Monday 15 December 2008
Hong Kong Faces Another Deflation Reckoning
Recent steep price falls in China have made deflation the new economic bogeyman, and another sizeable rate cut could be on the cards. Hong Kong is anxiously watching this unravelling on the mainland as it tries to avoid being tipped into another painful deflationary cycle.
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Hong Kong Faces Another Deflation Reckoning
Donald Tsang asks Beijing for help ... again
By Craig Stephen
14 December 2008
HONG KONG (MarketWatch) -- Recent steep price falls in China have made deflation the new economic bogeyman, and another sizeable rate cut could be on the cards. Hong Kong is anxiously watching this unravelling on the mainland as it tries to avoid being tipped into another painful deflationary cycle.
Businesses and government alike will remember the nightmare period of deflation in Hong Kong, spanning 1998-2003, with attendant asset-price collapses, credit contraction and budget deficits.
Unfortunately, nothing was done in the intervening decade to wean Hong Kong off its dependency on asset bubbles and property speculation. Now, Chief Executive Donald Tsang is up in Beijing again with his hand out for some policy favours to prop up the needy territory.
His trip comes as new data reveal the global financial crisis has not just winded China’s exports, but also stopped prices in their tracks. In November, China’s consumer price index rose just 2.4% from the year before, slowing from 4% inflation in October. Similarly, the producer price index decelerated from 6.6% to 2% in the same period.
Little wonder China’s top banking regulator, Liu Mingkang, said over the weekend that the mainland economy was “very likely to slide into deflation mode.”
Hong Kong now appears to face a converging range of deflationary pressures.
Property prices are following the equity market lower and are now 25% off last year’s highs, with some transactions reportedly 40% lower. In the city-state’s glitzy shopping malls, New Year sales began in November.
The currency peg to the U.S. dollar is another source of downward pricing pressure. As the Hong Kong dollar follows the greenback higher against the euro and a range of currencies in Asia, it is now faces a reverse in course by the yuan, feeding lower prices through the economy.
During Hong Kong’s last bout of deflation, the peg meant that asset prices and economic activity bore the brunt of pricing adjustments to external shocks. Job cuts and salary cuts were the order of the day, as sales and tax receipts shrunk.
Thus far, Hong Kong has escaped many of the high-profile redundancies seen around the world in the current crises. In fact, the big tycoon-controlled companies have conspicuously lined up to rule out job cuts.
Henderson Land Development Chairman Lee Shau-kee last week was the latest to promise his company would not shed jobs and that his staff would get pay rises and bonuses despite the financial turmoil. Sun Hung Kai Properties made a similar pledge last month, and Li Ka-shing, chairman of Hutchison Whampoa,, is also on record saying he has no plans for lay-offs and that his firms will not be cutting back investment.
But are they only delaying the inevitable and burying their heads in sand, or concrete?
Typically, debt becomes much more onerous in times of deflation -- revenues fall, making it harder to service that debt. Granted life’s easier if you’re operating in an oligopolistic market, but companies typically go into cost-cutting mode, which includes laying off staff.
But in Hong Kong, one difference for such big companies in such a small town is the consideration that their actions can have a big impact on sentiment.
If the property tycoons cut staff or salaries, many others may follow, accelerating deflation across the economy. Of course it’s not all altruistic -- What chance have the developers of selling their pricey flats if salaries are shrinking?
The government is also an interested party because it can say goodbye to land-sales revenue if the developers cannot sell their concrete blocks. Attention will then turn to its ballooning wage bill at a time of deflation and plunging tax receipts.
So far, instead of tightening its belt, the government has announced a wave of new civil service hires and questionable building projects, such as a bridge to Macau.
A contrast in behaviour is provided by HSBC, the biggest lender in Hong Kong. It has quickly reacted to the new environment by cutting staff and warning of further lay-offs, while at the same time tightening lending.
It seems we can forget easy money. Last month, HSBC raised its new mortgage rates by 75 basis points, the most in 10 years, and followed this by hiking interest rates on its local personal credit cards to 31.86% last week.
According to Citbank Research, the credit contraction cycle in Hong Kong is already upon us. Outstanding Hong Kong-dollar bank loans fell by HK$1 billion in October to HK$2.395 trillion, while foreign-currency loans dropped more sharply by HK$13.5 billion.
If the banks are preparing for tough times ahead, maybe the developers and government should be watching.
As the Hong Kong government ponders its next move, it is worth remembering the bitter pill from deflation last time around came in the form of tax hikes for everyone to plug the deflation deficit. But in a new era of stimulus economics, it appears few governments think they have to do these simple sums anymore.
We will have to see if Beijing can dispense some treats to avert a deflationary cycle in Hong Kong, but for now that seems unlikely.
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