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A nation must think before it acts.
With anti-government demonstrations in Hong Kong showing few signs of abating, speculation is growing as to what China might do next. Already, China’s Hong Kong Affairs Office head warned, “If the situation worsens further, and there is turmoil that the Hong Kong government is unable to control, the central government absolutely will not just watch without doing anything.” To that end, Beijing has assembled thousands of paramilitary People’s Armed Police (PAP), China’s internal security force, just outside Hong Kong’s border. Were they to enter the city to quell the unrest, it would likely be a bloody affair. Largely unarmed, the demonstrators will likely get the short end of the stick.
Still, Beijing is unlikely to go unscathed. Of course, it would draw international condemnation. But China has borne that before, especially after the 1989 Tiananmen Square massacre. Far more damaging to China may be how its intervention would undermine the credibility of the “one country, two systems” formula. Under that formula, China promised to give Hong Kong autonomy in its internal affairs for 50 years after its return from the United Kingdom in 1997. While Beijing could do without Hong Kong’s individual liberties, it would have more trouble doing without the benefits from the city’s autonomy in economic and monetary matters. Unfortunately for China, the two are closely linked through Hong Kong’s legal system.
Then again, Chairman Xi Jinping and other Chinese Communist Party leaders may not be too worried. After all, Hong Kong’s economic value to China is not what it once was. Hong Kong’s share of China’s GDP dropped from 16 percent in 1997 to just three percent in 2018. Over the same time, Hong Kong’s contribution to China’s total exports fell from 24 percent to about 12 percent. And, whereas Hong Kong’s stock exchange had once raised more capital for Chinese companies than all of China’s other stock exchanges combined, that is no longer so. Shanghai’s stock exchange overtook Hong Kong’s for the first time in 2017.
While such financial metrics are telling, they also mask Hong Kong’s enduring value to China. Despite the Chinese government’s efforts to build up Shanghai into its premier global financial center, Hong Kong remains, in many ways, China’s window to the world. Why that is can be traced to Hong Kong’s special status. It has enabled Hong Kong to support transparent courts that enforce well-established rule of law. That, in turn, has created a stable environment for investment and given investors “a sense of comfort and safety”—an intangible asset that is well known, but often underappreciated. That is especially true for foreign investors. In fact, more—not less—of China’s foreign direct investment (FDI) is now funneled through Hong Kong than a decade ago, rising from less than half of China’s total FDI to 72 percent of it in 2018.
Hence, it should be no surprise that many foreign companies and investment firms continue to use Hong Kong as their jumping-off point for business in China. That works the other way, too. Because so many investors are in Hong Kong, China has been able to leverage them to accomplish some of its national goals, like internationalizing its currency, the renminbi. Since 2009, Hong Kong has become the leading international trading center for yuan. In addition to facilitating trade settlement in yuan, Hong Kong has helped China gain greater global acceptance by creating yuan-denominated debt products (so-called “dim sum” bonds, named after Hong Kong’s breakfast dishes). That has enabled Chinese companies to raise foreign capital without exposure to exchange-rate risk, which has become a pressing problem with China’s devaluation of the yuan past the 7-yuan-to-the-dollar level in August 2019.
Meanwhile, Hong Kong’s deep and robust secondary equity market has made it a particularly attractive destination for Chinese companies seeking to raise that sort of capital. Hence, after Shanghai’s stock exchange tightened its listing requirements last year, bringing them closer to Hong Kong’s, Hong Kong’s stock exchange quickly retook the lead over Shanghai’s in terms of the capital raised for initial public offerings (or IPOs) in 2018 and is on track to do the same in 2019. Even without Chinese government support, Hong Kong’s stock exchange can boast a market capitalization of $4.2 trillion, compared to Shanghai’s $4.5 trillion. More than any other financial center in China, Hong Kong has provided Chinese companies with access to global capital markets. And such financing is what has enabled many Chinese companies to move aggressively abroad over the last decade.
Their overseas expansion has allowed Beijing to spread its political influence across Africa, Central Asia, and Southeast Asia. Hong Kong’s ability to raise financing for large infrastructure projects is what China needs for its rebooted Belt and Road Initiative. Many of the BRI’s ambitious infrastructure projects are simply too big to finance through bilateral loans alone. As China’s economy slows and its budgets tighten, the BRI will increasingly need to lean on equity and debt markets to raise the necessary capital. The best place to do that is still Hong Kong.
Should Xi send PAP forces into Hong Kong, local and foreign investors are likely to see the action as the beginning of the end for Hong Kong’s special status and, specifically, for its legal system. After all, how long will it be until Hong Kong’s courts begin operating like those in the rest of China? As a result, a few foreign firms have already begun to move to other parts of Asia, like Singapore.
Ironically, it was not long ago, in November 2018, when Xi praised Hong Kong for helping China to economically develop. Hong Kong’s capital markets, he said, led “investing on the mainland, setting examples of how market economies worked and serving as test beds for innovation.” Xi even trumpeted his close association with and affection for Hong Kong.
And so, if Xi was to act, he would be doing so in spite of his awareness of Hong Kong’s value to China. No doubt Beijing will do its best to reassure foreign companies and investment firms that it will keep intact the features that made Hong Kong into one of the world’s top financial centers, whatever the tweaks it might make to the city’s legal system. That is unlikely to be entirely persuasive. Uncertainty will rise. And while higher uncertainty will not snuff out Hong Kong’s financial industry overnight, it may start to more closely resemble those in Shanghai and Shenzhen than New York and Tokyo.
Ultimately that would diminish China’s ability to easily raise capital, whether for corporate or BRI needs. That, in turn, would make China’s economy less flexible and reduce its ability to weather economic storms. But to Xi and other Chinese Communist Party leaders, using force to end the unrest in Hong Kong may be worth it, if only to serve as a warning to the discontented elsewhere in China. To the rest of the world, doing so would serve as a reminder of what Beijing’s top priority is (and always has been): political control, at any cost, even its own.
(Image Source: Studio Incendo/Flickr)