Published: Jan 19, 2016 6:47 p.m. ET
Capital outflows could reflect permanent shift in confidence
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HONG KONG (MarketWatch) — China’s economic problems are now spilling into Hong Kong, opening up a new fault line of distress. The Hong Kong dollar peg has fallen for the fourth day in a row after the territory joined China last week in being hit by capital outflows.
This reversal comes as a surprise, as until recently Hong Kong’s problem had been coping with excess money inflows as investors switched out of a weakening yuan USDCNH, +0.0895% .
Under the peg that links the Hong Kong dollar to the U.S. dollar at 7.80 USDHKD, +0.0358%authorities will intervene if it trades beyond 7.75 or 7.85 to the U.S. dollar. Today it hit 7.809 to the U.S. dollar.
If Hong Kong begins to look like just another Chinese city with Beijing calling the shots, why should investors differentiate?
Hong Kong is particularly sensitive to capital outflows, given earlier inflows helped push interest rates down to the floor, fueling a property bubble and lending spree into China.
Analysts at Daiwa calculate that since 2005 the city has received $237 billion in net inflows from the rest of the world and further lending multiplied this amount by 2.5 times.
China's Growth Is Slowest in 25 Years
If any other major economy grew by nearly 7% a year, it would be seen as a triumph. In China, it is being seen as more evidence of deep problems.
The consensus remains that the Hong Kong Monetary Authority (HKMA) will defend the currency board, which has, after all, been in place since 1983. Daiwa calculates authorities have $100 billion of ammunition before intervention would contract the monetary base and higher interbank rates would really bite.
Much depends on whether we are beginning to see a sustained trend of capital outflows.
There are a number of economic and political shifts that appear to have turned against Hong Kong. Higher interest rates in the U.S. are expected to encourage outflows, while the economy is suffering a number of headwinds from lower retail spending and a slowing property market.
On Hong Kong’s governance and political development there is also evidence of deterioration.
In the past, a key factor in Hong Kong’s success has been its clear difference from Communist-run China due to its freewheeling capitalist economy — with its low tax rate, free press and established rule of law.
But increasingly that line appears to be blurring. If Hong Kong begins to look like just another Chinese city with Beijing calling the shots, why should investors differentiate?
It no longer appears to have a separate jurisdiction after a Hong Kong citizen who worked for a publisher was illegally kidnapped by mainland law enforcement officers and detained across the border.
Most attention has focused on the flagrant breach of Hong Kong’s rule of law and the damage to the “one country, two systems” principal of governance.
But it could also impact capital flows. If money managers also no longer feel safe speaking freely in Hong Kong, they are highly mobile and could take their business elsewhere. Hong Kong may also lose its role as an offshore safe haven for mainland Chinese money if law enforcement can now straddle the border.
Another sign of Hong Kong looking like just another Chinese city is the diminished status of its chief executive. At the annual meeting with China’s top leaders in Beijing, chief executive C.Y. Leung was downgraded to sitting on a small chair at the end of a table. Previously the leaders of Hong Kong and China would have sat on matching chairs, side-by-side.
If this new arrangement was in doubt, it was only necessary to listen to last week’s annual policy address by Leung. It could have been lifted straight from Beijing’s latest five-year plan as it trumpeted the nation-building “One Belt One Road” project.
A final explanation for the reversal in capital flows is simply that investors are removing bets on a potential appreciation in the Hong Kong dollar. It has been argued by various investors, including Bill Ackman that the Hong Kong dollar was significantly undervalued against the yuan CNYHKD, +0.0758% following its appreciation and it must move up. This presented a low-cost trade just to park money in the local currency and wait for it to go up.
But if this disequilibrium is going to be rectified by the yuan getting weaker, rather than the Hong Kong dollar getting stronger, it no longer makes sense.
The other wild-card factor to consider with Hong Kong’s apparent diminished autonomy is that it might be the Peoples Bank of China not the HKMA that will have the final say on defending the currency peg if capital outflows continue.
Given Beijing’s ham-fisted management of its currency and equity markets in recent months, investors might decide the Hong Kong dollar is not worth the risk.
http://www.marketwatch.com/story/have-investors-lost-faith-in-hong-kong-as-well-as-in-china-2016-01-19?siteid=rss&rss=1
