Transcript of a Press Video Teleconference on the International Monetary Fund's Preliminary Conclusions of the 2010 Article IV Mission to the People's Republic of China--Hong Kong Special Administrative Region

November 19, 2010

With Nigel Chalk, Mission Chief for Hong Kong SAR and Senior Advisor of the Asia and Pacific Department
Wednesday, November 17, 2010
Washington, DC

Ms. Daisy Wong (in Hong Kong): First of all, thanks everybody for joining this video teleconference. I’m Daisy Wong of the IMF External Relations Department. Today, this video teleconference is about IMF’s Article IV consultation with Hong Kong. I believe most of you have seen this preliminary statement on the conclusions of the Article IV Mission. Before we begin, let me remind all of you again, this conference call and the content of the preliminary conclusions are all embargoed until 11:00 a.m. Hong Kong time. So let me introduce the host today. In the middle is Mr. Nigel Chalk. He is the Mission Chief for Hong Kong and Senior Advisor of the IMF’s Asia and Pacific Department.

Mr. Nigel Chalk: Good morning.

Ms. Wong: Good morning. And to his right is Mr. Jeremy Mark of

IMF External Relations.

Mr. Jeremy Mark: Good morning and good evening.

Ms. Wong: And to Mr. Chalk’s left is Ms. Keiko Utsunomiya, also from External Relations. So, Mr. Chalk, could you start by giving a brief summary of the conclusions, please?

Mr. Chalk: I think the concluding statement of the mission speaks for itself. I’ll just make couple of points, one, is that we were in Hong Kong in the second half of October and we finished up the mission on October the 26th and provided our concluding views to the government of Hong Kong. And I should also mention that here in Washington, the staff’s views will be discussed by the Executive Board next week and we hope to have the staff report which associated with this consultation to be published later this month. But I won’t add to the content that was in the concluding statement, I think I’ll just take questions.

Ms. Wong: Okay, we-we’ll start taking questions from the floor now. Would you please identify yourself – your name and organization – before you raise a question?

Questioner: Hello, on the last remark of the conclusion you mentioned, the Renminbi market, but (inaudible) in China and other Asian countries employ more capital control rather than encouraging offshore loan market development. Can you, you know, tell us what kind of impact it will have on Hong Kong’s development in the long run.

Mr. Chalk: I think we see the development of an offshore Renminbi market in Hong Kong and the broader process of internationalization of the Renminbi to be a very positive aspect for Hong Kong. We’ve already seen an increase in financial services related to this internationalization of the Renminbi. Increasingly there are Renminbi bonds being issued in Hong Kong, obviously trade settlement in Renminbi through Hong Kong is taking off and I think all of this activity in Renminbi, as it’s expanding, is providing growth opportunities to Hong Kong. So we see it as a very positive development. It’s a process that will have to move step by step, and will have to move in concert with the cooperation and collaboration with the Mainland authorities. But what we see so far in terms of an expansion of offshore Renminbi, is quite a positive development.

Questioner: But it seems there is a delay of the much talked about (inaudible) as well as, you know, the (inaudible). Can you make some remarks on that as well?

Mr. Chalk: Yes, as you know the government has announced

that some of this Renminbi that will be accumulating in Hong Kong through trade settlement and also through Renminbi deposits from Hong Kong residents will be allowed back into the Mainland, through a quota mechanism, administered by the People’s Bank of China, and will be allowed to be invested into interbank bond markets on the Mainland. We also feel that there are scope for other ways for that Renminbi to find its way back home into the Mainland. And we pointed that out in the concluding statement that we do see scope for an expansion of Renminbi investments from Hong Kong into the Mainland through Renminbi lending by Hong Kong banks and Renminbi denominated Foreign Direct Investment.

Mr. Mark: Can we have another question, please?

Questioner: Hello. Actually, under the quantitative easing of the United States, the Hong Kong face many challenges of asset bubble and the rising of the property price in Hong Kong. So, would you give some suggestions for the Hong Kong government, how to deal with this situation? I mean that is that we can consider to launch some capital-control facility or, I mean, did we do the link the exchange rate system with the US dollar in Hong Kong, thank you.

