Author: Mei Ling Tan

Hong Kong is bracing for greater economic challenges as the prospect of a new cycle of interest rate rises drives fears of capital outflows that could put further pressure on the Asian financial hub.

Hong Kong’s property market, which has seen prices more than double since 2008, had already slowed in anticipation of a local rate hike, and analysts say a further slowdown will depend on China, which is facing its weakest growth in 25 years.

The city’s central bank on Thursday raised the base rate it charges through its overnight discount window to a seven-year high of 0.75%, tracking a decision by the US Federal Reserve to raise the range of its main rate by a quarter point, its first move in nearly a decade.

The Hong Kong dollar’s peg to the US dollar means the city’s monetary policy follows that of the Fed, which said in its statement on Wednesday it expects a gradual tightening cycle.

Norman Chan, the chief executive of the Hong Kong Monetary Authority (HKMA), warned of gradual capital outflows as hot money that had flowed in due to loose monetary policy exits.

“I would advise members of the public to make necessary preparations in terms of managing the credit, liquidity and other relevant risks in order to cope with possible shocks and adjustments that may arise from the normalisation of US and Hong Kong interest rates,” Chan said after the policy decision Thursday.

And although the immediate impact of policy tightening is likely to be limited, it comes at an increasingly uncertain time for Hong Kong, which is grappling with sluggish economic growth on the back of a slump in tourism and retail spending, as well as a slowdown in China.

About US$130 billion has flowed into Hong Kong dollar assets since 2008, when the Fed adopted its near-zero rate policy, according to the HKMA.

Hong Kong property sales slid 41.7% in November year-on-year to a record low, while the city’s property stock sub-index has dropped about 20% from multi-year highs hit in June. The index was up 0.8% early on Thursday.

Financial Secretary John Tsang, who last week flagged a rate hike as the biggest concern for the city’s economy, said Hong Kong had the ability to cope with large capital outflows, echoing a report from the International Monetary Fund this week that said risks were manageable.

“Whether Hong Kong will experience capital outflows next year depends not only on the pace of rate hikes by the Fed, but also China’s economy,” said Raymond Yeung at ANZ in Hong Kong, adding the property market faces some pressure in the medium term.

Commercial banks in Hong Kong will decide separately whether to increase their lending or deposit rates.

Any increase in rates could add to the city’s household debt to gross domestic product (GDP) ratio, which is already at a record high of around 64%, as repayment obligations rise.

For homeowners, it could also mean leaner times in a city where the average house price is 17 times household income, according to consultancy Demographia.

While the city has successfully weathered previous US rate hikes, Hong Kong’s economy is now more vulnerable as it struggles with weaker retail sales as fewer cash-rich mainland tourists stream across the border on shopping sprees.

Though policymakers have faced a growing chorus of criticism on the burden of holding a currency peg to the greenback, the government reiterated on Thursday that a peg is the best policy option for the city’s mercantile economy.

Expectations are the city’s economy will expand at 2%-3% rates in the current year, far below the heady rates of nearly 8% seen in the first quarter of 2011.

Some observers said the property market was still a concern.

“The key problem with Hong Kong right now is that (property) prices are already well ahead of earnings power and the economic situation,” said Nicole Wong, property analyst at CLSA.