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02 Nov 2012

Week in China: Peak valuations?

Buildings under construction.

There are fears liquidity will cause rises in property prices, which have increased 53 per cent since 2008

Hong Kong has a money problem, namely too much of it arriving in the city. The Hong Kong Monetary Authority (HKMA) stepped into the currency market four times between 20 October and 24 October, selling USD1.85 billion of Hong Kong dollars to stabilise foreign exchange rates. And this week it intervened again, selling a further USD350 million worth of Hong Kong dollars. This was the first significant intervention in the foreign exchange markets since December 2009.

The Hong Kong dollar is allowed to trade in a band of HKD7.85 to HKD7.75 against the US dollar, according to a policy that dates back to October of 1983. As the rate strengthened to the upper edges of the band in recent weeks, the government has been forced into active buying of US dollars in an effort to weaken the local currency.

Most analysts believe that this is the result of the third round of quantitative easing from the Federal Reserve in the USA. Hong Kong, where the shares of China's largest companies are listed, offers investors an easier way to play the China growth story and the city's Hang Seng Composite Index climbed for an 11th consecutive day last week, the longest run since July 2005. The rally has added almost USD180 billion to the index's market capitalisation since 13 September, calculates Bloomberg.

The newspaper China Business says that the sharp inflow of hot money is also a signal that investors are becoming more confident about China's economy. Recently released data may support this view. Exports grew at almost double the consensus estimates, rising 9.9 per cent year-on-year. Other indicators like steel output rose too from the previous month, and there is growing expectation that China will see more fiscal stimulus after the leadership transition is concluded (the new team will be announced later this month: see Talking Point; WiC 170.

"Investors are looking for alternative investments with higher returns, and many see Hong Kong as a good option," said Adam Chan, a senior analyst with China Construction Bank, adding that Chinese stocks will be the main target.

But some of the excess liquidity going into Hong Kong also appears to be coming out of China itself. The Wall Street Journal ran an article last month suggesting that as much as USD225 billion of capital departed China in the first nine months of this year, often evading the country's capital controls for destinations like Hong Kong.

This presents Hong Kong's authorities with a challenge. As hot money continues to arrive, the fear is that more liquidity will fuel further hikes in property prices, which have increased 53 per cent since the end of 2008. With prices already a sensitive topic in the city, new chief executive Leung Chun-ying was said to be eyeing controls on the market. And last weekend, his administration took its most significant action yet by announcing that non-local buyers (those without permanent residency in the city) will have to pay an additional 15 per cent tax upon purchase. The government also raised the duties charged on quick resales of property by five percentage points and extended the period during which they will apply from two years to three.

Many saw the move as designed to curb speculative buying from mainland China, although Tom Holland, writing in the South China Morning Post, said that the measures will not have much impact in bringing down prices. According to the government's own data, non-residents made up only 6.5 per cent of buyers in Hong Kong last year. And while interest rates remain so low, Holland suggested, Hong Kong locals have every incentive to continue snapping up real estate as an investment choice.

Despite this view, investors took the news as a negative for the city's property developers and on the day immediately after the announcement, the four largest property firms lost more than USD5 billion in market cap.

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