Fears Hong Kong is on the brink of a financial crisis

HONG KONG’S housing boom is starting to fray as monetary tightening by the US Federal Reserve forces the enclave’s authorities to tighten credit.

Home buyers have pulled out of purchases at the last moment despite losing large deposits, a sign that financial stress is biting harder, or that fear is creeping into the market.

The South China Morning Post said buyers had pulled out of five flats in Sun Hung Kai’s Park Yoho Milano complex this week, losing $250,000 (£196,000) between them. Another cancelled at the Sun Hung Kai Properties Martin II, losing $46,000; a further pulled out of the Zumurud development, losing $250,000. One developer is cutting prices by 10pc to clear inventory fast.

This is happening as regulators in mainland China clamp down on capital outflows through interbank accounts using the Hong Kong-shanghai Connect, aiming to stem any further fall in the yuan. The People’s Bank (PBOC) is squeezing liquidity in the offshore Hong Kong market and has lifted the risk requirement ratio for forward yuan contracts to 20pc. This makes it harder to short the Chinese currency, whose fall since June has been the steepest in a quarter century.

The PBOC appears willing to endure higher interest rates and risk a credit crunch as the price for defending the yuan. Overnight Shibor lending rates have doubled to 2.56pc over the last week. But this means further defaults by Chinese companies and a cold douche for Hong Kong, home to the world’s most overheated property market.

Hong Kong’s property boom is extreme by any standards. The price-toearnings ratio is at an all-time high of 19, compared to a peak of 14 before the East Asian crisis in 1998, which was followed by a 60pc crash in flat prices.

The Hong Kong Monetary Authority has to shadow Fed tightening since the Hong Kong dollar is pegged to the US dollar. It has had to intervene repeatedly since April to shore up the Hong Kong dollar and slow capital outflows.

This is done by selling “exchange fund bills”, which drain liquidity and tighten credit. Three-month Hibor rates have jumped 110 basis points to 1.89pc since October, closing most of the gap with US dollar Libor.

Capital Economics says 90pc of mortgages in Hong Kong are priced off three-month Hibor rates. It expects house prices to fall by a third before the excesses are purged. Bank of America predicts a fall of up to 20pc over the next two years.

What is happening in Hong Kong and China reflects broader woes hitting Turkey and other emerging markets as the Fed raises rates and reverses quantitative easing.

Hong Kong has drunk deepest from the pool of easy global money. The Bank for International Settlements says Hong Kong’s “credit gap” is 45 percentage points of GDP above its longterm trend, the most overstretched in the world. The gauge is a reliable predictor of banking crises. The BIS says that any persistent gap above 10 points is a warning.

The enclave’s fortunes have global implications. Its banking system is 8.3 times GDP, the same as in Ireland before it blew up in 2008. HSBC and Bank of China alone have Hong Kong deposits of almost $700bn between them.

The entrepot has played a key role in “carry trade” lending to Chinese companies trying to circumvent credit curbs on the mainland, and for speculation on London and Vancouver property.

Its fortunes are intimately linked to China, which cannot easily defend its currency and at the same time shore up its economy with looser monetary policy. Beijing seems to have concluded that the imperative now is to defend the yuan, concerned that any move beyond 7.00 to the dollar might set off capital flight. But it risks detonating a financial crisis on Hong Kong Island. The choices are becoming harder.