Mr. Chalk: Perhaps we can explain a little bit about how we see the property market situation in Hong Kong right now, and the challenges that will be facing in Hong Kong and then talk more directly to your question.

So, if we take a snapshot of the Hong Kong property market right now, it’s true that property prices have been going up quite fast. And in the luxury market, prices are now exceeding the peaks that they reached in 1997. Having said that, if you look at a broader range of indicators, it seems to us that the property market is not out of the line of fundamentals. Supply in the market is quite tight in Hong Kong at the moment, there’s a lot of demand coming from the financial sector professionals and from the Mainland as well as the domestic demand from Hong Kong residents. Mortgages are very cheap in Hong Kong right now, which makes financing housing purchases quite affordable. And indeed if you look at the affordability ratios in Hong Kong compared to late 90s, housing is much more affordable now than it was in the late 90s.

So when we look at the broader range of indicators, we don’t really see a clear sign of misalignment in the property market. Our concern, really, and the challenge facing the Hong Kong government, is if this process of a very quick increase in property price inflation continues at the rates we’ve seen over the past year, which have been around 20%, that would then increasingly start to push property prices away from the underlying fundamentals in the economy. And Hong Kong has a history that when prices move away from equilibrium in the property market, they pretty quickly come back down to earth and re-assert themselves back at equilibrium. So, that cycle would translate, in Hong Kong, into macro-economic volatility. Therefore, we see a role for public policy to step in to try and mitigate that cycle and-and smooth it out somewhat.

Now, you asked which policies they might have at their disposal. I think many of these policies have already been deployed by the government. I am thinking of things like macro prudential measures, lowering the loan-to-value ratio for property so that people don’t over borrow in order to invest in the housing market, making sure that debt-service ratios, are applied conservatively and perhaps even reducing the level of debt service ratios so that people are not spending an overly large share of their income on mortgage payments. So I think those things will help in terms of controlling some of the level of credit going into property.

I think at the same time, there are also fiscal tools that the government can use, certainly they’ve been stepping in to provide land to the market but that does take some time before it filters into the property market because of the lags between when the land is provided and when the construction is finished. There’s a role for taxation in the property market and the government has already increased stamp duties on property transactions. For luxury properties, I think there is scope to do more of that, and the other taxation measure that we’ve pointed to is to increase the property taxes in Hong Kong, now the property tax in Hong Kong--which you call ‘the rates’—and which are levied on the rentable value of the property has some scope to increase in order to make speculation in housing a much more expensive business and to lessen some of that speculative activity.

So I think all of those measures together, many of which have been already put in place by the government, would help smooth out this property price cycle. And as I said, our sense is that the government has already acted quite preemptively even beginning as early as October last year. =They’ve recognized this asset price cycle is an issue, and they’ve acted preemptively to try and smooth it out somewhat. And we think that they basically need to continue doing that. I would highlight that what is perhaps different in this cycle, relative to previous cycles we’ve seen in Hong Kong, is this fact that the government has acted very early in the cycle. So I would say that the property market in Hong Kong, or rather the financial system in Hong Kong, is probably much better prepared for a property cycle this time round than it has been in the past.

Questioner: Can I have a follow-up question?

Mr. Chalk: Yes.

Questioner: Do you think that, many

comments that maybe we can peg with RMB, I mean with the Hong Kong Dollars to fight with the asset bubbles problems? Do you think so?

Mr. Chalk: Yes, there’s been a lot of talk whether the

exchange rate regime in Hong Kong is appropriate. We continue to support the linked exchange rate system in Hong Kong. It’s been in place for 27 years, it’s served Hong Kong extremely well. It’s been an anchor of the monetary and financial stability. I think there’s some confusion between people somehow believing the current inflation in the property market is being driven by the exchange rate system. I think that’s untrue. This is not a problem that’s unique to Hong Kong. You see this kind of property price inflation in many other economies in the region, you see in it Singapore, you see it in Australia, you see it in Taipei. And I think that all of those economies have very different exchange rate regimes from that which Hong Kong has, and yet still have property price inflation. So I think our solution is to actually tackle the property market directly through macro prudential measures, and some fiscal measures and land sales. And not change the peg, the Linked Exchange Rate System.

