Too early to bail out yet?

THE recent enemy of the Hong Kong stock market is not interest rates, even though this is the current focus of investor attention.

A bigger threat is the relatively high cost of blue chips, following last year's 116 per cent rise, the highest on record since the 147 per cent increase in 1972.

The risk of China suffering a crash landing later this year, in line with the boom-bust cycle of the mainland economy, also poses a serious threat to the market.

Hong Kong's property prices are also reaching risky levels.

A sharp correction could occur, causing deflation, rather than inflation to engulf the territory, and hurting companies and individuals stuck with assets bought at record prices.

If things go wrong, investors may blame interest rates, but this is not the basic problem.

Local interest rates are tied to those in the United States and it is unlikely that US authorities will need to push rates up to painful levels in 1994.

In the US, inflation remains a minor problem at three per cent because companies still lack the ability to increase prices.

What is important is that interest rates are no longer declining, at a time when neither Hong Kong shares nor local real estate are cheap.

Furthermore, there is a risk that China could end up with a currency crisis and an out-of-control inflation rate, perhaps late this year.

This risk arises from Beijing's inclination to continue fast-growth policies in the face of such problems as high inflation, a deteriorating trade balance and infrastructural bottlenecks.

The failing health of Deng Xiaoping introduces additional uncertainty.

In the face of all these risks, interest rates could be the Hong Kong market's friend, rather than enemy, this year.

It seems unlikely that the prime rate, currently 6.5 per cent, would need to be raised above 7.5 per cent this year.

In that case, real interest rates would remain negative, since local inflation is at about nine per cent.

Such a situation may well help the Hong Kong market to overcome its other problems, prolonging the bull run.

Investors should become increasingly cautious, but it may be too early to bail out of the Hong Kong market.

Cheah Cheng Hye is managing director of Value Partners Ltd