Nov 17

China Watch Blog has learnt that Hong Kong’s “rapid” credit growth has increased the risk that banks make bad loans as the city faces a potential recession if the European crisis deepens.

According to the International Monetary Fund (IMF), credit has been growing at an extraordinary pace, particularly for loans in foreign currency.

Such growth may “lead to a worsening of average credit quality” and create “strains on bank funding,” it said.

The US Federal Reserve’s pledge to keep borrowing costs at near zero through at least mid-2013 and credit tightening in China have spurred loan demand from Chinese companies in Hong Kong, where a currency peg means the city’s interest rates track those in the US.

Hong Kong Chief Executive Donald Tsang last week that there was a 50 percent chance the global economy would shrink next year and Hong Kong may see “a couple of quarters of bad times” as Europe’s debt crisis roiled markets.

While the development of offshore yuan business is “positive” for the city, growing deposits in the Chinese currency could intensify competition for deposits in other currencies that result in higher funding costs, the IMF said.

China needs to raise the convertibility of its capital account to encourage yuan repatriation as the offshore market continues to grow, it said.

The IMF expects Hong Kong’s economy will slow to 4 percent next year, down from 5.75 percent this year, on weaker export demand.

Should the European crisis worsen and bring a “sudden downside shock” that cuts global growth by 3 percentage points, the city will fall into recession and the city government should prepare to adopt immediate fiscal stimulus such as tax reductions, the fund said.

Hong Kong will take “appropriate measures” to stabilize its monetary and banking systems if necessary, Hong Kong Monetary Authority chief executive officer Norman Chan said in a statement in response to the IMF’s report.

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