Tension runs high in Hong Kong weeks after Hong Kong's National Security Law (NSL) was passed. A source of controversy and vehement protests, the legislation criminalises any act of secession, subversion, terrorism, and collusion with foreign or external forces.
Many Hong Kong citizens fear that this law will mark the end of their freedom and personal security. Mere hours after the law was passed on 30 June 2020, citizens were arrested and detained for violating the law. Businesses, while generally more sanguine towards the NSL, are affected as well — those violating the legislation run the risk of having their operations suspended, or business permit revoked.
Some businesses who are known to be pro-democratic are taking pre-emptive measures to avoid accusations. Children's clothing retailer, Chickeeduck, removed a statue celebrating anti-governmental protests hours before the law was passed. Previously, the owner Mr Herbert Chow was adamant on keeping the statue despite requests to remove it.
Many organisations and companies are still waiting for clarifications on what is permitted under the new law. How will the NSL affect Hong Kong's economy?
Hong Kong is a long-established financial centre, having served as a bridge between the West and the East for decades. Some factors that made Hong Kong thrive are its Western financial infrastructure, rule of law (based on the common law system), the free flow of capital, and the fungibility of Hong Kong's currency with the American dollar.
Yet all these might be changing.
Compromising the common law system
Under the "One Country, Two Systems" policy, Hong Kong runs under the Basic Law, which guarantees fundamental rights and freedoms, independent judicial power, and the continuation of the common law system, among others.
According to Associate Professor Alfred Wu from the Lee Kuan Yew School of Public Policy, the implementation of the NSL might affect the common law system in Hong Kong, which will have significant implications on businesses.
"[The common law] enables [businesses] to have reference from other countries in the common system," said Prof Wu. He said that in the past, disputes with the government can be settled in court and businesses are able to challenge local administration and even legislation.
More importantly, the common law can restrict local government's intervention in businesses.
But with the new national security law, the government can accuse businesses of violating the national security goals. Beijing's legislation will override Hong Kong's law. Under the Chinese law system, the decision of the government cannot be resisted.
Rescinding Hong Kong's special customs status by the US
In response to the new legislation, the United States has started eliminating Hong Kong's special customs status. Defence exports were halted, and Hong Kong's access to high technology products were restricted to protect US national security.
Luckily, Hong Kong’s special tariff rates are currently largely unaffected, but this might change. "I do expect President Trump to raise tariffs on Hong Kong exports, since he has already said as much," said Kurt Tong, the former US consul general in Hong Kong, in a Reuters article.
While Mr Tong believes that such responses will hurt Hong Kong or the US more than Mainland China, Prof Wu reckons that the US would not be as widely affected as predicted.
"Hong Kong is very small [compared to the] US global strategy. The reason why the lawmakers in the US and the executive branch could take a very, very bold decision on Hong Kong is because it will not substantially affect the US economy," he said.
Minimal effect on China's economy?
Hong Kong has always been China's gateway to the international market, but Hong Kong plays a less significant role in China's economy now as compared to 1997. In terms of GDP, Hong Kong only accounts for 2-3% of China’s GDP.
"The basic message here is that China has decided that given the choice between security and stability of Hong Kong's reputation as an international financial centre, it will sacrifice the latter," said Associate Professor James Crabtree from the Lee Kuan Yew School of Public Policy in a CNBC interview.
Even if China's engagement with the international world through Hong Kong declines — which is likely — their economy will not be too affected. "The domestic market is very big, so if you're looking at post-COVID-19 recovery, Mainland China may be okay," said Prof Wu.
China will still survive by relying on their massive domestic market. In fact, Prof Wu believes that China can absorb the extra cost even if Hong Kong loses its special customs status and tariffs.
Even so, it is in China's favour to maintain Hong Kong's status as a financial hub. Many mainland Chinese companies rely on Hong Kong's large financial services sector, especially on Hong Kong's open capital flows for investment.
