The dynamics of Hong Kong's property market are complex and volatile. The HKMA welcomes actions to stabilise price behaviour. However, such actions should not include monetary policy or banking supervisory measures.
The peculiar dynamics of the property market, particularly in highly urbanised and densely populated Hong Kong, presents great challenges for policy-makers. It is difficult to understand, and even more difficult to structure, a policy framework that serves the overall public interest.
On the demand side, volatility is the key empirical feature, but it is not clear what the factors contributing to this volatility are, and their relative importance. Intuitively, demography, income, wealth, interest rate and price expectation should all be relevant in determining the level of demand. And specifically, in the short term, demand for residential property seems to be quite sensitive to price expectations. This is particularly so in Hong Kong, where the residential property market is extraordinarily liquid, in view of the greater homogeneity of the product, at least within reasonably large housing developments, and the relatively low transaction costs. The fact that residential property is a popular investment vehicle, much more so than in other jurisdictions, also makes demand sensitive to price expectations. For the same reasons, however, the demand for residential property in Hong Kong is not as sensitive as it is elsewhere to interest rates, or the financing cost. This may seem surprising, but it is an empirical fact that the fall in the mortgage interest rate from 11.5% at the beginning of 1998 to about 2.5% now has not done much to boost demand. It is also a fact that periods of strong demand for residential property in the past have coincided with periods of increasing interest rates.
On the supply side, and given that it takes time to build residential property, it is clear that the short-term elasticity would be quite low. In the case of Hong Kong, where land is scarce and land production (together with the necessary infrastructure) takes time, and where residential property largely takes the form of high-rise flats, the time lag for supply to catch up with demand is exceedingly long. The situation is further complicated by there being a monopolistic supplier of land - the Government - which has the difficult task of trying to bring forth a supply of land that is optimal in the long run. But what constitutes long run optimality in the supply of land is a hotly debated issue, and so are the institutional arrangements for achieving it. The relative importance of the relevant considerations - including social stability and financial stability, on top of the proper functioning of a market - changes constantly, along with shifts in public sentiment, which can be quite strong at times and even capable of derailing long-term policies.
The interaction of these demand and supply characteristics has meant rather explosive behaviour for residential property prices. Such behaviour obviously brings risks of all types, which we are all familiar with. The challenge is in the policy response. Do we leave the (not entirely free) market alone as much as possible (but we still need a long-term policy in the supply of land) and learn to live with and manage the risks, or should we take measures positively to dampen the explosive behaviour and the undesirable consequences? The undesirable consequences of the sharp downward adjustment in property prices over the past five years have proven to be quite damaging to the economy, and have to some extent undermined social and financial stability. Does the situation justify short-term demand or supply management measures? And what might these measures be? Are there any measures to improve the market dynamics to achieve greater stability in the residential property market?
These are difficult questions. From the point of view of the HKMA, we are no doubt concerned about the implications for stability in the banking system of further falls in residential property prices, which will be manifested in further increases in the number and amount of negative equity mortgages. We therefore support measures to dampen explosive price behaviour generally and in present circumstances to stabilise the residential property market. But we would also like to make clear that there is no scope for short-term demand management involving monetary policy or banking supervisory measures. The monetary policy objective of Hong Kong is singularly and quantitatively defined as the Linked Exchange Rate, requiring interest rates to move in tandem with US interest rates. In any case, the demand for residential property in Hong Kong is not as interest-rate-sensitive as in other jurisdictions. Our banking supervisory measures, important for the maintenance of banking stability, are not inhibiting the availability of convenient and favourable mortgage financing arrangements.
Joseph Yam
9 October 2003
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