Federal Reserve

Rate rise to prompt capital outflows from China and Hong Kong, say experts

Rise likely to lead to a stronger US dollar and weaker yuan, which will prompt more mainland Chinese to invest overseas

PUBLISHED : Thursday, 15 December, 2016, 8:35am
UPDATED : Tuesday, 03 July, 2018, 9:47pm

The US interest rate rise on Thursday is likely to lead to increased capital outflow from Hong Kong and the mainland, according to analysts.

Hong Kong Monetary Authority increased the official base rate by 25 basis points to 1 per cent on Thursday, just hours after the US Federal Reserve increased the benchmark funds rate by 25 basis points (bps) to a range between 0.50 per cent and 0.75 per cent – the first rate rise in a year.

Under the peg link system which means the Hong Kong dollar tracks the US dollar, the city needs to synchronise with any US interest rate movement.

“With the US interest rates now rising, it’s expected that some of the estimated US$130 billion of capital inflow into Hong Kong since 2008 will be exchanged back to the US dollar,” said the HKMA’s chief executive Norman Chan, during a press conference in Hong Kong today. “A capital outflow from Hong Kong is expected, and the Hong Kong dollar may trade at the weaker end of the peg at HK$7.85 per US dollar.”

Capital Link International chief executive Brett McGonegal believes there will be two to three more rate rises next year, which will lead to a strong US dollar against other currencies, including the yuan.

“The RMB will certainly be under more pressure from the strong dollar, but I’m not sure if we will see much more [movement] than we have seen recently,” McGonegal said.

For Hong Kong overall, he believes the rate rise will be negative, however.

“Money will become expensive, pushing property stocks lower and slowing transactions. I don’t like the look of the Hong Kong market over the next year. A tightening Fed is the wrong prescription for the current chill Hong Kong is feeling,” McGonegal said.

Marc Chandler, global head of currency strategy at Brown Brothers Harriman, said the US interest rate rises will mean the greenback will continue to strengthen against the yuan, pushing the Chinese currency to as low as 7.20 yuan/dollar by the end of next year, down 4 per cent from the 6.90 current level.

“Part of the outflow from China, especially the part that reflects the paying down of dollar debt, may continue,” Chandler said.

He said Beijing’s recent moves of adding capital controls, however, could help minimise the outflows.

The Chinese government last month carried out a number of measures to control the outflow.

They included a ban on mainlanders using credit cards to buy Hong Kong insurance products, and from the end of last month The People’s Bank of China also limited bank lending to the equivalent of 30 per cent of an applicant’s equity in an overseas firm in yuan.

The Chinese currency has fallen 7 per cent against the US dollar this year, after a drop of 5 per cent last year.

The devaluation has led to a wave of capital outflow by both individuals and companies to buy stocks, insurance policies, and other overseas investment products and assets.

China’s foreign reserves fell more than expected in November, by US$69 billion to US$3.052 trillion compared with US$3.121 trillion in October, according to government statistics.

It marked the largest monthly decline since January and was similar to the average monthly reduction of US$70.1 billion from August to January.

A Morgan Stanley report estimates that around 70 per cent of the drop was due to the falling value of the yuan against the dollar, following the US presidential election. Excluding valuation effects, foreign reserves still declined by US$21 billion in November, compared with a fall of US$9 billion in October, Morgan Stanley said.

Mark Konyn, group chief investment officer at AIA Group, said Beijing is likely to add further controls next year to limit the outflow, and stop the rapid depreciation in the yuan.

“Rather than allowing a significant exchange rate adjustment to deter the potential outflow, the authorities have sought a combination of exchange rate support and additional capital controls,” Konyn said.

“These conditions are likely to prevail as we go into 2017, although will fall short in terms of overall effectiveness.”

Stephen Innes, a senior trader at Oanda, however, said the government measures would not halt the capital outflow.

“With the US dollar expected to strengthen into the year end, the feedback loop will accelerate as the PBOC continues to burn through reserves to stem the tide.

These conditions are likely to prevail as we go into 2017, although will fall short in terms of overall effectiveness
Mark Konyn, group chief investment officer at AIA Group

“Moreover, I suspect the recent measures to curb loopholes in capital outflow will not turn the tide for depreciating yuan. These capital controls will likely accelerate in 2017,” Innes said.

Ken Wong, Asia equity portfolio specialist at Eastspring Investments, said the interest rate rise would not only lead to capital outflow from China, but also from Hong Kong.

“If the Fed raises interest rates faster than market consensus of two rises in 2017, then there is no doubt Hong Kong could also see pressure with capital outflows,” Wong said

“Just look at the 1-month HIBOR [Hong Kong interbank offer] rate, it’s gone from 0.36 per cent before the US elections to now 0.62 per cent in a little over a month.

“With the unexpected strengthening of the US dollar and acceleration of interest rate rises in the US, capital could start to flow out of Hong Kong and that could have a major impact for its financial sector,” Wong said.

While Wong believes the yuan will face pressure, he considers worries surrounding a significant RMB devaluation have probably been overdone.

“The Chinese authorities seem to be pursuing currency and market policies that promote stability. The RMB is now included in the International Monetary Fund’s Special Drawing Rights and given China’s economy is still able to maintain over 6 per cent GDP growth, long-term investors in China shouldn’t have too much to fear about significant RMB weakness,” Wong said.

Edmund Yun, head of investment solutions at CIC Investor Services, believes there will be three more rate hikes next year, but that the next won’t be until June.

“Although the RMB has continued its weakening trend against the US dollar following the US election, it has in fact appreciated against the euro and the Japanese yen, as recent economic data from China has shown there are some improvement in economic growth,” Yun said.

“Looking forward, we believe the RMB will probably continue to weaken against the US dollar but on a more gradual basis, probably in line with other major currencies such as the euro or yen. We may see RMB to surpass 7.0 to the dollar within 2017,” Yun said.