19 February 2019
Interest rates will be rising at the peak of Hong Kong’s property cycle. Photo: Bloomberg
Interest rates will be rising at the peak of Hong Kong’s property cycle. Photo: Bloomberg

If you think HK can weather the US rate hikes, think again

Most analysts believe that Hong Kong can weather the series of interest rate hikes in the United States in the coming two years just like it did in the last Federal Reserve tightening cycle when rates were raised by 425 basis points between 2004 and 2006.

After all, liquidity in the Hong Kong system has been ample; Hong Kong banks have robust balance sheets.

Meanwhile, the US is only expected to raise interest rates slowly over the next two years; it is not expected to hike as much this time around as it did in the 2004-06 cycle, thanks to the lack of inflationary pressures.

All seems well, but in fact it may be not. First and foremost, the strong Hong Kong dollar has been eroding the city’s cost competitiveness.

In addition to hurting exports, a robust currency also leads to a significant diversion of tourists to cheaper locations. This will hurt growth and force domestic prices to adjust downward.

On the back of a strong currency, higher interest rates will be an added economic headwind in the coming year. With the US Fed finally beginning its interest rate normalization process this week, it is a matter of time for commercial interest rates in Hong Kong to follow suit.

Some may draw a parallel positive lesson from the 2004-06 US tightening cycle, when Hong Kong weathered its impact without major problems.

Such a comparison, however, misses the point completely: Hong Kong is entering the current Fed rate hike cycle with record high leverage, sluggish GDP growth and at the peak of the property market cycle.

Hong Kong’s private sector debt is currently more than 200 percent of the GDP, significantly larger than the 130 percent in 2004.

Such a high debt stock means that even a gradual uptick in interest rates will cause the debt service burden to increase meaningfully, albeit slowly.

The sad fact is that Hong Kong’s debt service burden has been rising since 2013 on the large stock of debt alone, despite ultra-low interest rate levels.

Higher interest rates in 2016-17 will certainly push the debt service burden even higher.

But how high, you may ask?

According to my estimation, even if the US Fed only raises rates by 225 basis points in the coming two years, which would be about half the total rate hikes by the Fed in the last cycle and more benign than the average market’s expectation today, debt service burden in Hong Kong could swell to 22 percent of GDP by end-2017, the highest since 1999.

More broadly, interest rates will be rising in an environment where the Hong Kong economy is entering a downturn. Growth in Hong Kong has been weak and decoupled from the US in the current cycle, in contrast to 2004-06 when growth was robust and in sync with that of the US.

Real GDP growth in Hong Kong averaged a strong 8.0 percent year on year in the 2004-06 period. But it has been growing by an average of only 2.5 percent year on year since 2014.

Furthermore, interest rates will be rising at the peak of Hong Kong’s property cycle, potentially reinforcing the downward adjustment in property prices that has already been underway recently.

But in the 2004-06 period, data shows that Hong Kong’s property market was recovering from a cyclical downturn.

The only bright spot in the Hong Kong economy has been consumer spending, which has remained resilient so far this year, driven in part by the positive wealth effects from rising property prices.

However, this is going to change soon as property prices enter a correction, with analysts expecting a drop of 10 to 30 percent in the coming year.

Recent official data shows that resident consumption growth in Hong Kong had already slowed to 3.4 percent year on year in the third quarter of this year from an average 5.1 per cent year on year in the first half of the year.

The expected decline in property prices will create a negative wealth effect on consumption in the coming year.

All this conjures a weaker labor market outlook. Together with higher debt service burden, weak exports and decline in tourism, private consumption looks set to weaken further.

In fact, market expectation on private consumption growth has been revised down to below 2 percent for 2016 from the previous estimate of 4.5 percent.

The point is that even very gradual rate hikes will hurt Hong Kong under these circumstances.

This view on the US rate hike impact on Hong Kong may be out of consensus at this point. Time will tell if consensus will move out to catch up with my view.

– Contact us at [email protected]


Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”

EJI Weekly Newsletter

Please click here to unsubscribe