BEIJING´S BIG BET IN HONG KONG / GEOPOLITICAL FUTURES

Beijing’s Big Bet in Hong Kong

The security law over Hong Kong raises the question of whether Beijing passed it from a position of strength or weakness.

By: Phillip Orchard


When Beijing retook control of Hong Kong from the British 23 years ago, the understanding was that Hong Kong would maintain a high degree of autonomy under the “one country, two systems” framework for a period of 50 years. On Tuesday, the Communist Party of China declared that that time was up. And it did so with striking ease. There was no bloody Tiananmen-style showdown between the army and pro-democracy protesters; no tanks inside Victoria Park.

Beijing merely had its rubber-stamp legislature unanimously approve a sweeping national security law – one first announced just a month ago and never released for public comment – bypassing the Hong Kong legislature in violation of the city’s mini-constitution, known as the Basic Law.

The move presages a dramatic deterioration of political freedoms in Hong Kong. The security law, which will be enforced by separate courts and security forces effectively controlled by Beijing, is conspicuously broad, meaning things like peaceful pro-democracy protests, anti-CPC editorials and school curricula that don’t toe the party line could realistically be defined as “separatism, subversion, terrorism and foreign interference.”

At minimum, uncertainty about how the law will be enforced will have a chilling effect on civil society in Hong Kong. Activists are already disbanding their organizations and bleaching their Twitter accounts. If China starts making full use of its powers, there’s not much anyone can do to stop it.

China, of course, could’ve done this years ago. The main reason it didn’t is that it benefits enormously from Hong Kong’s reputation as a stable, rule-of-law oriented financial hub – a reputation earned through the city’s autonomy and political freedoms. The national security law will undoubtedly undermine Hong Kong’s standing and capacity to facilitate the mainland’s financial needs, posing enormous risks to the already-teetering Chinese economy.

But Beijing is betting heavily on its ability to mitigate risks and walk the line between eliminating political threats from the city without burning the whole system down. Already, there are some signs that the conventional wisdom is wrong, that the Hong Kong business community has been bluffing. And if it’s wrong – if squeamish foreign firms and banks flee, or if the move accelerates China’s financial decoupling with the West – the CPC appears to be willing to say: so be it.

Still Indispensable

Hong Kong’s economic importance to the mainland has steadily diminished since China began to open and reform its economy. In 1993, Hong Kong’s economy was equal to 27 percent of China’s gross domestic product. Today, it's less than 3 percent. Last year, the GDP of Shenzhen province alone surpassed that of Hong Kong. China is hardly an easy place to do business, but thousands of foreign firms and investors in the country have found ways to get fabulously wealthy without Hong Kong anyway.

Yet, Hong Kong is still indispensable in several ways, including as a transshipment hub for Chinese exports. Perhaps its most important role is as the mainland’s foremost gateway for foreign investment, as well as a place for mainland firms to raise dollar-denominated funding critical for expanding operations abroad. More than half of foreign direct investment into China in 2018 was routed through Hong Kong, and nearly half of projects on the mainland funded by overseas investment were tied to Hong Kong interests.

The flows go both ways: The city facilitated more than 55 percent of outbound Chinese FDI in 2018, including the bulk of funding for Chinese Belt and Road Initiative projects. The same year, it was the largest offshore clearing center for yuan, with its banks facilitating a little more than 75 percent of the world’s yuan-denominated payments. Chinese firms on the Hong Kong exchanges now boast a total market capitalization of more than $3.4 trillion, or some 73 percent of the market total. This number will rise if/when the U.S. makes good on its threats to delist Chinese firms from its own exchanges.

Foreign firms have benefitted from Hong Kong's relatively impartial courts, independent regulators and central bank; free flows of information and modern fintech infrastructure made operations far less risky there than on the mainland. Foreign banks were happy to avoid mainland capital controls and party meddling. Chinese mainland firms gorged on access to dollars they couldn’t find as easily elsewhere, with the greenback-pegged Hong Kong dollar perfectly interchangeable in the West and Hong Kong’s sophisticated fintech infrastructure tightly integrated with those in London and New York. Hong Kong also enabled them to avoid some of the regulatory and geopolitical risks that would come with listings on Western exchanges.

Naturally, Beijing had been eager to assert its authority over the city with as light a touch as possible to avoid disrupting the status quo. In lieu of brute force, it tried to rely more on things like cooption of Hong Kong institutions such as the legislature, media and the police and its ability to capture the interests of the city’s business elite to the mainland.