Ms. Wong: Other questions? Hi. Mr. Chalk is available to

take more questions so do you have more questions on, on the economic topics?

Questioner: I would like to ask that, do you see that there

are many other countries that exercise capital control. Does it have any significant impact on Hong Kong you have more hot money flow into Hong Kong?

Mr. Chalk: I don’t think so. I think the way the linked exchange rate

system is designed is that what’s much more relevant for Hong Kong is what happens in monetary policy in the US. As you know, the system in Hong Kong is designed to mirror the monetary policy of the US, and so if the US expands its balance sheet and expands the monetary base, Hong Kong will also expand the monetary base. So I think that’s a much more important factor that’s driving these very low interest rates in Hong Kong and high levels of liquidity in the system. To some extent, that’s being supplemented by some equity issuance in Hong Kong where, where issuers particularly from the Mainland are doing IPOs in Hong Kong that is attracting foreign capital into the economy, which then is not immediately being repatriated to the Mainland. So that adds to some of the liquidity in Hong Kong but ultimately, it’s really the, the US monetary policy that determines the level of liquidity and the level of interest rates in Hong Kong.

Questioner: I have some question about the hot money rushing in Hong Kong market. You have mentioned in the report over the past few years the monetary basis of Hong Kong has increased revenue. So do you see any signs of risks in the asset market increased in short-term or in the next few years, or even the bubbles in the market now?

Mr. Chalk: So, certainly when you have a system where

there’s a lot of liquidity sitting in the banking system, and potentially that liquidity will translate into credit, that always raises the issue whether that credit will end up in some particular asset class. And in Hong Kong, certainly property is one area where that credit and liquidity will go. So far, when we look at the property price in Hong Kong, we have seen some fairly rapid property price increases, around the order of 20% over the past year, but we still feel that’s consistent with the fundamentals in the Hong Kong economy. However, should that level of price increase continue at the same pace over the next year or two, that certainly would tend to push property prices away from fundamentals, away from the underlying supply and demand relationship in Hong Kong. And that’s really the primary concern we have. We don’t see that as an issue right now, but we do see it as a prospect for the future.

Questioner: What kind of indicators could we see in the way the fundamental practice makes--

Mr. Chalk: I’m sorry, could you repeat the question?

Questioner: Could you suggest some indicators in the next

year, maybe the tracking is seen pushing away the SMI cap from the fundamental?

Mr. Chalk: We look at a whole range of Indicators. We certainly look at the level of price growth in the market, we look at things like the volume of turnover, and the level of confirmer transactions in the market which are often indicators of speculative activity. We look at the rent price gap, how much rents are going up relative to prices. If we see rents and prices moving up together, that’s an indicator that strong demand in the market is driving it, rather than a deviation from fundamentals. And we also look at the prospects for new supply, coming into the market, over the next few years, which Hong Kong produces data on. The level of supply over the next couple of years is going to be relatively low and then increase after that, so we’ll be watching all of those indicators quite carefully to make an assessment of how the property market is doing.

Questioner: Do you think that is there any bubbles for the property market in Hong Kong right now? And you mentioned that there’s the some more physical measures for tackling the problems now. Then what kinds of measures do you think will be proper for Hong Kong right now?

Mr. Chalk: As I said, if you take a look at the property market right now, if you take a snapshot today, we don’t see that there’s a bubble in the property market, we don’t see that prices are deviating from fundamentals. However, the concern is if the level of price increases you’ve seen over the past year continue in Hong Kong over the next couple of years, it would seem to us likely that prices would deviate from fundamentals and the prospects for a bubble would increase.

