If Hong Kong isn’t careful, its economy could be set for another bout of “protracted and painful” deflation and a crash in housing prices like it saw in the late 1990s and early 2000s.
- Zuma Press
- Hong Kong has some of the world’s highest housing prices.
That’s the negative scenario painted by the International Monetary Fund in its annual assessment of Hong Kong’s economy, known by IMF geeks as an “Article IV consultation.”
Right now, Hong Kong’s economy is humming along; the IMF predicts GDP growth of 6.75% this year and 5% to 5.5% in 2011. But inflationary forces are building, with consumer prices likely to be rising at a 5% clip by the end of 2011. Housing prices have shot up at an annual 20% rate the past two years, raising the fear of a dangerous bubble that could eventually pop.
The IMF thinks the housing-price rises are manageable and in line with fundamentals—so far. Home prices don’t reflect “misalignment or disequilibrium,” said Nigel Chalk, senior adviser for Asia at the IMF. Tight land supply, low interest rates, rising incomes and rising rents all justify the increase in housing prices, he said.
But things could get ugly down the road for Hong Kong should housing prices and inflation continue to move higher and get out of equilibrium, as they did in the late 1990s.
Hong Kong’s fixed exchange rate system with the U.S. dollar means Hong Kong essentially imports the interest rates set by the Federal Reserve, currently very low. In other words, Hong Kong can’t raise interest rates to counter a housing bubble and inflation.
“Hong Kong has monetary policy determined by the U.S. in an economy growing much much faster than the U.S.,” said Mr. Chalk.
“Our concern isn’t now, it’s a prospective concern,” he explained. The worry is that down the line, the current situation could reverse, with a slowing economy (and weaker housing market) in Hong Kong and China but healthy growth in the U.S. The Fed would raise U.S. interest rates, and Hong Kong would find itself with an uncomfortable combination of dropping home prices and rising interest rates.
“You could end up where the property market starts to deflate, prices going down, but payments on household mortgages are going up,” Mr. Chalk said. “It becomes harder to pay your mortgage on an asset that has less value.”
Hong Kong experienced deflation and a shrinking economy following the Asian financial crisis in the late 1990s and the SARS epidemic of 2003. Housing prices dropped more than 60% from 1997 to 2003 before finally recovering. On average, housing prices in Hong Kong are still below the 1997 peak.
The IMF says failing to prevent a fast rise in prices now will sting later. “Depending on the amplitude of the upswing, the resulting downturn could prove both protracted and painful,” the article IV document says.
How to curb prices? Without the power of the interest rate, Hong Kong has to resort to other regulatory measures, such as increasing the portion of the home price that buyers have to pony up in cash. Hong Kong has done that already several times in the past year, but prices have just kept marching higher. The government has also announced it would increase the supply of houses by making more government land available to developers.
The IMF endorsed these moves, and thinks Hong Kong will have to do even more, such as lifting taxes on property transactions and investments. Mr. Chalk said “there’s a scope to expand those,” if prices continue to rise.
But even all these “macroprudential” measures might not be enough to counter the lack of interest-rate control. They may “at best only be able to mitigate the amplitude of the current upswing,” the report says.
Separately, on Hong Kong’s recently passed a minimum wage-law, Mr. Chalk said the IMF supports the initiative “as it’s desirable to have some protection for very-low-wage workers.” But he added that the law bears watching, and Hong Kongers should be prepared for the minimum wage to even fall, should the economy weaken.
“Our principal concern is to make sure it doesn’t hamper the flexibility of labor markets in Hong Kong,” he said. The government should closely monitor the level of the wage and let it “adjust as economic circumstances adjust, so that it could move up and down.”
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