Furthermore, China's Yuan is still not an international currency, but Hong Kong currency is still pegged onto the American dollar, making Hong Kong a more attractive place than Shanghai or Shenzhen for international investors and businesses.
Hong Kong's currency might be unpegged
Hong Kong has one of the world's largest currency trading centres, ranking third globally for US dollar trading. Its financial economy depends on its dollar peg.
"Every transaction has to be conducted in the US dollar," said Prof Wu, referencing to the use of the American dollar as the standard unit of currency in international markets. Hong Kong, with its currency pegged with the US dollar, currently has the capacity to do so, he elaborated.
However, fears of the discontinuation of dollar peg have spread amidst political turmoil and the rising US-China tensions. "If the Hong Kong dollar [is unpegged] with the US dollar now, Hong Kong [will have almost] no advantage [in the financial sector]," Prof Wu said.
Some experts reckon that these fears are unfounded. The establishment of the dollar peg predates the US-Hong Kong Policy Act of 1992, which gave Hong Kong its special trading status. US approval is not needed for the currency peg.
Even though the US can ban lenders from trading US dollars, strategists think that this is very unlikely to happen as banning financial companies from trading with Hong Kong might trigger a global market slump due to Hong Kong's importance as a financial hub. This is a consequence that will affect global financial markets, including the US.
Capital flight fears
Even before the NSL was passed, tensions and protests were fuelling capital flight fears. The vague legislation now still leaves many businesses hanging in uncertainty. Confidence in the financial market is wavering, and if investors and companies leave Hong Kong, there will be a large capital outflow.
TikTok announced their decision to stop operations in Hong Kong days after the new law was announced.
While international companies are able to shift their headquarters elsewhere and leave Hong Kong, SMEs do not have the same flexibility to do the same. Most lack the capital necessary for a shift. "They have no choice", Prof Wu said. "They need to develop the local economy. They need to serve the local people."
As China's influence over Hong Kong increases and the US takes a step back, Hong Kong companies might develop a stronger focus on mainland Chinese markets. "I think you'll see that Hong Kong becomes less of a global financial centre," Prof Crabtree said. "I think what you'll see is Hong Kong becoming more of a China-focused financial centre."
China is likely to move more capital into Hong Kong to 'cushion the blow' of losing its status as a global financial centre, he elaborated.
The new financial hub
The loss of status will affect the money being invested in China, and China's investing in the rest of the world. Whether the investment will slow down or become routed through other countries remains to be seen. But if Hong Kong is no longer the financial hub, then where will businesses go?
According to Prof Wu, based on geographical distance, Tokyo is a possibility. The Japanese government has begun debating about ways to make Tokyo more attractive to international firms. Taipei might take over as well, but they’re facing the same problem with Mainland China, said Prof Wu.
More businesses are also turning their attention towards Singapore. As one of the region's top financial centres, Singapore's status as a business hub has only been growing.
"Singapore will benefit substantially, but Singapore is already a global financial centre," Prof Wu said. It helps that Singapore is known to be a safe haven during times of global market volatility.
Indeed, there has been a notable change in investments to Singapore even before the law was passed. Singapore has seen an increase in foreign currency deposits even a month ago amidst Hong Kong's political instability and uncertainty from COVID-19. Since last year, foreign currency deposits at banks quadrupled to a record S$26.97 billion in April.
Hong Kong's future
Hong Kong still has several advantages to offer — such as the dollar peg and a large stock market — but these might change depending on the outcome of the US-China conflicts. Businesses are also waiting for the details of how the implementation of the NSL is going to affect them before making a decision.
"Corporate Hong Kong, if not rallying around, [is] going along with this decision in the name of stability rather than democracy," said Prof Crabtree.
Hong Kong's status as a global financial centre is likely to take a hit, but these tensions are not new. Businesses in Hong Kong have survived past protests and upheavals, and with careful navigation from companies and the local government, they might just be able to weather through the new round of changes without too much losses.
Photo credit: Ruslan Bardash