In terms of the policies that could be taken in order to mitigate that upswing in the property market, we’ve talked through several of them in our concluding statement. On the financial sector side to restrain credit going into property, the government can further reduce loan to value ratios on mortgage lending, and reduce those longer value ratios for a broader share of properties. They can also further reduce the debt service ratios that are currently in place for mortgage borrowing, that’s the share of an individual’s income that’s paid in their mortgage each month, to make sure that borrowers aren’t over-extending themselves.

We’ve talked about fiscal tools that could be used to restrain property price inflation in Hong Kong. So, increasing stamp duty on properties in order to dissuade speculative activity and turning over properties very quickly, and also introducing, or increasing the current level of the property tax, which you call ‘the rates’ in Hong Kong, to a larger share of the rental value of the property. That would also help raise the cost of investing in property and reduce some of the speculative activity. And then the final thing, I think, which the government has already done over the course of this year, is to expand the amount of land that’s provided into the market for residential real estate development.

So all of those things working on the credit side for the financial system, working on the tax side to dissuade speculation, and working on the supply side to provide more land to the market, I think all of those things together will, will help smooth out this property cycle.

Questioner: Thank you.

Ms. Wong: We have one more question from the floor.

Questioner: Hi. As you point out in the statement, one of the ways Hong Kong’s market has traditionally reacted to inflation restructuring if the market over-extends itself is through the labor market. Now, I guess since you concluded the consultations the minimum wage commission here has come up with a level for the new minimum wage, 28 dollars an hour. I wonder if I could ask you to comment, at that level, do you worry that it introduces an element of inflexibility into the labor market that would make it more difficult to adjust to any future deflationary shock?

Mr. Chalk: We supported the introduction of the minimum wage in Hong Kong, it’s clear that there’s a social demand for a minimum wage to protect low-income workers. We’ve argued that protection of low-income workers has to be balanced with, as you said, maintaining the flexibility in the Hong Kong system. It’s very important, given the linked exchange rate system, that asset, product and labor markets are able to adjust very flexibly to shocks. Now the level of the minimum wage that was introduced recently, we believe it covers around 11% of the workforce, we see that as reasonably consistent with maintaining flexibility in the labor market, there’s a large share of the labor market where that minimum wage is not binding. We do think it is important however, that were Hong Kong to be hit by a negative shock, a deflationary shock, that the system and the structure of the minimum wage would be able to move in both directions, both up and down in nominal terms, as the economic conditions change. So our sense is that this is an appropriate level that can be introduced now, assessed over the course of the next year or two, to see the impact on low-income workers and the low-income labor market, and then in a couple of years when there will be an opportunity to re-set the level of the minimum wage the government can look at that assessment and see if it is creating distortions in the market or if it’s overly constraining the flexibility of the labor market.

Ms. Wong: We have one more question on that side.

Questioner: Hello. In the report you said that the loose monetary conditions leading to faster credit growth. So I wondered, do you see the credit growth would accelerate for Hong Kong next year because of capital flow? And the other question as about the fiscal policy. You said that the fiscal policy has a role to play in dampening the attitude of the coming cycle, so may you elaborate more on this and you’ve also said in Hong Kong should discontinue, next year, to stop those temporary support measures, may I ask why?

Mr. Chalk: Let me talk first on fiscal policy. So what we see in Hong Kong is that when the financial crisis hit, the government appropriately stepped in with counter-cyclical fiscal policy through a number of measures in order to provide support to the economy. Now that was provided through temporary reductions in taxes, it was provided through reductions in public rental housing, rents and in things like “the rates” and lowering a number of other fees. There was also some support provided to the economy through loan guarantee programs for small- and medium-sized enterprises. That was perfectly appropriate when the financial crisis hit and the economy was in a down-turn and went into recession.

