Hanging Tough
The new Chinese leadership of this former British colony faced its first real test on Thursday--a virtual collapse of its stock market that sent shivers around the globe. So far, the government handpicked by Beijing hasn’t blinked.
Fears that the Hong Kong dollar may be the next domino to fall to the Far East’s reeling economies caused interest rates to rocket as the government defended the currency, prompting investors to bail out in droves. At day’s end, the Hang Seng index closed at 10,426.30--a one-day tumble of 10%. The fall caps a decline of nearly 25% in less than a week and a drop of nearly 40% since early August.
Until now, Hong Kong has been an oasis of economic strength in a region roiled by devaluation and market turmoil. The Hong Kong dollar is the only currency left in the area whose value has remained fixed versus the U.S. dollar. Although this protects Hong Kong purchasing power, it also makes the territory’s exports and the cost of doing business here more expensive--and less competitive--compared with its southeast Asian neighbors that have devalued their currencies.
Yet while investors quaked this week, Hong Kong’s leaders declared they were prepared to see even more stock losses in order to maintain a stable currency.
“There is tremendous determination on the part of the Hong Kong government to maintain the exchange rate. We have every confidence this can be done,” said Chief Executive Tung Chee-hwa, in London on an official visit. “Interest rates have gone up, and as a result there is a short-term repercussion on the stock market. This is to be expected.”
Many banks raised prime rates by 75 basis points to 9.5% on Thursday. Hong Kong overnight interest rates between banks surged to 200% at the close, after trading at 6% Wednesday morning.
For now, the government’s decision to stand firm is working: Despite Thursday’s stock market sell-off, the Hong Kong dollar early today held firm at about 7.73 to the U.S. dollar, and short-term interest rates fell from 200% to 50%. The stock index rose 2.6% in early trading.
But the risk of high interest rates is extreme in an economy so heavily dependent on real estate and the banking sector. Dramatically higher rates will devastate property values that are already seen as too high, creating profound problems for lenders. The upshot could be a deep recession or worse.
The decline of the stock market may be most frightening for China, which relies heavily on Hong Kong as a source for capital investment in its fast-growing economy. Now, with ultimate control over Hong Kong since its return by the British on July 1, the Chinese face the unfamiliar predicament of having to maneuver through a market crash.
China had been relying on confidence in its newly announced economic reforms and the Hong Kong market to boost its listing of government-backed China Telecom on Wednesday in New York and Thursday in Hong Kong.
But in an embarrassing debut, the stock slipped 9% in Hong Kong trading Thursday, making it the first red chip to fail to open at a premium.
Although the Bank of China has reportedly been quietly supporting the market, especially the China Telecom debut, Beijing publicly declared its confidence in Hong Kong on Thursday and resolved not to intervene.
“At the end of the day, it would not help confidence, even though China has lots of reserves,” said Diahann Brown, a senior fund manager at Thornton Management Asia Ltd. “If China can step across the line to protect Hong Kong, it can also interfere.”
Hong Kong says it has reserves of at least $88 billion and China has reserves of $120 billion with which to defend the currency.
Other red chips, or China-backed companies listed in Hong Kong, dropped nearly 30% Thursday, but bounced back for a final loss of more than 10%, on par with Hong Kong’s blue chips.
“The China concept has taken a big hit over the last weeks,” said Dave Harris, in the equity sales department of a prominent U.S. brokerage house. China will have trouble finding money in the region because the red chips are perceived as being overvalued, he added, which may mean a slowdown in privatization plans.
While Hong Kong officials remained outwardly calm, others were more excitable. On the fourth day of the largest drop in the Hong Kong index’s history, Ma So-kwang, a worker at a foreign exchange counter, held his head in his hands. “Oh, it was a bad day,” he moaned. “I lost a fortune.”
Throughout the day, crowds jostled in front of market screens in bank windows to watch the Hang Seng index’s steady decline. Investors programmed their beepers and cellular phones to provide a regular readout of stocks’ performance and to sound an alarm when the index hit a preset sell level.
In Hong Kong’s legislative council meeting Wednesday, lawmakers slipped away from a resolution praising Tung’s leadership to watch market reports on television and to telephone their brokers. In the same building, Chief Secretary Anson Chan held a quiet meeting with Treasury Secretary Donald Tsang to decide their course of action.
Chan, who is standing in for Tung while he is in Europe, acknowledged that Hong Kong is not immune to regional economic troubles but told investors not to panic. “Hong Kong cannot escape being affected in the short-term by what’s happening in the region,” she said Thursday, adding that “our fundamentals are very strong.”
Despite Hong Kong’s prudent monetary management and massive foreign exchange reserves, the dollar’s competitive weakness has attracted speculative attacks. The government’s defensive move in boosting interest rates seems to have stemmed some of the short-term borrowing necessary for such attacks. But the strategy has a cost.
“I don’t think the peg will break, but it’s going to change the economy fundamentally here,” said Andy Xie, an economist at Morgan Stanley Asia in Hong Kong. He predicted that high interest rates would knock property prices down and dampen consumption and growth for the year. “But it’s not terrifying like in southeast Asia.”
For Hong Kong’s millions of small investors, it’s scary enough. In this financial center, where 80% of the population is in the service sector, nearly everyone, from the tycoons to the chauffeurs, plays the stock market or is affected by it.
Hong Kong is nervously waiting to see where the drop will end.
But at least one person here is feeling smug. Jimmy Ho, a doorman at one of the territory’s five-star hotels, sold everything last week. He works at night, leaving him free during the day to monitor his stocks on his home computer. He still remembers the exact level of the market when it crashed in 1973, wiping out all his savings.
“I learned my lesson then,” he said, clad in a red uniform with gold braid epaulets. “In Hong Kong, people think the market goes up, up, up to heaven. Maybe this time they will learn that the market goes up and it also goes down.”
More on Markets:
* What the crisis might--or might not--mean for the U.S. bull run. A1
* The panic in Hong Kong spooked exchanges around the world. A1
* Broader U.S. indexes sank by 2%, just slightly less than the Dow. D6
