How will the new security law impact Hong Kong’s status as a global financial hub?

Tommy Wu
The key economic issues following China’s passing of the national security law for Hong Kong are whether the city will retain its role as a gateway to China, and its standing as a global financial centre
Lead Economist at Oxford Economics

The key economic issues following China’s passing of the national security law for Hong Kong are whether the city will retain its role as a gateway to China, and its standing as a global financial centre

Hong Kong’s new national security law took effect on 30 June, on the eve of the 23rd anniversary of Hong Kong’s handover to China from British rule. The proposal of the law was first approved by the National People’s Congress (NPC) during its annual session in May, with the law finalised and passed by the NPC Standing Committee on 30 June. The law was incorporated in the Basic Law, Hong Kong’s mini-constitution, without going through Hong Kong’s legislature.

The new law criminalises the four acts of secession, subversion of state power, terrorist activities, and collusion with foreign or external forces to endanger national security. While most cases will likely be prosecuted in Hong Kong, cases that involve “complicated situations” of interference by foreign forces may be prosecuted in mainland China. The law is not retrospective – meaning that those involved in protests over the past year will not be subject to the law based on their previous acts.

International responses to the new law

The passing of this law by Beijing has elicited international concern and responses. In late May, the US certified that Hong Kong no longer enjoys a high degree of autonomy from China. In late June, the US government suspended “preferential treatment to Hong Kong over China, including the availability of export license exceptions”. The US government also halted US exports of defence equipment to Hong Kong and plans to take steps to impose “the same restrictions on US defence and dual-use technologies to Hong Kong as it does for China”. Immediately after the announcement, China vowed to retaliate.

The US also announced the first round of visa restrictions on Chinese Communist Party officials accused of infringing on the freedom of Hong Kong’s citizens. In response to US sanctions, China announced visa bans on Americans who “behave badly in Hong Kong affairs”. However, both sides have not named specific targets. Meanwhile, the US Senate and Congress also passed the Hong Kong Autonomy Act that will impose sanctions on Chinese officials who undermine Hong Kong’s autonomy and penalise banks that do business with them.

Other western countries, as well as Japan and South Korea, have also expressed their concerns.

The EU “deplores” China’s decision to enact the national security law for Hong Kong. The UK announced plans to allow eligible Hong Kong citizens to resettle in the UK, as the UK government views that the new law in Hong Kong undermines the ‘one country, two systems’ principle and is a breach of China’s commitment under the Sino-British Joint Declaration signed in 1984. Meanwhile, the G7 nations may consider a coordinated response to the imposition of Hong Kong’s national security law.

To ease concerns over the law, senior officials from the Chinese government have continued to stress that the “one country, two systems” arrangement will be fully upheld, and only a “small minority” would be targeted by the new law. They also state that the new law will provide strong support for the city “to turn from chaos to stability and restart”, referring to ending the civil unrest which has taken place over the past year.

China also condemned any foreign interference as, from its perspective, the national security law for Hong Kong is a purely internal affair. Meanwhile, over 50 countries including Pakistan and Egypt supported China’s national security law for Hong Kong at UN’s human rights council.

Will Hong Kong maintain its status as a global financial hub?

Trade barriers and/ or high tariffs imposed by the US will hit US-Hong Kong bilateral trade, but the direct impact will likely be small. In particular, US exports to Hong Kong under export license exceptions were valued between $400 million to $500 million each year between 2016 and 2018, whereby almost all of these were likely re-exported elsewhere. This was less than 0.1% of Hong Kong’s total goods exports. Meanwhile, the possibility of imposing US tariffs on Hong Kong exports will not have a large impact either, given that only 8% of Hong Kong’s exports now go to the US.

The most important issue for Hong Kong is how its standing as a gateway in and out of China, and as a global financial hub, will be affected by the international response to the introduction of the national security legislation.

The restrictions on US exports of dual-use technology (tech used by civilian and military applications) may have an indirect impact on Hong Kong’s re-export business. Indeed, as high-end electronics products likely involve US technology, and electronics account for 60% of Hong Kong’s total goods exports, some of the electronics re-export businesses will be affected.

However, while the export restrictions by the US may dampen Hong Kong’s long-term development of the innovation and technology industry, at present the industry only accounts for 0.8% of GDP and as such will not weigh heavily on GDP growth in the short-term (Figure 1), compared with the trading and logistics sector which accounts for 21.2% of GDP and financial sector (19.8%). Moreover, despite these export restrictions, we still expect the industry to expand as it is part of Hong Kong’s strategy to integrate with mainland China.

Figure 1: The GDP share of financial services will continue to grow

The most important issue for Hong Kong is how its standing as a gateway in and out of China, and as a global financial hub, will be affected by the international response to the introduction of the national security legislation.

We see several reasons why Hong Kong will be able to broadly maintain this role, even if perhaps not as prominently as before. First, in our view, China has an incentive to ensure that the ‘one-country, two systems’ arrangement survives and to persuade the rest of the world that it is still in place.

Second, the bar for the US to take drastic action is high. Despite the strong US rhetoric against the national security law, the US measures taken so far have been quite modest. To date, the US has shied away from measures such as imposing the same tariffs on Hong Kong’s exports to the US, as on products from mainland China, or restricting cross-border financial transactions. And we still do not think such drastic measures are likely given that they would hurt Hong Kong and US companies more than China.

However, the international setting complicates things. With US-China tensions elevated, other governments have also expressed concerns about the national security legislation for Hong Kong. Hong Kong’s internal political turmoil has also received broad international coverage. In this setting, actions by the US and other governments will affect the perception of Hong Kong as a separate commercial and financial entity among international businesses and financial markets, hence creating uncertainty over Hong Kong’s prospects.

We think that China’s continued effort to open up means that it will continue to expand existing business and financial schemes, as well as roll out new programmes in the future where Hong Kong will play the key role as the gateway.

In the short-term, the negative impact will not likely be visible. Inflows into Hong Kong have been very strong in recent months and will likely continue in the near term, given the IPO spree of Chinese companies in Hong Kong so far, and for the rest of the year. Indeed, the strength in the HK dollar has triggered the central bank to intervene, with HKD hovering very close to the strong-side of the USDHKD trading band since April (Figure 2).

Figure 2: No imminent capital outflow pressure has been seen despite rising political uncertainty

In the medium-term, we expect Hong Kong will continue to be able to leverage its position as a key gateway in and out of China, especially in the financial realm. We see increasing investment from mainland China and integration with the Greater Bay Area as offsetting the uncertainty effect to some extent (Greater Bay Area refers to the geographic region including Hong Kong, Macau and nine other cities in Guangdong province including Shenzhen, China’s IT hub).

We think that China’s continued effort to open up means that it will continue to expand existing business and financial schemes, as well as roll out new programmes in the future where Hong Kong will play the key role as the gateway. One recent example of this is the ‘Wealth Management Connect’ rolled out in late June, which will attract cross-border investment flows in wealth management products between the Greater Bay Area and foreign markets through Hong Kong.

But there are clear risks that Hong Kong’s role as a special gateway in and out of China, and as a global financial hub will be eroded. The biggest risk factor is probably the overall development of US-China relations. Foreign investors and corporates may also hedge their exposure to the city. As such, foreign investment into Hong Kong will likely be affected to some degree due to these ongoing uncertainties.

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Lead Economist at Oxford Economics

Tommy Wu is a Lead Economist at Oxford Economics. He covers macroeconomic research and forecasting on the Asia-Pacific region and the China economy. Prior to joining Oxford Economics, Tommy was an economist at the Research Department in Hong Kong Monetary Authority.

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