Now the economy is coming very fast out of the recession and so we think the government should be symmetrical in the way it applied fiscal policy and in being counter-cyclical. So with growth this year we project at around 6 and three quarter per cent and will still be high next year in the five to five and a half per cent range. Counter-cyclical policy means withdrawal of the stimulus put in place during the financial crisis, and those temporary measures now should be rolled back in the coming budget.

On the second question on credit growth, we do see quite a rapid pace of credit growth in Hong Kong now, it’s around, it’s a little bit less that 20%, with around half of that credit going into housing over the past year. It’s unclear whether that credit will continue to grow, and it really depends on a number of factors: one, on the attitude of the banks towards risks of that expansion of credit, usually when you see fast credit growth like that then the banks become concerned about the underlying quality of that credit.

It will be dependent to some extent on the regulatory response of the Hong Kong Monetary Authority, so for example if they were to further reduce loan to value ratios in Hong Kong, that would slow credit growth. And it depends to some extent on the demand for credit from households and that will depend on the economic circumstances.

There is a risk going forward that credit growth will continue at a fast pace and continue to go into property and that would drive the property market. As property prices go up, there’s more collateral available for those borrowers to use to further borrow based on the value of their housing. That cycle we’ve seen in many countries, it’s a cycle that ends up in amplifying the property price cycle. We think that there’s a public policy role to step in and try to mitigate that upswing, which is why we’ve discussed in the concluding statement a number of measures that could be taken by the government in order to do that.

Ms. Wong: Thank you. Is there more questions?

Questioner: I would to ask you thought on how Hong Kong’s development of offshore business, that is how (inaudible). Have you any forecast for the—

Mr. Chalk: I’m sorry we didn’t hear the question.

Mr. Mark: What we heard was how the developing of the Renminbi business, but we didn’t understand what you were asking for a forecast of.

Questioner: How positive is it to happen to Hong Kong’s financial market.

Mr. Chalk: I think it’s a very positive development that Hong Kong’s really at the centre of the internationalization of the Renminbi. It’s relatively small right now in terms of the volumes of trade that are being settled in Renminbi, and the share of deposits that are in Renminbi, but certainly the growth prospects in that area are quite large. Hong Kong’s already benefitted from having that unique status as a Renminbi offshore centre, you’ve increasingly seen foreign companies and Mainland companies coming to Hong Kong to issue bonds in Renminbi which increases demand for Hong Kong financial services.

The increased amount of trade settlement that’s now being financed through Hong Kong in Renminbi is also a very positive development, and the fact that now the Mainland government has allowed some of this Renminbi to flow back into local bond markets in the Mainland will also benefit Hong Kong. So this process is just beginning, it’s certainly got some momentum under it, there’s a lot of international interest in this internationalization of the Renminbi, and as an international financial centre this certainly plays to the comparative advantages of Hong Kong.

Ms. Wong: Are there more questions?

Questioner: Good morning. As we know that recently China is planning to have some measures to control the growth of inflation, like tightening the credit or increase the interest rate. Do you see there is any influence to the Hong Kong economy on the short-term?

Mr. Chalk: Certainly the Hong Kong economy in increasingly integrated with the Mainland and so anything that happens on the Mainland certainly will affect Hong Kong. I think the recent increase in food inflation in the Mainland, is directly relevant for Hong Kong. A lot of the imports of food are coming from the Mainland. We’ve done some research study which shows there’s quite a close link between inflation, particularly in Guangdong, and the food inflation that hits Hong Kong, so there’s a direct impact in terms of raising food costs into Hong Kong.

In terms of the steps that the government’s taken in the Mainland we’ve been very supportive of those. Even earlier this year we’ve been saying that the Mainland economy is growing very strongly, it’s really appropriate now that monetary stimulus be withdrawn, and we see this increase in interest rates on the Mainland as a positive development as supporting that withdrawal of monetary and credit stimulus on the Mainland. The increase in interest rates in the Mainland I don’t think has a really strong impact on Hong Kong directly though.

Ms. Wong: OK two last questions.

