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By Don Weinland
16 Dec 2015
What’s another month – or 12 – for near-zero interest rates? Banks in Hong Kong must be asking the question on the eve of what is expected to be the US Federal Reserve’s first move in close to a decade to bring the world back to normal borrowing costs.
One early warning sign for banks is the patchy outlook equity strategists have on Hong Kong’s stock market, which is dominated by local lenders and real estate developers.
“We see Hong Kong as the most vulnerable in the region, essentially because of the way the Hang Seng Index is structured,” said Frank Benzimra, head of Asia equity strategy at Societe Generale.
About 25 per cent of the Hang Seng Index is composed of local banks and property developers, the firms most sensitive to a higher cost of borrowing. Financial firms comprise about 73 per cent of the Hang Seng China Enterprises Index (HSCEI), and banks 41 per cent – one reason why Societe Generale says it is short on it.
Taiwan’s equity market, by comparison, is about 50 per cent technology firms, which are more closely in step with demand from the United States. That connection between markets and economic cycles will lessen the blow from higher rates.
Hong Kong’s economic gait, however, is not in sync with the United States’.
This a primary reason for the gloomy vision of Hong Kong banks in 2016. The sector has a high level of leverage at exactly the time when higher borrowing costs will depress economic growth and property prices.
“The risk is that rates will rise as economic growth slows,” a dangerous combination, says Liao Qun, chief economist at Citic Bank International in Hong Kong. He expects the uptick in rates to push local year-on-year gross domestic product (GDP) grow below 2 per cent next year.
Hong Kong’s 32-year-old peg to the US dollar virtually imports monetary policy from the United States. Higher rates across the Pacific mean that interest rates here will inevitably rise and that local policymakers have few tools to manage it.
Most economists agree that an end to nearly a decade of ultra-low interest rates is necessary – especially given that it was the cheap funding into the property market that has pushed prices to 170 per cent above those in 2009.
But in Hong Kong, no time feels like the right time for the banks.
Even a light increase in rates can wrinkle up certain parts of a bank’s balance sheet. Private non-financial sector debt is an example and leverage here jumped to 190 per cent of GDP mid-year compared to just 125 per cent in 1997, the last time Hong Kong experienced a banking crisis.
Earlier this year, outstanding loans had reached 209 per cent of GDP growth at the end of March, a record high and up from 203 per cent in the third quarter of last year, according to Moody’s Investors Service.
“Credit intensity – it is actually one of the reasons why people are worrying about the Hong Kong banking sector,” said Adrienne Lui, an economist at Citi in Hong Kong. “China and Hong Kong is one of the places that has credit intensity rising. It means most of this money is going to less profitable investments, which means that in the future it can potentially become an issue, especially now that we worry about defaults in Hong Kong.”
Tamping down that high level of leverage will be painful in an environment where it is expensive to roll over bad debt.