As a premier Asian financial center parked at the doorstep of one of the fastest-growing economies on the planet, Hong Kong has long lived a charmed life.
The former British colony’s western-style legal and regulatory system made it a magnet for global investors interested in buying listed Chinese stocks on the Hong Kong Stock Exchange. Its banks, insurance companies, ports and cargo carriers have made a nice living off their powerful neighbor. An added bonus: Since 2008, low global interest rates in the post-financial crisis era have powered a property market that has kept the $300 billion economy humming, Bloomberg reported.
Yet now China’s economy is decelerating and just turned in its weakest full-year economic growth since 1990. Global investors are no longer gravitating to Hong Kong—they’re scrambling for the exits.
The Hang Seng Index has slumped 13% so far this year. Housing prices have fallen 8% from their September peak and are poised to drop as much as 30% this year, according to Bocom International Holdings Co. analyst Alfred Lau. The Hong Kong dollar peg is under pressure and short-term interest rates have spiked. Exports are falling and big-spending Chinese tourists are staying away.
“Hong Kong is facing a wave of pressure,” said Kevin Lai chief economist for Asia excluding Japan at Daiwa Capital Markets in Hong Kong, who likens the growing storm to the market gyrations of the Asian Financial Crisis. “The situation right now is potentially worse” than the regional turmoil in 1997 and 1998.
Lai is particularly concerned about the rapid credit expansion over the past five years as Chinese companies rushed to borrow in Hong Kong, leaving the city’s banks “massively leveraged and exposed.” Daiwa estimates that $237 billion in broad inflows has poured into Hong Kong since 2005.
For Hong Kong, the worst-case scenario could play out like this: A sustained dive in the Hang Seng Index and heavy downward pressure on the local dollar triggers a massive departure of capital, squeezing liquidity in the banking system and driving up interest rates. That in turn sparks a speculative attack on the local dollar peg, forcing the Hong Kong Monetary Authority to defend it by spending its foreign-currency reserves. Or abandon the peg altogether.
Capital flows out of Hong Kong appear to be accelerating. The Hong Kong dollar has traded at the lower side of its trading range against the US dollar, and recently touched a seven and a half year low versus the greenback. Local interest rates have also surged: The 3-month Hong Kong Interbank Offered Rate has jumped 30 basis points to 0.69 since the end of last year, exceeding the London Interbank Offered Rate on Jan. 20.
A sustained spike in HIBOR could push mortgage rates higher, further hurting housing affordability, Morgan Stanley analysts led by Derrick Y. Kam wrote in a note. The bank said it cut its price targets for Hong Kong property stocks by an average of 17%.
