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Hong Kong's economy could be in for a nasty surprise

Investors in Hong Kong may be in for a nasty surprise from mainland China.

Hong Kong "knows a thing or two" about boom and bust, says Harry Wilson in The Sunday Telegraph. Spectacular bubbles have been followed by huge crashes throughout its history, with low US interest rates often to blame.

The Hong Kong dollar is pegged to the US currency, so the former UK territory tends to import lax US monetary policy and the sector everyone rushes into is property. But this time the source of the problem is closer to home.

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Hong Kong "is in the path of a typhoon developing on the mainland", according to Sharmila Whelan of Asianomics.

On the one hand, mainland Chinese have been driving up property prices in Hong Kong so much so that the territory's citizens call the mainland investors locusts. And on the other, China's credit bubble, which has seen a rise in loans almost equal to the size of the entire US banking system since 2009, seems likely to cause a nasty downturn that would "severely buffet" Hong Kong.

Given the scale of lending, bad loans are set to pile up in the Chinese financial system. Nomura is especially concerned about the property market, with the number of ghost towns on the rise and developers running out of cash as the government tries to clamp down on lending.

The IMF notes that the ratio of residential construction to GDP reached 9.5% in 2012, higher than the peak in Japan and much higher than the US figure during the subprime bubble.

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This matters to Hong Kong because its exposure to the mainland has jumped since 2008. Before the global crisis, China had never represented more than 10% of the total external claims of Hong Kong-based financial institutions. But as the West slumped and recovers only very slowly, and the Chinese lending splurge took off, that changed fast.

By last year, China exposure was 49% of claims. One extreme example, says Wilson, is Wing Lung Bank. Its mainland loan book jumped from 8% of total loans to 40% in four years. "The danger to Hong Kong from its exposure to a Chinese crash is clear."

This is especially the case when you consider that the financial sector is several times the size of the economy, as Duncan Innes-Ker of the Economist Intelligence unit points out. It also accounts for almost half the stock market. Hong Kong may appear to be booming now, but investors may soon be in for a nasty surprise.

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