By Kung Chan and Xia Ri
In recent years, with the impact of a series of events such as the U.S.-China trade war, the COVID-19 pandemic, and the implementation of the National Security Law, the situation in Hong Kong has undergone unprecedented changes.
As a regional international financial center and a free trade port, future development of the island is facing a different trajectory from that of the past. Its globalized features are likely to fade, and its ability to attract international capital may also decrease. Local capital in Hong Kong will continue to shift, showing a clear trend toward “mainlandization”. After years of tracking research, ANBOUND’s founder Kung Chan believes that Hong Kong’s economy may encounter some profound problems and risks, mainly in five aspects:
Firstly, there is the issue of the Hong Kong dollar’s status and financial stability. In 1983, amidst a sharp depreciation of the local currency, the Hong Kong dollar (HKD) was pegged to the USD, establishing a linked exchange rate system. Through optimization in 1998 and 2005, the system has been structured to trade within a narrow range of 7.75 to 7.85. Corresponding to this system, Hong Kong has built up substantial official foreign exchange reserves, a robust and reliable banking system, a prudent fiscal philosophy, and a flexible economic structure. However, in July 2020, Bloomberg reported that the U.S. was considering applying pressure on China regarding recent developments in Hong Kong. One option discussed was banning Hong Kong’s banks from accessing USD, excluding it from the SWIFT international payment system, making it difficult for foreign investors to exchange HKD, and stopping the flow of USD into Hong Kong. In such a scenario, the long-standing linked exchange rate between the HKD and the USD could be decoupled. Although the proposal is ultimately not passed and hence not implemented, it serves as a significant warning for Hong Kong, as a similar situation could arise in the future. If the HKD were to be decoupled from the USD, maintaining its stability would require significant resources and capital investment. Otherwise, it may face severe fluctuations that could jeopardize the long-term stability of the Hong Kong financial market.
Secondly, the island is facing the issue of international status and social security stability. Over the past decade, Hong Kong’s economy has experienced a noticeable downturn amid the impact of the 2008 financial crisis, social unrest, and the COVID-19 pandemic. Data shows that after achieving a high year-on-year growth of 6.8% in 2010, Hong Kong entered an era of slow growth of under 3% that lasted for eight years. In 2019, it experienced negative growth for the first time, with a contraction of -1.68%. Since 2020, its economy has been struggling due to the pandemic’s effects. According to the Census and Statistics Department (C&SD)’s preliminary estimates, Hong Kong’s GDP declined by 3.5% in real terms for the entire year of 2022 compared to 2021. Its economic prosperity is likely to continue to decline, and fiscal revenues may face challenges, ultimately leading to a significant decrease in international status and posing a threat to the overall stability of the social security system.
Thirdly, capital status and property value are another issue of concern. The Hong Kong Stock Exchange (HKEX) and the Hong Kong Securities and Futures Exchange (SFC) are at the forefront in Asia, continuously attracting investments from around the world. However, since the legislative actions triggered by Article 23 of the Basic Law, a significant amount of capital and institutions have been withdrawn from the island. According to data from C&SD, in November 2022, there were 8,978 overseas companies in Hong Kong, a decrease of 71 compared to the previous year, with 46 of them being regional headquarters. The number of companies set up in Hong Kong by countries such as the U.S. and the UK has been declining. The U.S. has been gradually reducing its presence since 2018, with a cumulative reduction of 93 companies this year. At the same time, the UK has decreased by 4 companies to 134, and France has decreased by 9 companies to 80. With the outflow of capital from Hong Kong, the once-thriving real estate market has also contracted, leading to a decline in property values. Property services groups like CBRE and Knight Frank estimate that Hong Kong’s property prices will continue to decline by at least 10% in 2023. As capital flows out and the real estate market contracts, Hong Kong’s capital market will likely continue to weaken, affecting both capital status and property values.
Fourthly, there are concerns in regard to the matter of the island’s Special Administrative Region (SAR) status and Hong Kong passport. Hong Kong enjoys the status of an independent free port and has gained widespread recognition worldwide. Consequently, its passport holds significant value, encouraging migrants to reside, work, and live there. All goods imported and exported in the Hong Kong region are subject to zero tariffs, with no value-added tax or consumption tax. Any profits from transactions within the tariff area are exempt from taxation, making it a global duty-free haven. Additionally, Hong Kong’s corporate and personal income taxes are noticeably lower than those in most developed countries. Corporate tax for companies based on the island ranges from 8.25% to 16.5%. In 2020, accounting firm PwC and the World Bank ranked Hong Kong as the country with the friendliest tax system. Moreover, possessing a Hong Kong passport not only allows access to visa-free or visa-on-arrival entry in many countries but also provides relatively comprehensive social security and welfare benefits. For example, children can enjoy 15 years of free compulsory education, and Hong Kong’s public hospitals offer free outpatient and inpatient services to citizens. Additionally, individuals can receive unemployment benefits, retirement pensions, and elderly living allowances. However, with the strengthening of Mainland China’s policies toward Hong Kong, its SAR status has been affected, showing a trend toward greater integration between the island and the mainland. This has, to a certain extent, influenced the status of an independent free port and weakened the value of the Hong Kong passport.
Finally, there is the issue of trade status and employment of residents. As one of the world’s three major free ports, Hong Kong has long enjoyed an unparalleled trade status, which has been highly valued by developed countries in the past. However, in the current context of anti-globalization and the decoupling between the U.S. and China, Hong Kong’s trade status may face potential declines in the future. C&SD shows that in April 2023, the overall export volume and import volume of Hong Kong goods decreased by 16.7% and 15.5%, respectively, year-on-year. From January to April, the overall export volume and import volume decreased by 19.8% and 15.6%, respectively, year-on-year. In April, the overall export trade volume was HKD 338.3 billion, a year-on-year decrease of 13%, and the import trade volume was HKD 374.9 billion, a year-on-year decrease of 11.9%. This marks the 10th consecutive month of year-on-year decline in its import and export trade volume. The potential decline in trade status will also significantly impact residents’ employment, income, and overall economic prosperity. Statistics from C&SD indicate that the seasonally adjusted unemployment rate from March to May 2023 remains at 3.0%, the same as that from February to April 2023. The combined unemployment rate for industries related to consumption and tourism remained unchanged at 4.2%. Specifically, the unemployment rates for the retail trade and catering services remained the same at 3.8% and 4.8%, respectively, while the unemployment rate for accommodation services fell to 3.5%. Unemployment also declined in some industries, notably construction, wholesale, and human healthcare.
Final analysis conclusion:
In recent years, Hong Kong has shown a noticeable trend of “mainlandization” in its modern historical cycle. Due to the rising uncertainties, the island’s future development may face five significant underlying risks, including the issues related to the status of its currency and financial stability, its international position and social security sustainability, the status of capital and property values, the special administrative region status and Hong Kong passport, as well as the trade status and residents’ employment. Hence, it is crucial for relevant authorities to be aware of such risks and take proactive measures.
Kung Chan and Xia Ri are researchers at ANBOUND