The Past, Present and Future of Hong Kong

At a time when China looks poised to be the world’s largest economy beating the USA we explore the reasons why the Hong Kong protests hold so much economic as well as political significance for it.

BY RATTANDEEP SINGH                                                                                               6 Mins Read

Brief look at history

The journey of Hong Kong starts at the end of the Anglo Chinese opium wars when Britain won overwhelmingly and negotiated the then Qing dynasty into loosening trade and currency rules along with  handing over some obscure islands at the mouth of the Pearl river delta , which till then were not at all anything but some barren uninhabited islands. But when the Chinese handed over these obscure islands to the British (by the means of a 99 years lease), nobody would have thought of how tremendous their progress would be in the coming century.

Over the years these island came to be known as Hong Kong, and remained as one of the main trading centres of the British with the Chinese. After World War 2, the British moved to establish democratic policies along with a great degree of openness based on the ideals of the free market. This combination made Hong Kong to emerge as a great economic giant in the late 20^th century.

When Deng Xiaoping started a nationalistic campaign of reunification of China, the question of sovereignty of Hong Kong and Macau became large obstacles. But after continued back and forth, the Sino- British joint declaration was signed on 19^th December 1984. With this declaration it was made clear that Britain would hand over Hong Kong to China in 1997, while it was endorsed that Hong Kong would continue to enjoy its democratic freedoms till at least 2047 under the one nation two systems framework.

In 1997 when Hong Kong was finally transferred to China, it was an economic giant. Having closely integrated its economy with global supply chains, Hong Kong was a hub of electronic exports. Along with the free market system prevalent in Hong Kong, it was a trade hub for the Chinese as they would use Hong Kong as a base to reach out to the world. It is important to note that Hong Kong made up about 19% of China’s total GDP at a time in the 1990’s , but now with the exponential rise of China in the last 3 decades the economic contribution of Hong Kong has shrunk to just 2.7% .

The true economic significance of Hong Kong.

Even though Hong Kong makes up just a fraction of Chinese economy, the contribution of Hong Kong in China’s exponential rise has been too good to ignore.  As Hong Kong reels under the disruption caused by the pro democratic protests, which started in response to the proposed Hong Kong - China extradition treaty bill have now transformed into a do or die situation where Hongkongers view this as the last chance to save their city's autonomy and preserve their democratic freedoms. This has made business particularly hard for the financial services sector which plays a huge and dominant role in the functioning of the Hong Kong economy. This uncertainty has its effect on the economy , which is on the verge of a recession , with its GDP having contracted for the last 2 quarters and on the same path for the 3rd quarter as well. While Hong Kong struggles to get things back into order given the recent protests by pro democratic Hongkongers it has been a hard run for its exceptionally large and dominant financial sector.This new uncertainty throws a host of challenges for China as well.

Ignoring the political aspects, the economic value of Hong Kong is truly enormous for the Chinese economy. Given its free market system, liberal tax regimes, robust trade rules and its economic intertwining with the Chinese mainland investors have long used Hong Kong as a hub to do almost everything with china, be it trade, foreign direct investments or stock market issues raising enormous sums of money from the public.

To talk numbers, we should look at the amount of loans given out by Hong Kong to the mainland which amount to about 725 billion dollars. Hong Kong has been a home to about 73 percent of all IPO's launched by the mainland companies. Last year Chinese companies raised 64 billion dollars of funds through IPO’s out of which about 35 billion came from Hong Kong with about 20 billion contributed by Shanghai and Shenzhen combined. Even now Alibaba has launched an 11 billion dollars IPO in Hong Kong which shows the real significance of Hong Kong’s capital markets.

Even the Shanghai and Shenzhen stock exchanges which aspire to beat Hong Kong have established connect schemes with the Hong Kong exchange whereby foreign investors can trade mainland stocks on Hong Kong exchange.

In case of debt financing and the bond markets, Hong Kong continues to be the largest market for Chinese firms to raise money through offshore financing. Last year Hong Kong contributed about 33% of all the offshore funding received by Chinese firms (totaling 165.7 billion dollars).

The Chinese government has made Hong Kong the face to take an active part in global bond markets with annual flows of around 10 trillion dollars.

The Chinese mainland banks in Hong Kong have been continuously growing their assets and now hold the largest portfolios amounting to over 1.2 trillion dollars.

And losing out your largest funding source at a time when the mainland economy is already slowing would not be in China’s best interests. Hong Kong handles the largest share of the services sectors with respect to China contributing about 20% even larger than the US's 17% according to China’s commerce ministry.

Another very important area is the internationalisation of the Yuan. Here China hopes to leverage Hong Kong’s Forex markets in order to pave way for greater acceptance of its currency and to reduce its reliance on the US dollar. Given China’s closed market and strict capital controls as of now the yuan’s convertibility to the Hong Kong dollar is crucial to enable trust in the yuan and to ensure more liberal trading and settlement systems

One of the many important reasons why China would like to keep Hong Kong intact is that both Shanghai and Shenzhen are still nascent compared to Hong Kong and would not be able to cope up with the huge pressure that would be created upon them following the downfall of Hong Kong.

Moreover it plays to China’s interests to keep its firms on Hong Kong rather than allowing them to go to New York or London as Chinese authorities have larger control over transaction in the Hong Kong markets when compared to dealing that take place in other offshore markets. This aspect of control that is exercised by the Chinese authorities is also pivotal to why China would not like Hong Kong to fall apart as a financial center.

Conclusion

All these benefits provided by the Hong Kong’s free markets contributes to a systemic arbitrage. This arbitrage provided by Hong Kong is something China values very much and would not like to erode very rapidly as it takes time to build alternative systems , which China is already building in the form of Shanghai and Shenzhen. Even though the protests lead to a systematic demise in Hong Kong’s advantage over China, China would be happy to see the mainlandization of Hong Kong as it translated to greater control and would mean that Hong Kong’s role is exceedingly taken on by the cities of Shanghai and Shenzhen which remains China’s top objective when it comes to its economic policy regarding Hong Kong.