VZCZCXRO8541
PP RUEHCN RUEHGH
DE RUEHHK #2472/01 1651046
ZNY CCCCC ZZH
P 141046Z JUN 06
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC PRIORITY 7275
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC

C O N F I D E N T I A L SECTION 01 OF 02 HONG KONG 002472 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EAP/CM AND EB 
TREASURY FOR OASIA GKOEPKE 
STATE PASS USTR 
USDOC FOR 4420 
NSC FOR WILDER 
 
E.O. 12958: DECL: 06/14/2031 
TAGS: ECON EFIN HK CH
SUBJECT: INTERPLAY OF U.S. INTEREST RATES AND LOCAL STOCKS 
COULD DELAY CHINA BANK LISTING AND SLOW HONG KONG'S ECONOMY 
 
Classified By: Chief Simon Schuchat; Reasons: 1.4 (b/d) 
 
 
SUMMARY/COMMENT 
--------------- 
 
¶1. (C) Driven by jitters over the direction of U.S. interest 
rates, Hong Kong stocks have seen double-digit declines over 
the past month, in line with the sell-off affecting other 
Asian exchanges and, to a lesser extent, the U.S. markets. 
This city's economy, however, is heavily oriented towards 
finance and property, and it is therefore particularly 
sensitive to higher U.S. interest rates as well as negative 
market sentiment.  Among the views of our contacts: a 
continued market decline could delay key listings planned for 
this year, including the Industrial and Commercial Bank of 
China (ICBC), which is reportedly aiming to conduct an 
initial public offering (IPO) in September.  Continued local 
uncertainty about U.S. Federal Reserve interest rate policy 
is driving investors out of the market ad leading those who 
stay in to more heavily discont stocks seen as relatively 
risky.  If upcomingU.S. inflation data leads to 
greater-than-anticiated Fed tightening, Hong Kong will be 
affected mmediately because its currency is pegged to theU.S. dollar, local mortgages tend to be adjustable-ate, and 
the city's wealth is heaily invested in local property.  The 
jury is still out, however, on whether the combination of 
anxiety about U.S. interest rate policy and stock declines 
has already become an economic force in its own right. 
Further, with recent broad-based and above-trend growth (8.2 
percent GDP expansion in the first quarter), Hong Kong 
probably has some wiggle room even if negative market 
sentiment is sustained for an extended period. END 
SUMMARY/COMMENT 
 
SHARP DOWNTURN, LIKE OTHER ASIAN EXCHANGES 
------------------------------------------ 
 
¶2. (U) Hong Kong's main stock index, the Hang Seng (HSI) hit 
a six-year high on May 8 and has since seen a double-digit 
decline, as has the Hang Seng Chinese Enterprise Index 
(HSCEI).  The local slide is in line with other key regional 
markets, with the notable exception of Shanghai, whose 
positive performance reflects ongoing reforms as well as the 
closed nature of China's capital account: 
 
Index                               Percent Change 
                                     Since May 8 
 
Hong Kong (HSI)                         -11.9 
Hong Kong China Stocks (HSCEI)          -19.2 
Shanghai (SSE-CI)                         3.2 
Japan (Nikkei)                          -19.8 
Korea (Kospi)                           -17.1 
Taiwan (Taiex)                          -15.2 
London (FTSE)                           - 9.0 
US (S&P 500)                            - 7.6 
 
 
HOLDING THE FED RESPONSIBLE 
--------------------------- 
 
¶3. (C) Conventional wisdom ties the recent global sell-off 
primarily to concerns about the scope of U.S. inflation and 
direction of interest rate policy.  Beyond the data itself, 
however, is the question of how market participants perceive 
the actual clarity of Fed policy in the wake of Chairman 
Bernanke taking over from Alan Greenspan, according to a new 
Deputy General Manager at Hang Seng Bank, Andrew Fung.  Fung 
was highly critical of what he termed "unclear signals" from 
the Fed, suggesting that a lack of obvious direction with 
regard to interest rates has generated unnecessary confusion 
and volatility for global markets that is itself creating 
economic harm.  Fung said that as far as Hong Kong's market 
is concerned, it will be difficult to restore confidence 
among investors.  Fund managers have now become excessively 
pre-occupied with protecting themselves from further losses 
that threaten their performance.  Consequently, they are 
differentiating risk among investments in more pronounced 
ways, and many are staying on the sidelines, particularly by 
parking money in lower-risk bonds.  Even if uncertainty about 
interest rates cleared up tomorrow, many players would stay 
out of the market for at least several months, according to 
Fung.  Of course, if adverse U.S. inflation data comes out 
 
HONG KONG 00002472  002 OF 002 
 
 
and the Fed actually does tighten more than expected, 
prospects for stocks in Hong Kong would be very negative for 
the rest of the year, he said. 
 
