Hong Kong's Misguided Response to Property Bubble

Hong Kong has for 170 years been the benchmark for capitalist free markets. No tariffs, no exchange controls, no nationality or residence restrictions on ownership of property, no extra taxes for foreigners. But suddenly the territory Kong is acquiring capitalism with Chinese characteristics.

In a panic move to try to raise his own low level of popularity and address concerns about rapidly rising property prices, new Chief Executive C.Y. Leung has imposed a 15 percent tax on purchases of residential property by those who are not permanent residents. This is largely aimed at mainland investors as other non-permanent residents are only a small part of the market.

The move is quite unprecedented and raises questions about Hong Kong’s general commitment to the other economic freedoms which it has so long enjoyed. From the very beginning of British colonial rule, official policy had been to encourage all forms of commerce and treating all nationalities as enjoying similar freedoms.

The move has led to an immediate steep drop in mainland interest in apartments, though it has yet to be see whether there is a significant and lasting impact on prices. Mainlanders still interested in acquiring Hong Kong property assets can anyway still buy office and retail space and items such as car parks.

The impact of mainland buyers is anyway probably vastly exaggerated. The main reason for rising prices is very low interest rates and the undervaluation of the Hong Kong dollar because of its peg to the US dollar and the prospect of at least another two years of exceptionally low rates as indicated by US Federal Reserve chairman Ben Bernanke.

In 2011 mainlanders accounted for just 6 percent of residential transactions and though the number had risen, it was perhaps to 10 percent overall and 20 percent for sales of new flats While significant at the margin, the mainland interest has clearly been of very secondary importance compared to low interest rates.

The longer-term factor at work has been the government’s years of deliberate starvation of new residential land supply, a policy aimed to keep prices high. Although the Leung government is addressing this, it will time for much new land to become available.

Nor are prices, at least in the context of interest rates, particularly outrageous. Although there have been some spectacular prices recorded at the top end of the residential market, those for mass market apartments in the New Territories have only recently surpassed those in 1997 at the height of the last boom.

Public unhappiness with rising prices is anyway far from universal. At least one third of the population is incapable because of low incomes on getting on the private housing ladder at all and will continue to rely on public rental housing – a shortage of which is another consequence of the policies of the previous administration. The measures also hurt Hong Kong residents who are happy to sell their apartments at recent high prices. And they will damage mainlanders’ view of Hong Kong as a safe and fair repository for their assets.

If Hong Kong can discriminate against non-residents in this way, why not impose higher taxes on them in other areas if that suits short-term political demands? The lack of top-level awareness of Hong Kong’s fundamental principles of taxation is alarming and blame must lie equally with Leung and with Financial Secretary John Tsang, who has been in the position for five years but whose budgets have been knee-jerk responses to particular situations rather than part of any coherent fiscal plan.

Leung’s position is also puzzling because his whole professional career has been as a property surveyor and he is thus well acquainted with the fundamentals of that market. So this move suggests a that he has a very shallow understanding of government and the need for consistency, and has so far also proved an inept politician despite a reputation for willingness to change policies and an ability to express himself coherently.

The anti-foreign tax came together with an extension from two to three years of a surcharge on stamp duties payable on sale of residential properties held for less than these number of years. Again this is an attempt to lay the blame for rising prices on “speculators,” the usual phantom demon trotted out by governments to cover their own failings or issues beyond their control. It is a bureaucratic interference with markets which has done absolutely nothing to stem rising prices since it was first introduced two years ago.

The one solution that the government is not willing to contemplate is changing the peg of the Hon Kong dollar to the US dollar at a fixed rate of about 7.8:1. That may be a reasonable position to adopt, but having done so it must accept the consequences, in this case too much cheap money courtesy of Ben Bernanke and a currency which looks cheap to mainlanders with their rising yuan.

The irony of this anti-mainland tax is that it is being introduced by a chief executive who has spoken much about the need for closer integration with the motherland and pushed for developments in the border areas and in transport links which would further integrate, at least with Shenzhen, a city where standards of living and governance are far below those in Hong Kong.

Hong Kong people are nervous about such physical integration. What they want to see maintained is Hong Kong’s difference, the difference that allows for free exchange, does not discriminate against non-resident money, personal or corporate, and sticks with long-established principles and practices. Certainty is a key ingredient of city states which rely on commerce. The decline in standards of administration in Hong Kong has been underway for a while. But this discriminatory tax introduced in the hope of short term political gain, is the clearest example of a leadership which has no clear idea of what Hong Kong stands for and how to ensure its future prosperity under the One Country Two Systems principle.