers, which make investment in new construction projects less attractive.

But there is a second order effect, too. A softer property market weakens companies' balance sheets and chips away at banks' asset quality.

That makes companies nervous of investing, and banks less willing to lend to fund investments, especially in a city where the owners of small companies commonly put their own flats up as collateral against business loans.

Putting these two effects together, Chow estimates that a 15 per cent decline in the property market cuts private investment by almost 4 percentage points.

A decline in the value of flats would have a big effect on household balance sheets

On top of that, falling property prices eat into the revenues of the Hong Kong government, which both directly and indirectly relies on the property market for as much as a third of its income.

That shouldn't trouble officials too much, considering they have enough accumulated reserves to cover years of budget deficits.

Even so, the overall effect of a slump in the property market on Hong Kong's economy would be severe.

Chow is forecasting a 5 per cent decline in property prices this year, followed by a 15 per cent fall next year; a fall she expects to knock a full percentage point off the city's GDP growth in 2014, reducing it from 3.8 per cent to just 2.8 per cent.

So maybe a property market correction isn't such good news after all.

tom.holland@scmp.com

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Giwaffe
Ever since the property boom from the 1990s, economic growth has been substantially funded by credit (debt), which is very difficult to discern from non-credit funded economic booms.
The property market is a case in point. When prices are low, individuals can afford to purchase property with just their savings. As prices rise, individuals must begin to borrow as savings alone cannot fund the property purchase. As prices continue to rise, some individuals become unable to purchase property even with borrowing. Obviously, there will come a time when the aggregate borrowing capacity of the people of HK is reached and no one in HK will be able to afford to buy property. One could argue there are external capital flows, but this misses the point. More importantly, a high price property market will divert future earnings and savings away from investment and into debt servicing, which leads to future stagnation and decline. The perceived "gains" of today are really just smoke and mirrors down the road.
A scenario like this cannot possibly end well. What HK needs is a readjustment in the level of the property market so that future earnings/savings can be diverted away from debt servicing and into investment.
johnyuan
Banks are the beneficiary from mortgage payments – high yield and low risk. Absolutely no risk especially the mortgagees are Chinese (in Hong Kong) with a variable interest rate mortgage. It is just stating the fact. My social comment will be less polite. The bankers are using money to create more money which is just being a parasite diverting capitals away from productive work. LKS knows well, he once advised everyone not to indulge in property speculation because it is just a bowl of sugar balls in sugar soup -- all sugar and nothing else. The government should listen to Li and get Hong Kong off the property addiction. Do something more useful and productive.
caractacus
The thrust of this article is that the market should be manipulated so property prices do not fall.
This is precisely what the administrations of Tung Chi Wah and Donald Tsang did, resulting in the crazy property prices and rents we now see. Just how long do you think Hong Kong people can afford to pay massively inflated prices and rocketing rents for residences, shops and offices when their incomes cannot keep pace? By your logic within 10 years half the population will be working and sleeping on the street, while the fat developers and bankers look down on them from the Peak. Thank goodness the rotten Henry Tang was not elected, we might have seen the return of the Workhouse too.
As Dragon Eyes says, rent control did not cause the sky to fall.
maecheung
Tom...a lot of what you said has some truth to it....BUT I have to disagree with you on the consumer's spending. Most goods are made outside of HK, and any big item discretionary consumer spending goes to benefit other countries, for example, the purchase of an expensive BMW/Mercedes benefits Germany, cosmetics purchase goes to Japan/South Korea, so on and so forth. The only local real beneficiary is the Developers and the Big Landlord, who can raise the rent at their own will.
Giwaffe
@maecheung: Great point. The private consumption spending that leads to the most benefit for the HK economy is in the food, hospitality, and services industry. Discretionary item spending only benefits HK in that local workers are hired to sell those products since said products are manufactured abroad. Of course, landlords will always benefit from rent but in the aggregate they contribute a fraction of what they earn back into the economy. Landlords are regressive to an economy; the higher the level of rent or property value, the greater the barrier to new business formation and economic growth. Thus, landlords can only gain at everyone else’s expense. The more happy the landlords, the more unhappy the rest of society. Therefore, the best environment to foster sustainable economic growth is usually a minimally priced property market and minimal rent environment.
grouperm
@ Giwaffe. The comment "to foster sustainable economic growth is usually a minimally priced property market and minimal rent environment" is short sighted. Rents in a market-based economy such as HK are based on supply/demand. The only way you'd have minimal pricing power for a landlord is in locales where there is minimal demand and then what do you have? Detroit USA. So I ask, would you rather be in a economically and socially decaying monolithe or would you rather be in a dynamic city which has over the past over 100 years been at the center of world trade? Your answer will inevitably lead you to restate the cure for which ails the socio-economic imbalance in HK.
SpeakFreely
Disregard what happen Hk long term is only one direction, down.. Why? Aging population similar to Japan, complacent Hk people, finance center soon to be replaced as yuan will float soon, and 2049 is coming soon, what do u think china will do? Anyone worked in china before understands how china works. Don't you?
Giwaffe
Some great comments below! =)
Of course a drop in property values will reduce private discretionary spending, but this is only based on the rationale that a) people “feel wealthier/poorer” from perceived unrealized gains/losses on the value of their property and; b) borrowing against home equity to increase spending. Borrowing to increase consumption only works on the micro scale, but is actually unsustainable on a macro scale. Spending and investment should come from savings, not debt, otherwise the GDP increase from such spending and investment is only temporary.
I would also argue that any slowdown to GDP from a property readjustment would be temporary, and GDP would increase once consumer expectations had adjusted. Government revenues could be protected by diversification, such as through increasing property taxes. This would increase the carrying cost on property which in turn discourages speculation and distortion of the property market, a fundamental need such as food and education.
CY Tung had long term strategy vision. The property market was actually corrected to its historically reasonable levels at its lowest point back in 2003-2004 after SARS. It is unfortunate HK as a whole did not recognize this and work together to maintain that level. Otherwise, we would not be facing the multitude of social, economic, and structural ills that we face today.
maecheung
Blame this on "Bow Tie" and his collusion with "Superman" and other developers.
taihang
It's academic, QE won't be abandoned any time soon, and in any case there is the whole asset purchase program to wind up before you can start to think about higher interest rates. HK got addicted to the medicine without even having the disease, now it has to suffer the asset bubble side effects, and eventually it will suffer from the effects of misallocated capital once withdrawal happens.This peg sure is good stuff!

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