The Bad And The Worse Scenario For Hong Kong Real Estate

As the slowdown of the Chinese economy appears to be more likely, one has to ask the question of what is going to happen for Hong Kong, and in particular, Hong Kong property.

The reason I find it necessary to bring this issue up is that the overall market view on Hong Kong real estate remains that as long as the Federal Reserve keeps rates low, the real estate market will be fine, while failing to consider the potential threat from the slowdown of Chinese economy (or believing that a slowdown of Chinese economy is impossible).  Controversially, I argued that the People’s Bank of China is probably getting more important than the Federal Reserve, especially in the case for Hong Kong.  The reasons are, first of all, because of the close link between the Chinese economy and Hong Kong.  And secondly, the monetary policy in the United States will remain accommodative for an extended period of time.

That means, in my view, the People’s Bank of China is a more likely candidate responsible (indirectly) for any monetary tightening in Hong Kong for the months to come.  I have discussed the mechanism of how the actions of the People’s Bank of China have tightened credit in Hong Kong indirectly.  In short, as the People’s Bank of China tighten monetary policy and credit in China, companies are having more difficulties in obtaining credits, such that those who are capable of raising money or borrowing money from Hong Kong would have done so.  As a result of that, money flows away from Hong Kong, inadvertently tightened monetary policy.

Now we have got a better sense of how tight credit is in China.  Small to medium sized companies, for instance, resort to borrowing from pawnshops and loan sharks as many of them cannot borrow from banks.  Real estate developers and (potential) home buyers alike are also feeling the squeeze.  There were also some bizarre stories of how companies use copper as collateral to obtain financing from banks (H/T to a reader of mine).  These are anecdotal evidences for sure, yet all point to the same reality: credit is tightened.  As long as the government and the People’s Bank of China maintain its tightening stance, a significant slowdown would become more likely.

Let say a significant slowdown is going to happen, I believe that the Hong Kong property market will most certainly feel the pain. The fractional reserve banking system, which creates money through extending credit, would run in reverse and destroy money in the event of slowdown as companies and local governments fail.  Thus the monetary condition might be squeezed in China, and through the mechanism I described, the monetary condition in Hong Kong will be squeezed as well, such that interest rates will go up sharply.  Also, as banks in Hong Kong have been lending more and more money to Chinese companies, banks in Hong Kong may become more cautious in lending to anyone in the event of a slowdown, making it even more difficult for any one to borrow.

Buyers from the Mainland China has been blamed in the past few years for driving up real estate prices.  In the event of a significant slowdown, however, this money flow from China to Hong Kong real estate will slow, or even stop.  In this worst case scenario, money “destruction” in the banking system of China will also mean wealth destruction, that means significant corrections in real estate and stock prices are possible.  As people become poorer, they are much less likely to be investing elsewhere.  If the wealth destructions are severe, one should not be surprised if they sell their overseas assets (including Hong Kong real estate) and cash in, even though this is so unthinkable today.

Now I am not suggesting that this is certainly going to happen.  For one thing, even though a slowdown is now almost inevitable, it is not clear whether it is going to be a crash scenario or a soft-landing scenario, which is what everyone is hoping for.  For a “hard-landing” scenario in China, it is obviously necessary to be prepared for the worst (i.e. don’t be too shocked when that happen).

For a “soft-landing” scenario, the likely outcome is somewhat elusive.  There is no previous “soft-landing” scenario in China which we can now benchmark with as the conditions today are so much different from the previous successful soft-landing attempt (see The Forgotten Real Estate Bubble Of The 1990s), in which economic growth was somehow intact, but inflation has been brought down, and localised real estate bubbles in coastal cities went bust without severe consequences.  Also, the economic relationship between China and Hong Kong back then was arguable less close than today.  Finally, the Federal Reserve was tightening monetary policy in 1994, while the Federal Reserve is now remaining accommodative, meaning that the 1994 real estate prices corrections were driven by both China and the US factor, while today’s correction will likely be triggered only by the China factor.

In both scenario, however, I think the story is pretty much the same, i.e. slowdown of China’s economy will be negative for Hong Kong real estate, although I cannot possibly say the exact negative impact there will be.

This article originally appeared here: Hong Kong Property: In The Event Of A China’s Slowdown
Also sprach Analyst – World & China Economy, Global Finance, Real Estate

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