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A construction site in Beijing. The authorities on the mainland have taken a series of measures to try to rein in soaring property prices. Photo: EPA

Hong Kong, China most at risk of financial crisis within next three years, bank warns

Over 40 out of 60 economic indicators suggest crisis is coming, including soaring debt and property prices, reports says

Hong Kong and mainland China are the most vulnerable economies at risk of a financial crisis over the next three years as over 40 out of 60 economic indicators are sending alarm signals, including runaway property prices and soaring levels of private debt, according to an investment bank report.

Emerging markets are more at risk of a financial crisis than developed countries and Asia – excluding Japan – is the region most at risk, led by Hong Kong and mainland China, the Nomura report said.

A slew of “early warning indicators” signal a crisis within the next 12 quarters, it said.

“Twenty years on from the Asian financial crisis, the region is once again vulnerable, but the financial stress points are more domestic,” analysts Rob Subbaraman and Michael Loo wrote in the report.

The Asian financial crisis started in Thailand in July 1997 with the collapse in the value of its currency and spread throughout Asia.

Many economists believe Asia is more resilient to shocks in the financial system now because many countries in the region have more flexible exchange rate policies, their current account deficits have turned to surpluses and foreign reserves have increased, but the Nomura analysts are among the few flagging the dangers.

The report released on Wednesday said the various indicators have reliably signalled at least two-thirds of the past 50 financial crisis in a sample of 30 countries with data going back to the early 1990s.

The indicators include ratios of private credit to gross domestic product (GDP), private debt to service ratios, effective exchange rates and property and equity prices.
Pedestrians walking past tower blocks in Shek Tong Tsui in Hong Kong. Photo: AFP

“Both Hong Kong and mainland China have large credit and real property gaps,” the report said. “Because the Hong Kong dollar is linked to the US dollar, [interest rates are] also at risk of rising sharply were the Fed [US Federal Reserve] to accelerate its rate hike cycle.”

The Asian financial meltdown in 1997 touched off a six-year property slump in Hong Kong that shaved more than two-thirds off prices and saddled the city with a stagnant economy and deflation.

The kind of property buying fervour that preceded the last bust seems to have returned.

Property prices are at record levels in the world’s most expensive housing market, mortgage borrowing is booming, developers are bidding up the cost of land to new records and people young and old, including from mainland China, are lining up to buy newly-built apartments.

“Studies of past financial crises show that they are more likely to occur when there are parallel credit and property market booms. As in 1996, this is the case in several Asian countries today,” the Nomura analysts wrote.

Private credit in mainland China accounted for 211 per cent of China’s gross domestic product in 2016, up from the 90 per cent in 1996.
A construction site in the centre of Beijing. Photo: AFP

Soaring property prices have forced people to borrow more. China’s household debt as a proportion of GDP has more than doubled to 40.7 per cent in less than 10 years.

While developed nations have higher rates of household debt, Chinese families are much more leveraged because incomes are lower.

The country’s total debt rose from 157 per cent of GDP in 2008 to 260 per cent last year and is still rising. Moody’s downgraded China’s sovereign debt rating in May for the first time in almost 30 years.

While China acted like an economic stabiliser in the 1997 financial crisis by depleting foreign reserves to safeguard the yuan’s exchange rate, it could become a source of instability as Asia is now more dependent on China’s economy. “The world’s second-largest economy, to which the rest of Asia is very exposed, is flashing several signs of vulnerability,” said the Nomura analysts.

“Whether China is willing to tolerate some short-term pain for long-term gain, by persevering with deleveraging, closing zombie companies and letting markets play a more decisive role, remains to be seen. The one thing that is clear is that the longer China delays, the bigger the risk of disruptive adjustments from which the contagion to the rest of Asia could be substantial.”

Fitch Ratings analysts Stephen Schwartz and Dan Martin said in a report published earlier this month, however, that Asia was more resilient to financial shocks compared with 20 years ago.

The risks of an outright crisis were mitigated by several factors, including China’s relatively closed capital account. “Nevertheless, a sharp slowdown in China is one of the biggest risks to the rest of the region,” they wrote.

Yuan Gangming, an economics professor at Beijing’s Tsinghua University, said a crisis was unlikely to occur in Hong Kong or mainland China because Chinese people would strive to repay bank loans, even though it might take several generations to pay them off.

“The private debt level may be intolerable in Western countries, but the situation is quite different here,” Yuan said. “The property bubble will not burst, at least in the coming three years in Hong Kong and Beijing, as governments will not sit and watch it collapse.”

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This article appeared in the South China Morning Post print edition as: Early warning signs of danger
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