Heavy Private Debts May Cause the Next Crisis in Hong Kong — the Quiet Panic

Kyle Bass (2019) has recently submitted a letter to the Wall Street Journal titled “The Quiet Panic in Hong Kong” to discuss the origins of Hong Kong’s impending crisis. Even though some of the data may have to be verified, the overall analyses of the causes of the impending crisis are interesting and relevant.

A. Credit-fuelled Asset Boom

First and foremost, almost all financial crises are heavily related to debts, Hong Kong’s impending crisis is no exception. Figure 1 shows the sharp increase in Private-Credit-to-GDP ratios between Hong Kong, the US and Japan, when the US and Japan were deleveraging after the Global Financial Crisis 2008, Hong Kong’s private-credit-to-GDP ratio has grown from about 170% to over 300% in 2018.

The reasons for such a substantial increase in private debts are directly related to the currency board arrangement of Hong Kong, thus it is unique for Hong Kong. When currency peg met with an ultra-low interest rate period, it incentivizes investors to arbitrage by borrowing HKD at a lower interest rate, and without currency exchange risk.

“ As a result of free money (Hong Kong’s overnight lending rate was roughly 0.5% for 8 years), Hong Kong’s residents, banks, and companies did what anyone would expect them to do: they borrowed, geared, and levered. Hong Kong private sector leverage is now the highest of any nation in the world. In 2010, Hong Kong grew its GDP 7% while its interest rates stayed at emergency levels with the US at zero.” (Bass, 2019)

Figure 1 Private Credit to GDP Ratio of HK, USA and Japan, 1978–2018. Source: Bass (2019)

Furthermore, it is particularly attractive for China investors to borrow in Hong Kong and invest in Mainland China, as debts are highly regulated and required a much higher interest rate than that in Hong Kong:

“Its currency peg to the USD forced Hong Kong to import US monetary policy, while its largest trading partner (China) was preparing to grow credit to the tune of half its economic output in a desperate effort to stimulate GDP growth. Thus, in 2008, interest rates in Hong Kong collapsed essentially to zero in lock-step with US interest rates, while China began an aggressive credit expansion. …Free money in Hong Kong and double-digit credit growth in China drove the greatest economic expansion Hong Kong will ever experience.” (Bass, 2019)

Thus, Bass (2019) contended that “Hong Kong’s banking system is one of the most levered in the world at approximately 850% of GDP (with 280% of GDP being lent directly into mainland China).”

Figure 2 Bank Assets to GDP Ratio HK, 1991–2018. Source: Bass (2019)

However, I cannot find the data that match the figure. If I refer to Census and Statistics Department’s data on Gross External Debt and GDP, I found that the latest Gross External Debt to GDP Ratio in 2018 was 466%, and the Banks’ Lending to GDP Ratio was 293%, as shown in Figure 3. The Ratios are increasing and have almost been doubled in the past 15 years.

Figure 3 External Debt to GDP Ratios HK, 2002–2018. Source: Census and Statistics Dept (2019)

Having said that, Bass’s (2019) worry on the heavily levered banking sector is still valid. Figure 4 shows that Banks’ Lending to Gross External Debt Ratio has been stable at about 60% to 70% in the past decades, which is the overwhelmingly dominant sector in Gross External Debt of Hong Kong. The next two sectors are intercompany lending (about 15%) and other sectors (about 20%).

Figure 4 Sectoral Debt to Gross External Debt Ratios HK, 2002–2018. Source: Census and Statistics Dept. (2019)

In contrast, the Government Debt to GDP Ratio and the Household Debt to GDP Ratio are relatively modest. For example, the latest Government DTGR (2018/3) and Household DTGR (2018Q3) are just 42.5% and 70%, even though both have been increasing in the past decade. HKMA (2018a) has also published an article to defend the financial stability of public debts and household debts in Hong Kong (for details, see my article Yiu, 2019).

B. Aggregate Balance and HIBOR

Bass (2019) also identified the following 3 recent phenomena that jeopardize the financial stability of Hong Kong: “the highest leverage on record, mortgage loans that float and reset monthly, and rising rates”. The situation is acute because “the HKMA has spent 80% of their reserves [aggregate balance] over the past year or so.” Figure 5 shows the negative relationship between the aggregate balance and Hong Kong Interbank Offer Rate (HIBOR). Thus, if Bass (2019) contended that if the aggregate balance continues to drain, HIBOR will continue to spike. When the aggregate balance goes to zero, then the banking system could collapse, and warns that “Hong Kong currently sits atop one of the largest financial time bombs in history.”

Figure 5 Negative Relationship between HIBOR and Aggregate Balance of Hong Kong. Source: Bass (2019)

Yet, besides aggregate balance, HKMA (2018b) posited that there are still about HK$1,053.7 billion Exchange Fund Bills and Notes in the Monetary Base, as shown in Figure 6. The total net fund outflows in these years accounted for less than 20% of all the past inflows since 2008.

Figure 6 Aggregate Balance and Exchange Fund Bills and Notes HK, 2008–2018. Source: HKMA (2018b)


Bass, K. (2019) The Quiet Panic of Hong Kong, Letter to Wall Street Journal, 25 April. https://www.zerohedge.com/news/2019-04-25/quiet-panic-kyle-bass-hong-kongs-looming-financial-political-crisis?fbclid=IwAR3tnSxENmlHjw0kvhYMdpn6l9nuuNyCoJK6bXd0pc1Ct63mNHsCNG8y72Y

Census and Statistics Department (2019) Gross External Debt and GDP. https://www.censtatd.gov.hk/hkstat/sub/sp260.jsp?tableID=044&ID=0&productType=8, https://www.censtatd.gov.hk/hkstat/sub/sp250.jsp?tableID=030&ID=0&productType=8

HKMA (2018a) Understanding Household Indebtedness in Hong Kong, Sep 14, Research Memo 07/2018, Hong Kong Monetary Authority. https://www.hkma.gov.hk/media/eng/publication-and-research/research/research-memorandums/2018/RM07-2018.pdf

HKMA (2018b) Briefing to the Legislative Council Panel on Financial Affairs, Nov 5. https://www.hkma.gov.hk/media/eng/doc/about-the-hkma/legislative-council-issues/20181105e2.pdf

Yiu, C.Y. (2019) Credit-fuelled Asset Price Boom, Mar 19, Medium. https://medium.com/@edwardyiu/credit-fuelled-asset-price-boom-4d2a002f280c

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