Hong Kong: what next for China's halfway house?

Any military intervention by Beijing would threaten the role the city plays in opening China's economy to the world. Photo / Getty Images

As Hong Kong police clashed with protesters last Sunday, firing tear gas and rubber bullets into a crowd in the central business district, chief executive Carrie Lam was at a very different event across the city. She was guest of honour at a youth summer camp organised by China's People's Liberation Army.

Ms Lam's host was Major General Chen Daoxiang, a senior Chinese officer in Hong Kong who used another public event on Wednesday — the celebration of the 92nd anniversary of the creation of the PLA — to deliver a clear message: the world's largest army was prepared to put down the protest movement in the city should China's President Xi Jinping give the order.

"Violent protests" were "absolutely impermissible", he said. At the same time, the PLA released a video showing his men engaging in riot prevention and anti-terrorist training.
The comments have raised what once would have seemed an unthinkable spectre: that the city could face its own version of the 1989 Tiananmen Square crackdown on pro-democracy supporters in Beijing.

Hong Kong, however, is very much not Beijing. Ever since China began its economic reforms in the late 1970s — and especially since the handover when it was returned by the UK to Chinese control — Hong Kong has been a vital conduit to the rest of the world.
China's acceptance of the "one country, two systems" formula, by which China guaranteed Hong Kong 50 years of political and legal autonomy after the 1997 handover, has been an important part of its claim to be a reliable international partner. It is central to Beijing's aspirations to eventually take back control over Taiwan, which it regards as a renegade province.

Hong Kong has provided a forum to bring together businesses and investors from very different systems who might not otherwise trust each other. For wealthy Chinese with worries about political events at home, it has also been an essential bolt-hole.

Military intervention — even if that is still just a vague threat — would shatter the essential role Hong Kong has played as a business and investment halfway house.

"If China wants to mix with the outside world, it needs Hong Kong to do that because capital cannot move freely outside of China," says Terence Chong, the executive director of the Lau Chor Tak Institute of Global Economics and Finance at The Chinese University of Hong Kong. "You still don't have an alternative."

Yet despite the economic and political risks, some sort of crackdown remains possible — both because of the reluctance of Chinese president Xi Jinping to be seen backing down in the face of protesters, and because it is not clear what concessions would be necessary to end the demonstrations.

The protest movement that started as opposition to an extradition bill to allow Hong Kong to send criminal suspects to China for trial has turned into a popular revolt. Even though Ms Lam has shelved the bill, the protesters have expanded their demands to include direct elections for the chief executive and the Hong Kong legislature.

A protester holds a placard from a bridge as others march beneath. Photo / Getty Images

As the protesters have dug in, the government has taken an increasingly hardline approach. This week, it charged 44 people arrested over the weekend with rioting, which carries sentences of up to 10 years in prison. Meanwhile, police have yet to charge the gangs filmed attacking protesters and passers-by while they were returning home on the city's commuter railway in the outlying district of Yuen Long earlier in July.

There is no sign of the movement losing steam. Civil servants were the latest group to join in, holding their own demonstration on Friday. This has put the onus back on Beijing to either offer a compromise, to calm the situation, or to escalate it.

"It looks like a vicious cycle and whatever silver lining there might be has to come from Beijing," says Willy Lam, a China expert at the Chinese University of Hong Kong. "But we don't see Xi Jinping adopting conciliatory measures because he is an arch-conservative and he likes to show a tough guy image."

As Beijing weighs its options, the headline figures suggest that Hong Kong has become less important. When the UK handed back control in 1997, the Hong Kong economy was equivalent to 18 per cent of the mainland's gross domestic product. Now it accounts for less than 3 per cent of China's economy.

But those numbers disguise the role that the city still plays. In order to raise funding in US dollars, Chinese companies lean heavily on Hong Kong's financial markets — markets which are rooted in the city's independent legal system based on English Common Law.

