HONG KONG: The biggest question facing market policymakers is how to prevent future bubbles. Hong Kong may have to face that challenge sooner rather than later. The combination of ultra-low US interest rates and liquidity flooding in from the mainland is driving up property prices.

Last week, Henderson Land sold a 6,158-square-foot duplex for a staggering $57 million to an unidentified buyer - setting a world record on a square-foot basis. Outspoken Hang Lung Properties chairman Ronnie Chan is skeptical (about the state price). "Don't believe it completely. People who can afford to buy luxury apartments are not silly," he said.

Nevertheless, rich buyers from the mainland have become an increasingly important force in the Hong Kong market. Mainland purchases account for 15 percent of individual buyers, and for 21 percent of demand for units costing more than HK$10 million ($1.29 million), according to a survey by Nomura.

This is helping to drive up property prices across the board. The cost of the most expensive homes - those larger than 160 square meters - is up 25 percent this year. Overall, prices are up 17 percent, though they are still almost 30 percent below their 1997 peak.

The broader problem is Hong Kong's currency peg, which links its currency to the US dollar and - indirectly - to US interest rates.

This year, the Hong Kong Monetary Authority has injected an unprecedented quantity of Hong Kong dollars into the money market to stop local currency appreciation, driving the money supply to a record high.

Moreover, with borrowing costs at a near record low, house buyers have an incentive to borrow. The amount of new approved mortgages surged to the highest level in history in June. Hong Kong plans to raise the down payment required for luxury flats to 40 percent from 30 percent. This will help curb borrowing. But it will not affect mainland buyers that much, because many of them pay in cash. The problem will get worse when the mainland gradually eases control of its capital account. Then there will be more money flowing in and out of Hong Kong, which is China's gateway to the world.

So far a resurgent property market looks like a happy headache. Nevertheless, it highlights the central conundrum for Hong Kong: enjoying the benefits of a stable currency linked to the US dollar risks having to put up with wild swings in asset prices.

Reuters

(HK Edition 10/24/2009 page5)