Here's proof that Hong Kong can tackle rate hikes should they come

Thanks to it being a highly leveraged economy.

Whether a highly leveraged economy like Hong Kong can handle higher interest rates has been a debated issue.

According to a research report from Hang Seng Bank, it sees little likelihood of a severe blow to the local economy when monetary tightening is underway.

It has three reasons: Forward guidance to reduce uncertainty; the health of the household sector depends on the asset side of the balance sheet as well; and it’s not all about the Fed.

Here's more from Hang Seng Bank:

Forward guidance to reduce uncertainty. The impact of the eventual rate hikes partly depends on how much the US Fed's forward guidance about its future rate increases has been built into market.

In our view, there has been enough advance guidance from the Fed to anchor interest rate expectations. The combined forces of reduced policy uncertainty and improved growth prospects in the US are likely to largely offset concerns over higher funding costs.

The health of the household sector depends on the asset side of the balance sheet as well. If assets exceed liabilities, households can afford to spend more over the rest of their lifetime.

In typical life-cycle consumption theory, household spending is not driven by debt but, instead, by net worth. It therefore makes little sense to focus solely on the liability side of the balance sheet. It is true that household debt has risen sharply over the past five years, but the pace of growth of liquid assets has been even faster.

The household debt-to-deposit ratio currently stands at a near decade-low of 14.3%, suggesting that domestic household balance sheets still look healthy in aggregate.

It’s not all about the Fed. A direct analogy to the rate hikes is the so-called ‘taper tantrum’ phase in the summer of 2013, when the Fed’s hawkish comments brought forward the expected timing of a rate hike and generated a sharp reaction in capital markets.

Hong Kong performed reasonably well during this period. Renewed capital inflows pushed up the value of the Hong Kong dollar, even though most other Asian currencies came under strong selling pressure.

It appears to us that the strength of the Hong Kong dollar lies in the city’s sound fiscal and balance of payment positions, as well as its role as a hedging instrument against greenback appreciation.

The key lesson from the 2013 experience is that non-rate factors are more important. If history is any guide, the economy should do well if normalising policy occurs in response to an improving economy.