When you squeeze a balloon, you can never be sure where the bubble will pop out.
This is something like the uncertainty faced by investors, analysts and economists watching Hong Kong as the monetary authorities react against an apparent influx of “hot money”.
Click to enlarge
Banks, the stock market and property could all feel the effects of these inflows through inflated balance sheets or prices.
This is not yet happening, however, and the local government is also acting to prevent it happening in residential property. The question is not only about from where the hot money has come but also to where it has gone.
There is a related mystery, too, over the strength of capital outflows from China – a key source of hot money entering Hong Kong. Outflows appear to have been strong for much of the year but the signals used to judge this have gone into reverse.
“It’s always difficult to tell where hot money is coming from,” says Paul Tang, chief economist at BEA in Hong Kong. “But now it is much more likely to be from other markets, mainly the US and much less so from mainland China.”
First, the simple facts. The Hong Kong Monetary Authority has intervened five times in the space of two weeks to weaken the local currency, injecting HK$17bn and taking about US$2bn out of circulation. It said it expected net inflows to increase for some time.
Since the US Federal Reserve launched its third round of quantitative easing, the Hong Kong currency has strengthened. It is pegged to the US dollar at HK$7.8 and the HKMA must act if it hits either side of the trading band of HK$7.75 to HK$7.85.
Hong Kong is not alone in seeing strengthening pressure on its currency in the wake of QE3 – as the Fed action is known.
South Korea, Taiwan and other Asian countries have seen their currencies appreciate against the US dollar, while one way to view the October interest rate cut in Australia is that it was done to prevent another round of strengthening for the Aussie.
Hong Kong had similar issues during the first round of QE in the US in 2008-09. During that spell, the HKMA injected HK$650bn to hold down the exchange rate, many more times the amount spent so far in this round.
Back then, the cash injection was positive for the economy. There was a strong property market with a rising proportion of mainland buyers and strong Chinese corporate initial public offering activity in Hong Kong, which attracted international investment, say analysts at Citi.
There were also improving export markets as 2009 wore on and so good demand for corporate credit growth and trade finance. All of these things gave the hot money places to be usefully employed. Now things are much different.
In the stock market, an initial explosion of blocktrades and shares placings after QE3 led to almost $7bn worth of follow-on capital raisings or stakes changing hands in a range of listed companies. The Hang Seng rose almost 14 per cent by mid-October.
Investor fatigue set in before even the first decent-sized IPO could get
under way, however, and this week Fosun Pharmaceutical had a shocking debut. Also, market volumes have remained flat since QE3 against much of the rest of the year, suggesting no great leap in fund inflows.
In residential property, prices are up about 14 per cent this year. The government has instigated a 15 per cent stamp duty aimed at foreigners and speculators, partly designed to curb hot money flows.
But transaction volumes have been weak, according to Barclays analysts,
while the proportion of mainland buyers has been shrinking.
It is down from a peak of 42 per cent of new sales in the third quarter of last year to 23 per cent in the third quarter of this year, according to Credit Suisse analysts.
This may be slipping further. They note that in the recent sales of new blocks called Century Gateway and Kadoorie Hill, developers reported that mainlanders bought just 5 per cent and 10 per cent, respectively.
This trend runs counter to the view that there has been a wave of capital flight from China this year with estimates of $200bn-plus. It supports instead the view that companies on the mainland have been holding on to US dollars they have received in payments.
Either way, the pressure of funds flowing into Hong Kong from China does not look huge. The sharp rally in the renminbi against the US dollar suggests at the very least that less money may be seeping out of China.
So, the main area that could be seeing the money inflows then is Hong Kong’s banks, where deposits grew by 1.3 per cent, or about HK$99bn in September.
This though presents a problem, as analysts at Barclays note. Corporate credit demand is weakening, especially compared with 2008-09, while cross-border trade credit has weakened as mainland China interest rates have been cut and liquidity improved.
Furthermore, demand for mortgages is declining, with analysts at Citigroup pointing out that some Hong Kong banks have been increasing commissions to brokers to win more business.