Questioner: You mentioned about the capital inflow to the region and(inaudible) in Hong Kong, so can you give like a rough estimation of how long it will last? And lately the sovereign debt crisis in Europe will it weight on Hong Kong economic outlook, or trigger some capital outflow, by any chance.

Mr. Chalk: I think it’s very difficult to predict the level and pace of these inflows into Hong Kong. It’s interesting to note that the majority of the inflows came into Hong Kong last year and since the beginning of this year the exchange rate has been towards the centre of the band and there hasn’t been a large surge of inflows. Certainly a more expansionary monetary policy, and expansion of the Federal Reserve’s balance sheet, in the United States will feed directly into Hong Kong as the exchange rate system is designed to do. Also one can imagine that if there were an increase in IPOs from mainland and foreign companies in Hong Kong that would also add to inflows. I think predicting that actual size of the inflows is quite difficult.

Questioner: Any sign of capital outflow? Like, given the European debt crisis?

Mr. Chalk: I don’t think we see any sign of those on the horizon, of flows coming out of Hong Kong, in fact I think Hong Kong’s generally perceived as a safe haven for flows. So when risk-aversion goes up we tend to find flows going into Hong Kong not coming out of them.

Questioner: You have given many comments about the property market, could you also say some words about the equity market because we can see the liquidity in the market is flowing into the property market or the equity market now. Do you see any disadvantage if the capital was suddenly flowing out of the region?

Mr. Chalk: Yes, certainly looking at the equity market, there doesn’t seem to be any sense of Hong Kong equity markets showing very high rates of increase. The Hong Kong equity market tends to move in line with border equity indices in Asia, and I think that reflects the fact that the Hong Kong equity market is actually a very internationalized equity market. It includes a large amount of capitalization from Mainland companies but also international companies from all over the world are there, so it tends to move in line with global trends, unlike the local property market which tends to be more driven by local factors.

So we don’t really see much asset price inflation in equities in Hong Kong. So far it seems to be largely concentrated in the property market. I should just say that the policies that have been taken so far on the property market have been very proactive in insulating Hong Kong. If you look at past cycles in Hong Kong where both property and equity markets move together, and you compare it to this cycle, I think it’s pretty clear that the government has acted much more preemptively this cycle. Having learned the lessons particularly of ’97, the government has moved to guarantee financial stability, and they’ve moved to make sure that credit is being conservatively given to borrowers in the property market. So if you look at this cycle in Hong Kong relative to other cycles, I think the Hong Kong economy is far better prepared than it ever has been in the past to withstand and absorb this kind of asset price, credit driven cycle.

Ms. Wong: Actually we have a very last question.

Questioner: In the report you mentioned that inflation for next year in Hong Kong, your prediction is about five percent inflation. So do you see that cooling down of the property price is the only way to lower the inflation prediction?

Mr. Chalk: Yes. Our inflation forecast for next year largely reflects the lagged effect of what property price increases have happened already in Hong Kong. As you know the mechanism by which this happens is that property prices tend to go up in Hong Kong, that then in turn drives up rents, but it takes some time for those rents to feed through into consumer price inflation because people tend to sign up for one or two year contracts on their rents, and they’re only adjusted periodically. So most of the inflation I think we see next year would be coming from rents feeding into consumer price inflation.

Having said that, the rapid pace of economic growth, the decline in unemployment, and the increase in food prices in the Mainland, all of those will also feed into inflation and that’s why we have a forecast of around 5% for next year which is probably higher than most other analysts. So it’s a combination of a fast-growing economy and an output gap that’s closing quite quickly, plus the increase in rents that you’re seeing in the Hong Kong economy feeding through into consumer price inflation.

Mr. Mark: OK, we’d like to thank you very much for joining us today for this press conference. I just want to say that we’re joined today by Keiko Utsunomiya who is the press officer in the IMF external relations department for the Asia Pacific region and she’s always available to assist you along with Ms Wong.

Ms. Wong: Thank you Jeremy. So thank you everybody for participating in today’s teleconference, again the content is embargoed until 11am. OK, thank you very much.


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