Hong Kong: Simmering along

IFR Asia - 20th Anniversary Special Issue 2017
5 min read
Steve Garton

Twenty years after colonial rule, Hong Kong’s relationship with China is once again a source of anxiety.

The years leading up to Britain’s handover of Hong Kong to China on July 1 1997 were an uncertain time for local residents. Despite the Sino-British commitment to an orderly exit and 50-year transition period, many local citizens were worried that China would send tanks over the border as soon as the British withdrew.

Around one million people emigrated from the territory between the signing of the Sino-British Declaration in 1984 and the handover date, many of them to fast-growing Chinese communities in Vancouver, Toronto, San Francisco, New York and London.

In the financial markets, investors were less concerned, sending the Hang Seng index to a record 15,196.79 on June 27 1997, the last trading day before the handover. Some economists were advising caution, noting that the run-up before the key date was driven mainly by mainland buyers rather than fundamental value. Others, however, saw that as a positive.

“We went through shock, denial and eventually acceptance before 1997,” said Paul Yang, head of Greater China at BNP Paribas. “Then we saw China investing in Hong Kong. If their intent was not to allow this liberal economy to continue, then why were they buying?”

The same rationale may apply today.

Political discontent, encapsulated in the 2014 “Umbrella revolution”, has brought Hong Kong’s relationship with China under the spotlight, and that focus is certain to intensify as 2047, the end of the 50-year transition period, approaches.

A 30-year horizon may seem distant today, but extensive infrastructure investments connecting Hong Kong and China could suggest that policymakers on both sides of the border are banking on the city’s long-term prosperity.

As well as high-speed rail links and a controversial bridge connecting Hong Kong to Macau and Zhuhai, mainland property developers have recently emerged as the highest bidders for several pieces of land in Hong Kong.

Shanghai rival

Arguably the biggest threat to Hong Kong’s role in the financing markets comes from Shanghai, where plans to allow international listings and the introduction of a free trade zone had raised fears that the mainland’s commercial capital could usurp Hong Kong as the international gateway to China.

Those plans, however, have failed to take hold. China’s State Council dropped any reference to an international board in Shanghai from its latest five-year plan, and business in the much-vaunted FTZ has hardly been brisk.

“It’s a great place to work if you want to collect mail,” quipped a senior banker at an international bank with operations in the zone.

Recent restrictions on capital outflows have also dampened expectations that China will bring down its financial borders any time soon.

In the immediate future, a sudden liberalisation would send mainland investors rushing into the strengthening US dollar, leading to massive capital outflows. In the longer term, many analysts believe China will selectively open international windows in Shenzhen, Shanghai or even Tianjin to ease the pressure, rather than liberalise the whole system.

A crisis, of course, could challenge that consensus. A dreaded ‘hard landing’ for China’s economy could tip its banks into turmoil and force regulators to open up to international capital sooner than expected.

Even in that scenario, Hong Kong’s long history as a global gateway for both inbound and outbound Chinese investment and its strengths as an international law jurisdiction mean any Chinese rival would have a long way to go to catch up.

“Hong Kong in 1997 was a unique window into China,” said Yang. “Today there are more ways in, but it is still very valuable to China.”

A new peg?

Hong Kong’s 20th anniversary as a Special Administrative Region of China has renewed the debate over the future of the city’s currency, which has been pegged at 7.8 to the US dollar since 1983.

Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis, argues that the tight dollar peg, through a currency board system, may no longer be appropriate as Hong Kong’s ties to mainland China increase.

“While Hong Kong is still linked to the US economy, such linkage is increasingly weaker while that of the mainland is clearly stronger,” she wrote on June 28. “It might be wise for Hong Kong economic policies to think of different strategies to deal with the choice of the currency to peg to, while maintaining the currency board regime which has benefited the city for so long.”

A peg to the renminbi would not work today because of the Chinese currency’s limited convertibility, but Garcia Herrero suggests Hong Kong could create a currency basket as an interim measure by introducing another liquid and relevant reference to the currency board.

In that scenario, she sees another politically charged currency as the answer.

“The obvious choice is the euro.”

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