Investment bank Nomura warns in a report that early warning indicators signal a crisis within the next three years, with Hong Kong and mainland China being the most vulnerable economies at risk of a financial crisis.
“The world’s second-largest economy, to which the rest of Asia is very exposed, is flashing several signs of vulnerability,” analysts Rob Subbaraman and Michael Loo wrote in the report released on Wednesday.
“Whether China is willing to tolerate some short-term pain for long-term gain, by persevering with deleveraging, closing zombie companies and letting markets play a more decisive role, remains to be seen. The one thing that is clear is that the longer China delays, the bigger the risk of disruptive adjustments from which the contagion to the rest of Asia could be substantial.”
The report noted that various indicators have reliably signaled at least two-thirds of the past 50 financial crisis in a sample of 30 countries with data going back to the early 1990s. The indicators include ratios of private credit to gross domestic product (GDP), private debt to service ratios, effective exchange rates and property and equity prices.
“Both Hong Kong and mainland China have large credit and real property gaps,” the report said. “Because the Hong Kong dollar is linked to the US dollar, [interest rates are] also at risk of rising sharply were the Fed [US Federal Reserve] to accelerate its rate hike cycle.”
“Studies of past financial crises show that they are more likely to occur when there are parallel credit and property market booms. As in 1996, this is the case in several Asian countries today,” the Nomura analysts wrote.