Effects of capital flow on the equity and housing markets in Hong Kong

• Date: 01 August 2017
• Author: Kenneth K. Chow,Yin‐Wong Cheung,Matthew S. Yiu
• Published date: 01 August 2017
• DOI: http://doi.org/10.1111/1468-0106.12233

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SPECIAL ISSUE ARTICLE

Effects of capital flow on the equity and housing

markets in Hong Kong

Yin‐Wong Cheung

1

| Kenneth K. Chow

2

| Matthew S. Yiu

3

1

CityUniversity of Hong Kong, HongKong

2

Hong Kong Monetary Authority

3

Hong Kong Institute for Monetary

Research, Hong Kong

Correspondence

Matthew S. Yiu, Hong Kong Institute for

Monetary Research, Hong Kong Monetary

Authority, Hong Kong.

Email: msfyiu@hkma.gov.hk

Abstract

The revival of strong capital flows to emerging econo-

mies following the global financial crisis in 2008–2009

has rekindled the debate on effects of excessive capital

inflows. We study the effects of official and illicit capital

flows on Hong Kong, which is a small and open econ-

omy with minimal restrictions on cross‐border fund

movements. It is found that the official and illicit capital

flow measures display a low level of comovement and

exhibit differential effects on Hong Kong's equity and

residential housing markets. The results highlight the

complexity of managing capital flows, and the relevance

of sector‐specific capital management policies.

1|INTRODUCTION

The 2008–2009 global financial crisis (GFC) led to severe economic stresses around the world. In

response, a few advanced countries, including the USA, introduced accommodative monetary

policies, dubbed quantitative easing (QE), to stimulate domestic demand and revitalize their

impaired financial markets. However, the QE programs raised concerns about overabundance

of global liquidity. It is estimated that from early 2009 to early 2013, the central banks in the

USA, the UK and Japan generated liquidity of US$3.95 trillion.

1

The excess liquidity triggered

capital flows to the rest of the world in search of good returns. Economies in the Asian region,

especially emerging ones, were among the most popular destinations for yield‐seeking capital.

2

The surge in global liquidity, and the related excess capital flows after the GFC, rekindled the

debate on the adverse capital flow effect on emerging markets.

3

Capital inflows usually help

1

The USA, for example, generated US$2.2 trillion liquidity between March 2009 and April 2013 (Yiu & Sahminan, 2017).

2

Aziz and Yarcia (2014) and Cho and Rhee (2013), for example, study the US QE effect on Asian economies.

3

For brevity, capital flows and cross‐border capital flows are used interchangeably.

Received: 26 January 2017 Accepted: 20 April 2017

DOI: 10.1111/1468-0106.12233

332 © 2017 John Wiley & Sons Australia, Ltd Pac Econ Rev. 2017;22:332–349.wileyonlinelibrary.com/journal/paer

deepen and broaden financial markets and provide additional funds for the economy. However,

policy‐makers in emerging Asian economies are extremely concerned about the economic

threats caused by unchecked and excessive capital flows that undermine the structural integrity

and medium to long‐term economic prospects of their economies. These threats are not only trig-

gered by QE, but also by a reversal and withdrawal of such policy. The potential danger of the

tapering policy is clearly illustrated by volatile responses of emerging markets to rumours and

discussions in mid‐2013 about the possibility of the US Fed to scale down its QE policy.

Studies on capital flows cover a range of issues, including their determinants, benefits and

costs. Some studies investigate what and how policies should be adopted to manage the effects

of capital flow. It is generally agreed that the effect on economic performance depends on both

the nature of the capital flow and the economic and institutional environment of the recipient

economy. Furthermore, capital flows can have non‐negligible effects on monetary and financial

stability and the real economy. Empirical studies, however, yield inconclusive evidence on the

net benefits of capital flows; see, for example, Obstfeld (1998), Levine and Carkovic (1999),

Edwards (2001), Reisen and Soto (2001), Berument and Dincer (2004) and Obstfeld (2007).

Capital controls of different forms have been imposed by different countries to curb capital

flows and, hence, their adverse effects. In general, researchers affirm that capital controls asso-

ciated with market interventions cause capital misallocation and inefficient use of resources,

which has severe costs in terms of long‐term growth and welfare. Despite this, capital controls

are still commonly used in some developing countries. The IMF in the early 2010s modified its

policy stance on capital controls. Several IMF studies expound that under certain conditions,

capital control measures and macro‐prudential policies provide protection against macroeco-

nomic and financial instabilities (Ostry et al., 2010, 2011; The Strategy, Policy and Review

Department, IMF, 2011).

4

However, Gochoco‐Bautista and Rhee (2013) argue the new IMF

framework is hard to implement. In summary, the emerging general consensus recognizes the

positive roles of macro‐prudential policies and capital controls in managing macroeconomic

and financial instability.

Hong Kong provides a good setting for assessing capital flows and their effects on the recip-

ient economy. Its minimal capital controls and large financial sector, one of the largest in the

world, mean that it is heavily exposed to international capital flows. In addition, it has adopted

the linked exchange rate (LER) system, a modern currency board system that has pegged the

Hong Kong dollar to the US dollar for more than 30 years. Limited exchange rate flexibility

and free capital mobility mean the effect of capital flow can quickly show up in its monetary sys-

tem and affect its real economy. Hong Kong must maintain a high level of economic flexibility

and adopt appropriate macro policies and suitable macro‐prudential measures to mitigate the

effects of volatile capital movement.

5

When capital flows into an economy, it will typically increase demand for local currency

assets, including bonds, stocks and real estate and push up their prices. In the case of Hong

Kong, equity and real estate property are among the most popular asset classes to foreign inves-

tors. The Hong Kong stock market is one of the largest in Asia and the world. It also ranks high

in global IPO and fundraising activities. The Hong Kong housing market is often deemed spec-

ulative and, from time to time, gets into the news for its high real estate prices. The price

4

Fernald and Babson (1999) and Yu (2009), for example, claim that capital controls insulated China from adverse global

financial volatility effects during crisis periods.

5

Darbar and Wu (2015) study the macro‐prudential policy of five economies, including Hong Kong.

CHEUNG ET AL.333

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