DELAY IN INITIAL PUBLIC OFFERINGS? 
----------------------------------- 
 
¶4. (C) Fung believes that market sentiment has already 
changed so significantly that Hong Kong is unlikely to look 
attractive to IPO issuers for months to come.  Noting that 
ICBC reportedly plans a listing in September, Fung predicted 
the bank would delay it for two reasons.  First, it may be 
hard to raise the money ICBC is looking for in a declining 
market.  Second, there is an issue of "ego" involved:  the 
Bank of China just had a very successful IPO priced at 2.2 
times book value.  Fund believes ICBC will only be willing to 
go forward if it believes it can match or exceed that figure. 
 Backing up Fung's sentiment about an IPO downturn are 
reports that local property developer Shui On Land has had 
lackluster response to its IPO (underway this week), and that 
Henderson Land is set to delay its listing of a real estate 
investment trust, originally anticipated to take place later 
this month. 
 
AN ARGUMENT FOR OPTIMISM 
------------------------ 
 
¶5. (C) Standard Chartered Global Economist Tai Hui displayed 
an optimism that contrasted with Fung's negative sentiment. 
Concerning IPOs, Hui believes that it is faith in the issuers 
themselves that will determine the success of new offerings. 
Based on the Bank of China's recent success amidst a falling 
market, both institutional and retail investors are likely to 
warmly embrace ICBC's debut, which Hui doubts will be 
delayed.  Shui On's IPO was perhaps over-valued to begin 
with, and Henderson's delay may be attributable to unrelated 
business issues.  As for the direction of Hong Kong's stock 
market, Hui predicted choppy weeks ahead, but argued that 
there has been no change in the positive fundamentals 
underpinning the companies trading here.  In his view, 
markets were too optimistic in early May with regard to 
global inflation and monetary tightening trends.  Now they 
are overdoing it in the other direction.  Hui also pointed to 
the role of hedge funds, whose trading patterns during this 
period of uncertainty are likely increasing market 
volatility.  He suggested that that stabilization will come 
for Hong Kong and other regional markets, perhaps as a result 
of inflation data from the U.S. Fed turning out weaker than 
feared or a revised perception that the Fed has indeed 
reached the end of its tightening cycle.  Hui acknowledged 
that he and his colleagues at Standard Chartered stood out as 
more optimistic concerning these trends than many other 
forecasters. 
 
EFFECT ON HONG KONG 
------------------- 
 
¶6. (SBU) Much of Hong Kong's wealth is tied up in property. 
Consumer demand among the middle and upper classes here is 
vulnerable to changes in interest rates, which affect 
payments on adjustable mortgages.  Because the local currency 
is pegged to the U.S. dollar, local interest rates rise and 
fall with those in the U.S. (barring temporary variances 
caused by surges of speculative capital).  As a result, Hong 
Kong stands to be affected significantly by U.S. inflation 
data and interest rate decisions. 
 
¶7. (SBU) Local economic growth, however, has recently been 
broad based and above trend, so there is likely significant 
wiggle room, even if market sentiment remains negative for an 
extended period.  The 8.2 percent first quarter GDP growth 
capped off two years of impressive expansion, much of it 
fueled by China's continued high rate of growth.  Most 
analysts expect that determined moves in the mainland to slow 
loan growth and avoid overheating in specific sectors will 
dampen economic activity here as 2006 progresses.  A 
continued rise in U.S. interest rates would add to that 
effect.  That said, local investment banks continue to plan 
on 6 to 7 percent growth this year and none have reduced 
their projections based on concerns about a negative wealth 
effect caused by recent uncertainty in local financial 
markets. 
Cunningham