Current price gains unsustainable and vulnerable to US moves

HONG KONG: The Hong Kong Monetary Authority (HKMA) has warned that the city is at risk of seeing bubbles forming in its asset markets, which could cause market fluctuations and therefore impact investors when capital inflows reverse.

"The potential risk is huge," Norman Chan, chief executive of HKMA, said yesterday, addressing the city's legislators on worries about potential asset bubbles.

The local stock market gained about 52 percent last year as measured by the benchmark Hang Seng index while home prices surged nearly 30 percent on average, driven by cheap money after governments around the world flooded the market with huge liquidity in the wake of the financial tsunami in 2008.

Capital inflows into the city amounted to HK$640 billion in the five quarters through December 2009, the HKMA said earlier.

Over the last 10 months, capital inflows reached HK$420 billion, Chan said.

The money inflows were mainly attracted by equity fund-raising activities such as initial public offerings, said the de facto central bank chief, noting that locally-listed mainland firms raised HK$340 billion from the local market last year.

Most of the funds raised by these non-local firms haven't been remitted and remain in the local banking system.

"Capital inflows could continue in the future if the local stock market remains robust and equity fund-raising activities persist while interest rates in the US stay at low levels," Chan said.

This easy monetary environment threatens to cause asset bubbles, Chan warned, citing signs that consumer prices and expectations for asset prices are rising.

However, a reversal in capital flows some day could trigger a plunge in asset prices, causing losses to investors, Chan added.

Interest rates will likely rise as capital flows out of the city in big volume, causing further impacts on the financial market, he said.

This reversal in capital flows could be triggered by hikes in US interest rates or a strengthening US dollar, as institutional investors who have borrowed cheap dollars to invest in the region will be forced to unwind their carry-trade positions, the HKMA chief warned.

Current low interest rates worldwide are unsustainable in the long run, he said.

While stopping short of calling it an asset bubble, some market watchers believe prices in local asset markets have outrun the economy. "Asset prices have climbed back to levels that are not supported by economic fundamentals," Paul Tang, chief economist at Bank of East Asia, told China Daily.

He attributed the current "high" asset-price levels to ample liquidity and the low cost of money, which "cannot be sustained in the longer run".

Stocks in the local market are currently trading at prices about 18-20 times their expected earnings for 2010, higher than historical average of 15-16 times but still below stretched levels of above 22 times.

"Shares currently are not expensive, but they are not cheap either," said Daniel Chan, a senior investment strategist at DBS Bank.

He said current home prices haven't discounted the negative factor of potential hikes in interest rates. He added that higher costs for money will weigh on asset markets.

"It won't surprise me if interest rates rise back to normal levels of around 4-6 percent," he said.

HKMA has kept its base rate at a record-low 0.5 percent since late 2008 following the financial tsunami.

Meanwhile, replying to questions by legislators, the HKMA chief admitted that the Hong Kong government has no exact figures on property purchases by mainland residents in the city.

But industry sources had estimated that mainland residents bought about 10 percent of homes sold in the city last year, the HKMA chief said.

(HK Edition 02/02/2010 page4)