It occasionally reached across the border to snuff out perceived threats to mainland political stability, most famously with its 2015 kidnapping of Hong Kong booksellers and wayward tycoons, but otherwise it largely avoided trying to muzzle the pro-democracy movement altogether. Evidently, Beijing felt that the protests of the past year had made the status quo no longer tenable.

How the Law Could Backfire

The national security law may well address Beijing’s concerns about political threats to mainland stability. But it will be extraordinarily difficult for China to impose the sorts of tight social controls needed to truly squash dissent without harming its financial vitality. Can banks credibly claim to be able to protect the privacy of their clients if and when the CPC – which wants to prevent corrupt mainland figures from using Hong Kong as a haven for their assets – demand access to their books?

Will financial analysts face prosecution if they publish an unflattering assessment of a Chinese state-owned enterprise? Can foreign firms expect a fair shake in court if seeking redress against a Chinese firm with suction among the CPC elite? Will Beijing feel compelled to bring down the great firewall around Hong Kong, cutting off free flows of information that are the lifeblood to the industry? What’s the risk of getting caught between Beijing and rival foreign governments like Washington, which is steadily ramping up pressure of its own over Hong Kong and threatening to deprive figures and institutions that support the law of access to critical U.S.-dominated financial networks?

So far, Hong Kong’s business community has been conspicuously supportive of the law. Even high-profile foreign institutions like the London-based Standard Chartered and HSBC – whose iconic headquarters in the city was designed as a monument of capitalism and has often served as a base for protesters – have thrown their weight behind it. To be sure, some are relieved by the prospect of returning to stability. Some, presumably, have good reason to fear the costs of openly opposing the CPC. Beijing has reportedly warned foreign banks that they’ll lose access to lucrative mainland accounts if they cause a fuss.

Still, Beijing wants to give itself room to apply the law as it sees fit, and is therefore unlikely to carve out explicit exemptions for commercial sectors. This means uncertainty over exactly how Beijing will exercise its power will hang over the business community in Hong Kong indefinitely, regardless of how much it actually decides to use the law. The sense that politically motivated prosecution or even rendition is just a misstep or misunderstanding away won’t vanish even if Beijing tries to exercise restraint. And if seemingly random, politically motivated interpretations do become the norm, foreign banks and firms will increasingly look elsewhere.

According to an AmCham survey released after the law was announced in May, some 40 percent of Hong Kong businesspeople polled said they were already considering pulling up stakes. Sixty percent said their operations would be negatively affected by the new law.
Beijing is going to great lengths to guard against certain risks. For example, Chinese financial regulators for the first time explicitly pledged to support Hong Kong’s currency if the city sees a surge of capital flight. Critically, Chinese money has steadily come to dominate the city, diminishing the risks, if only a little, of a foreign exodus.

It's making halting but notable progress on reforms intended to make foreign institutions more comfortable operating in mainland centers like Shanghai, Shenzhen and Hainan. It’s gaining headway on efforts to reduce the country’s dependence on the dollar by, for example, setting up alternate systems to facilitate cross-border transactions and a digital currency that could facilitate foreign trade without access to dollars. China realizes that it’s still home to the world’s most valuable labor pool, its fastest-growing consumer base, and among its deepest wells of investment capital.

It views the issue as similar to the question of how much longer foreign firms will be willing to depend on Chinese manufacturing and supply chains. So long as there’s money to be made in China, there’s good reason to believe that foreign firms will stomach a lot to keep their slice of the pie.

But China can’t eliminate all the risks of a major hit to Hong Kong’s value as a financial hub.

With the Chinese economy – and, in particular, its banking sector and bevvy of private firms struggling to pay down dollar-denominated debts – already under immense stress thanks to the coronavirus pandemic, the consequences of even a modest hit to Hong Kong’s currency or credibility in foreign finance circles could carry major costs.

This raises the question of whether Beijing is doing this out of weakness or strength.

In other words, is it willingly taking on these risks because it thinks it has succeeded in making them manageable – and, by virtue of its relative success in handling the pandemic, making itself ever-more indispensable to the global economy and ever-more immune to U.S. pressure?

Or because China's internal pressures turn concern about unrest spilling over from Hong Kong to the mainland into an existential fear? Or because it figures financial decoupling from the West and the accompanying capital flight were inevitable? Or merely because the protests have embarrassed Xi Jinping personally to the point where he had to act?

In truth, the answer is probably some mix of all of the above. China is strong and ambitious and yet contending with existential risks on seemingly every front. With Hong Kong, as with so many of its other woes, Beijing is stuck choosing between unsavory options. In these situations, its authoritarian impulse typically prevails. It leans on the only thing it really trusts – its own power – prioritizing control over capitalist efficiency, and figuring out the rest later.