In my briefing to the Legislative Council in mid-November last year, I mentioned that the capital inflow of over HK$500 billion into the Hong Kong dollar was unprecedented. Since then, funds have continued to come in, though at a more moderate pace. Between the fourth quarter of 2008 and the end of 2009, a remarkable HK$640 billion has flowed in.
Hong Kong is a completely free and open economy. The absence of restrictions on capital flows and reporting requirements renders Hong Kong a competitive and attractive international financial centre. At the same time, this openness limits our ability to compile data and perform analysis on the volume and nature of fund flows. Nonetheless, the HKMA has gathered information from a number of sources in order to better understand the nature of the HK$640 billion inflow into the Hong Kong dollar since the fourth quarter of 2008. The following paragraphs summarise our findings:
- The inflows took place in two phases: from the fourth quarter of 2008 to the first quarter of 2009; and from the second quarter to the fourth quarter of 2009.
- During the first phase, HK$220 billion flowed in. Following the collapse of Lehman Brothers, tightened credit conditions prompted local banks and corporations to repatriate funds from abroad in order to meet liquidity needs at home. Another reason underlying the inflows was the introduction of the full deposit guarantee, which made Hong Kong a "safe haven".
- Even more funds flowed in during the second phase, as a total of HK$420 billion flowed in over a period of three quarters. But the nature of these flows was different from that of the first phase. As the various monetary and fiscal programmes introduced by the US and Europe showed their effects, financial markets and the real economy began to stabilise. Substantial amounts of funds notably in the form of US-dollar carry trades started to flow into Asia, especially Hong Kong. While Hong Kong's stock market began to rebound in the second quarter of 2009, there was a simultaneous pick-up in fund-raising activities, such as IPOs, rights issues and placements. More than HK$500 billion was raised through the stock market during the year, and of this amount, about 70%, or HK$340 billion, were raised by companies from the Mainland. Because most of the offerings involved international placement and thus many overseas investors, large amounts of funds flowed into the Hong Kong dollar.
- One may ask shouldn't those Mainland corporations that raised Hong Kong dollars in the stock market soon exchange the proceeds into other currencies and repatriate them back to the Mainland. Our informal survey suggests that, at the end of November 2009, about three-fourths of the funds (HK$260 billion) raised by these Mainland corporations might still be held as Hong Kong-dollar deposits within the Hong Kong or Mainland banking systems instead of being exchanged into renminbi or other currencies. This situation is evidently a temporary phenomenon. Most Mainland companies do not have operations in Hong Kong and thus the proceeds raised would likely be used for financing activities on the Mainland or elsewhere. So they will gradually exchange the Hong Kong-dollar proceeds into other currencies and remit them out of Hong Kong. Their Hong Kong-dollar holdings are likely to decline over time. However, should fund-raising activities remain highly active in 2010, there may be further inflows of fund countering the outflows arising from the repatriation of the proceeds raised.
- One may wonder why the HKMA had to sell large amounts of Hong Kong dollars to the market in 2009, but not in 2006 and 2007 when the fund-raising activities were just as active. Those familiar with the money markets will have noticed that, during 2006 and 2007, the Hong Kong dollar-US dollar interest-rate spread was quite wide, leading to carry trades that involved selling Hong Kong dollars. These carry trades countered the demand for Hong Kong dollars triggered by equity-related fund inflows. In contrast, the interest-rate differentials narrowed considerably in 2009. The spread between one-month HIBOR and its US counterpart, for example, decreased from about 130 basis points at the end of 2007 to the current 20 basis points. As a result, carry trades diminished and no longer provided a counteracting force against inflows of funds.
- Some contend that another reason behind the inflows was cross-border purchase of local properties. In the absence of reliable data, we can rely only on market guesstimates. According to market sources, there is an increasing trend of Mainland individuals buying Hong Kong properties and property transactions involving Mainland individual buyers (excluding Mainland buyers in the form of corporate entities) increased from 4% of total transactions in 2006 to 10% or more in 2009. While it is difficult to estimate the demand for Hong Kong dollars required to settle these transactions, it is likely to be not insignificant.
With this analysis, we now have a better understanding of the nature of the substantial fund inflows in the past five quarters. It seems that the majority of these funds are not short-term speculative funds, but are instead related to liquidity management and fund-raising activities. Even so, we must not be complacent as the intended use of the funds can change sharply. As the current environment of abundant liquidity and low interest rates are likely to persist, the risk of an asset-price bubble remains high. I have urged banks, corporations and the general public many times to manage their risks carefully and to refrain from reckless lending or borrowing that may leave them unprepared for a reversal in interest rates. Once again I would like to use this opportunity to alert the public to this issue and to remind banks to exercise caution in approving mortgage lending to ensure that they have prudently managed the credit and interest-rate risks.
Norman T. L. Chan
Hong Kong Monetary Authority
1 February 2010