Here's Why Hong Kong Is Particularly Vulnerable To Massive Deleveraging

hong kong

Photo: US Navy

The Chief of HSBC Stuart Gulliver warned Asia that there could be an Asian credit crunch according to the Financial Times

In my view, Stuart Gulliver is only stating the obvious.  As European banks are set to be deleveraging either by raising fresh capital or reducing risk-weighted asset (RWA), one option would be to cut back lending to other regions.  Earlier I have already pointed to a piece of research from StanChart, highlighting that China, Hong Kong, Singapore and Korea are the most exposed to European banks lending, so if EU banks decide to cut back (and it will most certainly do due to all those mess in Europe), these countries will be most vulnerable.  On top of that, because US banks are also in some way exposed to Europe’s sovereign and banks, so it is hard to imagine that US banks will not be deleveraging when EU banks are.

So the cut back from European institutions (without US banks filling in the gap) could mean less inflow of capital or even outflow out of the region.  For places with pegs with the dollar, like Hong Kong, outflow of capital cannot be adjusted through exchange rate, so money supply and hence monetary condition will be tightened in response.  Indeed, the market turmoil in August and September resulted in weakening of EM currencies, and that prompted EM central banks selling US dollar for their own currencies, and that tightens monetary condition.  Also, do not that China’s foreign exchange reserve actually fell in September, and that could mean capital outflow if continued.

Given the death spiral of the Eurozone, there is absolutely no room for complacency, but we are indeed observing some really amazing level of complacency here.  The hope here is that perhaps the Chinese will ease policy very substantially, and the Federal Reserve (and indeed the European Central Bank) will do more quantitative easing.  But there is no reason why one can really count on them to save the Hong Kong economy as well as the property market. 

For China easing, one has to note that the very endgame of China’s monetary easing will be Chinese Yuan depreciation, and now even someone close to Chinese policymaking has made that explicit.  For Hong Kong, this could be deflationary if Hong Kong dollar remains pegged with the US dollar (note: I am bullish on the US dollar), and for many investors in Hong Kong who own shares in Chinese companies, the consequence is self-evident if Chinese Yuan depreciates and your shares are denominated in Hong Kong dollar.  Even if China don’t go down that path, one should really question the “conventional wisdom” that China must stimulate its economy in full force even economy slows too much, and more importantly, that massive fiscal and monetary stimulus will work for sure.  There should be, in my view, absolutely no complacency to believe that China’s easing will help.  Unfortunately, this appears to be the prevailing wisdom.

For the Federal Reserve, what I have to suggest is that recent data coming out from the US have largely been better than expectation.  I am not particularly bullish on the US economy, but the US economy has not fallen off the cliff.  In short, the US economy does not appear to be bad enough to warrant immediate quantitative easing.  Yes, I don’t necessarily disagree with the judgment that eventually there could be quantitative easing, but just not yet.  Who knows by the time the Fed does ease, the Hong Kong economy has already fallen off the cliff.

For the ECB, that’s just the same.  The European economy IS falling off the cliff as the debt crisis is escalating, but the Maastricht Treaty prohibits direct monetisation of debt, and the German all-mighty Bundesbank folks are obsessed with price stability, so it is hard for the European Central Bank to really be the lender of last resort (which is, if the ECB is willing to take that role, could be a relatively easy way to at least stabilise the situation).  So again, maybe the ECB will be forced to do QE, but just not yet.Who knows by the time the ECB does ease, the Hong Kong economy has already fallen off the cliff.

Worse still, as the Eurozone is basically finished, no one can rule out any disorderly break-up of the Eurozone now.  If that happens, everyone will be affected, and there should not be any hope that the People’s Bank of China, the Federal Reserve and the European Central Bank can ease the economy out of the mess.

I have to say that again: don’t be complacent.  Hong Kong economy is extremely vulnerable to external shock, and Hong Kong cannot, and should not count on PBOC, Fed and ECB opening the printing press, because that may not be all that helpful.  It is quite probably going to be too late, and probably not very helpful, or both.

This article originally appeared here: HONG KONG: Beware Of EU Banks Cutback; Don’t Count On Others’ Easing
Also sprach Analyst – World & China Economy, Global Finance, Real Estate

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