Hong Kong Property: The Impact Of China’s Tightening26 March, 2011, 23:53. Posted by Zarathustra
Tags: Economy, Hong Kong, Real Estate
Since the Japan’s earthquake hit on 11 March 2011 and I subsequently call the “beginning of the end” of the Hong Kong property bull cycle, sentiment has deteriorated somewhat. Fear not, this is not the end (in a Churchillian tone). It’s just the beginning of the end.
I have repeatedly said that Hong Kong property prices are driven by money flow. The reason for low interest rates is that money flowing into the banking system, increasing the money supply (because of the linked exchange rate system, capital flow can only be adjusted through money supply, not exchange rate), making the interest rates low. The interest rates in the United States can be totally irrelevant to interest rates in Hong Kong, so we should never look only to the United States when we try to predict what is going to happen in Hong Kong.
I set out a few possible scenarios on how capital flow will be unfavourable for Hong Kong property earlier this year in my forecast. I put quite some emphasis on the impact of monetary tightening on China and Hong Kong real estate market, and on the possibility that Chinese buyers retreat from the market:
Although it is commonly assumed that Chinese Yuan appreciation will be good for Hong Kong property because home prices in Hong Kong will look cheaper and inflation in Hong Kong will be higher, there is also a downside for this argument. Chinese Yuan appreciation is essentially a tightening policy from the Chinese perspective. If, together with more interest rate hikes and reserve requirement ratio increases, economic growth in China will slow, and there will be a danger that the Chinese property bubble is going to burst. Even though it is in the Chinese government interest not to create a recession in China, when it comes to moderating economic activities, no government can claim to be omnipotent. If tightening in China continues, there might be a real possibility of a spill over to Hong Kong property market.
Now we are finally seeing some impact from the China’s tightening (although still very mild at the moment). Sources told me that there is an increasing demand for loans from Chinese companies because credit is “very tight” in China. Actually, we know that very well: real estate developers in China have been unable to raise money from the Chinese banking system, forcing some big Chinese real estate developers to raise capital from the debt market in Hong Kong. Looking at my list compiled previously on the cost of borrowing by Chinese real estate developers, you should realise how lucrative it is for banks to lend money to Chinese real estate developers instead of Hong Kong households, who could borrow money at as little as 1% of interest rate to buy a flat. And as it turns out, that happens for Chinese companies across various sectors (and we have got the confirmation from some really senior bankers in Hong Kong).
We can look a bit further into the history to see how an aggressive tightening in China may have an impact on Hong Kong. Previously I have briefly investigated the first real estate bubble in communist China, which came to an end in 1994 after the government implement aggressive monetary tightening in the second half of 1993. The burst of the first real estate bubble in communist China led to large number of unfinished buildings as real estate developers failed.
The side-effect of that round of tightening was, interestingly, a slowdown of the economy in Hong Kong, and a correction of Hong Kong property market. If you look at the chart of Hong Kong property prices, it is clear that Hong Kong property prices peaked in early 1994. Stricter government intervention aside (and you should be reminded that government measures are generally useless), both China and the United States were tightening their monetary policy in 1994. As I mentioned before, China started tightening its policy in the second half of 1993 to curb inflation and stop speculations in real estate bubble. At the same time, interest rates in the United States also increased since 1994.
Some has suggested that the macroeconomic regulation in China had a large role to play for the 1994-1995 property market correction, but the exact mechanism of how the tightening in China back then spill over to Hong Kong was not very well documented, and it is hard to tell whether China or US had the larger role to play. But the result is clear: interest rates in Hong Kong rose since early 1994, and the economy slowed down.
Source: Centaline, HKMA
Source: Census and Statistics Department
Of course, we should be aware that the situation now is not entirely comparable: monetary policy in the United States will still be loose for the time being, which is a good news for now. But the economic link between China and Hong Kong is now much closer than more than a decade ago, which suggests that any tightening in China will have a greater impact now than it had 16 years ago.
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