[HONG KONG] Surging investment from mainland China has jolted Hong Kong's stock market from the doldrums, but the volatility of such flows, driven by an unfamiliar breed of investor, presents new risks to the stability of the city's economy and currency.
A Reuters analysis shows that Chinese investors have moved a net US$68 billion into Hong Kong-listed stocks via the Shanghai-Hong Kong stock connect programme since its launch in November, the vast bulk of it during just a few days in April.
That new money, plus tens of billions of dollars from a separate channel for Chinese institutional investors and untold flows from Chinese-controlled offshore funds, has helped push the market's capitalisation to HK$28.6 trillion (S$5 trillion) in April from HK$25.5 trillion in November.
That is driving profits in Hong Kong's financial industry, presenting opportunities for companies to raise capital and perhaps boosting consumer confidence.
But this tide of cash can flow out as quickly as it flowed in, especially if investors conclude the rally has run too far ahead of the slowing economies on both sides of the border.
"With the help of China's opening up, Hong Kong's status as a global financial centre has been enhanced. However, its economy is also entering into a bubble cycle, and it's just the beginning," said Raymond Yeung, analyst at ANZ in Hong Kong.
The Shanghai Composite Index has gained over 70 per cent since late November when the central bank made a surprise cut to interest rates, and the rally began overflowing into Hong Kong stocks in April, pushing the Hang Seng index up more than 11 per cent so far this month to a seven-year high.
"(Inflows) will add pressure to the already high property prices and cause inflation," said Yeung. "It will also bring more risks when sudden capital outflows happen."
According to exchange data, 62 per cent of mainland Chinese investors in Hong Kong in 2014 were ordinary retail investors, who tend to behave very differently to the institutional fund managers Hong Kong is accustomed to.
On average, domestic Chinese investors hold a stock for as little as 24 days, compared with 260 days in Hong Kong, UBS analyst Lu Wenjie said in a research note. "These two groups of investors are totally different, and there will be certain chemical reactions as they meet," wrote Charles Li, CEO of the Hong Kong exchange (HKEx), on his blog.
HKEx data for 2014 shows mainland investors made up only 5.1 per cent of its total cash market trading by value, lagging institutional funds from the UK and United States, which together accounted for over 20 per cent.
But that equation is changing rapidly.
The stock connect scheme means Chinese investors can invest up to 250 billion yuan (US$40.3 billion) in Hong Kong markets, and that quota is expected to be widened this year. And the Chinese flows are amplified by foreign money riding on its coat tails.
All of which has pushed volatility in the Hong Kong and Shanghai bourses to record highs, producing wide price swings.
The potential for vast and sudden moves of liquidity in and out of the Hong Kong dollar will also complicate monetary policy.
Hong Kong operates one of the world's last remaining currency pegs to the U.S. dollar, which means it must buy or sell dollars when the currency looks set to exceed its daily trading band.
In recent days, the Hong Kong Monetary Authority (HKMA) was forced to intervene multiple times as demand for Hong Kong dollars spiked. "Invariably the investment opportunity at any one time will be on one side or the other, and this is likely to create sudden inflows and outflows that will put pressure on the Hong Kong dollar peg," said Francois Perrin, head of Greater China Equities for BNP Investment Partners.
Two individuals familiar with the exchange's thinking said Hong Kong, not Beijing, had originally requested the imposition of quotas for the programme for fear an exodus of capital into China could put pressure on the exchange's trading system and the dollar peg.
HKEx said the quotas "were mutually agreed between the regulators and the exchanges as a means of managing risk in the initial stages".
HKMA declined to directly answer questions related to the impact these flows might have on monetary strategy, but reiterated its policy to "monitor the market developments closely and maintain the stability of the Hong Kong dollar".