Anti-extradition protesters use makeshift shield to defend themselves during a clash with police outside the Legislative Council Complex. Photo / Getty Images

Without the legal framework, China's legion of state and privately owned companies could struggle to continue to raise war chests of US dollars in the city, while Hong Kong's status as a safe base for those companies to invest overseas could also be threatened.

"I do not see an entirely open capital account, as we know it, being adopted any time soon on the mainland of China," says Joseph Yam, former chief executive of the Hong Kong Monetary Authority, the city's de facto central bank.

Hong Kong's capital markets are now dominated by Chinese corporations, which accounted for 91 per cent of the $9.4bn raised in initial public offerings this year in the city. In debt capital markets, Chinese companies have borrowed $647bn in US dollar fundraising, or 75 per cent of all US dollars raised in Asia this year. Most of those debt deals are launched in Hong Kong.

There are other signs, however, that Hong Kong's economic importance is fading. The territory remains dependent on its oligopolistic and overpriced property sector, in which supply is tightly controlled, even as neighbouring Shenzhen, home to technology giants such as Tencent, has surged ahead to become China's Silicon Valley.

Some business leaders believe that the equity markets in Shenzhen and Shanghai are realistic contenders to replace Hong Kong as Asia's top financial centre. In 2017, before markets became spooked by the trade friction between the US and China, Hong Kong was only third largest in the world by funds raised in IPOs — Shanghai and New York were ahead by value.

Protesters stand off with police during a demonstration in the area of Sheung Wan. Photo / Getty

"In the past there was a long way for Shanghai to catch up. Now [China is in] a position to, attract back, and list A-shares," Laura Cha, chairman of the Hong Kong exchange concedes, referring to shares listed in the mainland. "Hong Kong cannot be complacent."

The battle between protesters and the government is already hurting Hong Kong's economy. Iris Pang, an economist at Dutch bank ING, has lowered her outlook for GDP growth for the year from 1.8 per cent to 1 per cent.

"The independent legal jurisdiction of Hong Kong is what Hong Kong needs, and it's what China needs," Ms Pang says. "China will not destroy this aspect of Hong Kong any time soon."

As political and economic pressure builds, rifts are starting to appear even among Hong Kong's tycoon class — which, since the handover, has tended to take Beijing's side.

David Li, executive chairman of the city's last family-owned lender Bank of East Asia, told local media in July that he supported an independent investigation into the actions of the police. In stark contrast, 82-year-old Tung Chee-hwa, another tycoon and the first chief executive of Hong Kong following the handover, said on Wednesday foreign forces such as the US and Taiwan had helped organise the protests. It is a claim often repeated by officials in Beijing.

Crowds of protesters gathered in Hong Kong as the city braced for another mass rally. Photo / Getty

Business groups and some of the city's financial bodies are pushing the government to compromise. The normally conservative Hong Kong General Chamber of Commerce called for the extradition bill to be completely withdrawn, ministers to be made accountable for the mishandling of the protests, and an independent commission of inquiry to probe "the root of the tensions".

James Tien of the city's pro-establishment Liberal party, says he believes just the withdrawal of the bill and an inquiry might be enough to satisfy some members of the movement. "If these two issues were addressed, the majority of people would cool down." he says.

Analysts say the rising economic pressures on China, from slowing growth to the trade war, mean that Beijing will seek to avoid the nuclear option of a military intervention in Hong Kong, instead opting for a war of attrition. This was the strategy the government used during the wave of pro-democracy protests in 2014, which eventually petered out as the public tired of disruption.

Whatever the outcome, some senior business figures are hoping Hong Kong can muster the same resilience it brought to past crises. "Over the years it has faced a number of difficult circumstances, like the SARS[flu] crisis, Occupy Central and the global financial crisis," says José Viñals, chairman at Standard Chartered. "And Hong Kong has always survived those crises and come back to what it knows how to do."

- Additional reporting Nicolle Liu

Written by: Don Weinland, Joseph Leahy and Henny Sender

© Financial Times 2019