SINGAPORE (May 28): It has been a tense week for Hong Kong. Civil unrest has re-emerged following the proposed passage of a controversial National Security Law by the Chinese central government. This has prompted the US to deem the territory no longer “autonomous” from the mainland, potentially threatening the special trade status it enjoys with the US amid growing US-China great power conflict.
The latest move in a prolonged tussle between Beijing and Hong Kong over the latter’s autonomy within the “one country, two systems” framework, the legislation -- announced at the 2020 session of China’s National People’s Congress -- broadly seeks to criminalise “treason”, “secession”, “subversion”, “terrorism” and “foreign interference” in Hong Kong. Such legislation is aimed squarely at the widespread protests that have rocked the city since last year, which Beijing believes is the product of "foreign interference".
Observers have warned that such legislation undermines Hong Kong’s judicial independence under “one country, two systems”, prompting questions about the city’s continued autonomy. “No reasonable person can assert today that Hong Kong maintains a high degree of autonomy from China, given facts on the ground,” declared US Secretary of State Mike Pompeo today. The Hong Kong Monetary Authority (HKMA), Hong Kong’s central bank, clarified however that free flow of capital and free convertibility of the HK$ will continue pursuant to Hong Kong's Basic Law.
William Pesek of the Nikkei Asian Review, warns that the new law could potentially “devastate” Hong Kong’s economy. With the Trump administration effectively withdrawing its recognition of its autonomy from mainland China, Hong Kong could lose special economic and trade privileges it currently enjoys with the US. The perceived loss of judicial independence could also hurt Hong Kong’s reputation for transparency and rule of law, discouraging trade and investment in the city.
Despite this “quadruple whammy” of Covid-19, political unrest, great power rivalry and constitutional uncertainty, the Hong Kong economy remains relatively resilient. Granted, Covid-19 has resulted in Hong Kong’s largest fall in GDP growth in its history (down 8.9% y-o-y), with unemployment jumping 1% m-o-m almost instantly -- including in the usually resilient financial and professional business services sector. Still, the relatively stable Covid-19 situation has resulted in a somewhat more optimistic economic outlook going forward.
“Traffic data points to relative improvement in retail sales performance ahead, probably on entering May and June because compared to the rest of the world, the situation in Hong Kong is relatively stable,” says DBS economist Samuel Tse. He sees domestic consumer sentiment returning to normal as the government winds down social distancing measures in the coming weeks. With 40% of consumption-led growth contributed by tourism expenditures, however, full economic recovery will likely be a gradual process as the tourism market slowly rebounds.
In the meantime, Hong Kong's traditionally fiscally conservative government has unleashed an unprecedented amount of economic stimulus, with the fiscal deficit rising from a projected 0.4% in FY19/20 to 9.5% in FY20/21. This is the first time that the government has run a fiscal deficit since the SARS epidemic in 2002, with spending coming in the form of a HK$10,000 (S$1830.17) monthly cash handout, a 50% wage subsidy and delayed tax payments. HKMA has slashed the Hong Kong base rate to 0.5% while its countercyclical capital buffer has been reduced from 2% to 1% to ease credit access for financial institutions.
Tse says that the government’s fiscal position remains robust in spite of this unusually high level of spending. “We are actually quite comfortable with it because while the fiscal reserve will drop from HK$1.2 trillion (S$ 219.56 billion) HK$0.8 trillion -- which is the lowest level since 2016 -- this is sufficient to maintain government expenditure for another 14-15 months,” he explains.
On the trade front, recently-released April export figures report an 8.2% reduction in exports YTD due to low factory capacities on mainland China. Nevertheless, with the Chinese economy swiftly easing out of lockdown, recovery in factory production on the mainland could reignite Hong Kong’s economy owing to the strong economic synergy between the two economies. Manufacturing unfortunately remains weak in Hong Kong’s major trading partners despite a minor rally, with the Purchasing Managers Index (PMI) remaining below 50 in most countries.
A more worrying long-term trend are the Phase 2 trade negotiations to resolve the US-China trade war. The talks will be crucial for Hong Kong since they are likely to focus on technological products, with such goods forming 70% of Hong Kong’s re-exports (99% of total exports). Yet it is uncertain if such talks will succeed amid growing animosity between the US and China, with DBS Chief Economist Taimur Baig going so far as to predict a “New Cold War” going forward.
See also: DBS economists predict new 'cold war' between US and China
Backed by considerable foreign reserves worth US$441 billion (S$626.4 billion) -- currently double Hong Kong’s monetary base -- the HK dollar’s peg to the US dollar is holding steady at the strong end of 7.75 to 7.76. Upward pressures on the HK$ from significantly higher HIBOR interest rates vis-a-vis LIBOR will be mitigated by stronger liquidity as arbitrage carry traders take a long position on the HK$. A weaker Chinese Yuan (CNY) following Pompeo’s derecognition of Hong Kong’s autonomy could, however, hinder Hong Kong’s export recovery to China.
Investor sentiment is recovering from the Covid-19 shock as the Hang Seng Index recovered 7.7% following a trough in March. The market recovered a third of its losses from the announcement of the new National Security Law last Thursday, though it came down 0.64 points at time of writing following Pompeo’s announcement. With little observable capital outflow from Hong Kong despite the eventful past few days, Tse reckons that investors are taking a “wait and see” approach as the Covid-19 situation unfolds. No massive capital flight has yet taken place in Hong Kong despite continued civil unrest in Hong Kong over the past year.
The property market has remained relatively resilient, with prices only falling 6.8% from an all-time high in 2019 following the beginning of last year’s Hong Kong protests and 3.3% due to Covid-19. Sale of larger units has been disproportionately affected by the inability of mainland investors to buy such properties, though a “home-bias” among local investors has seen stronger performance for smaller and medium-sized units.
