Much has been written about the erosion of Hong Kong’s political and administrative autonomy as Beijing leans on Chief Executive Leung Chun-ying and his allies to promote One Country over Two Systems. But scant attention has been paid to the erosion of the territory’s commercial and financial autonomy.
Hitherto it has seemed that closer ties with the mainland brought unalloyed benefit through Hong Kong’s hosting of the offshore listings of major state enterprises, the flow of mainland money into the local property market and of booming mainland tourism and re-export trade volumes.
Hong Kong is seen as the primary center for yuan currency trading and is now promised a “through-train” to enable stocks listed in Hong Kong and Shanghai to be traded, subject to limits, in each other’s markets. All such interactions are routinely described as win-win situations for Hong Kong and the mainland, with Hong Kong in particular benefiting from preferences accorded to it by Beijing either as one-off deals or within the framework of the Closer Economic Partnership Arrangement (CEPA).
However, there are costs to all this which undermine Hong Kong domestically and internationally. Most problematic at least in the short term could prove the closer financial integration between a small, open economy and a huge, partly closed one. Real danger for Hong Kong may well lurk in the massive increase over the past three years in the exposure of Hong Kong banks to mainland borrowers.
As of September 2013, Hong Kong banks’ loans to non-bank mainland entities totaled HK$2.16 trillion (US$277 billion) and total mainland exposure HK$3.48 trillion (US$446 billion). The rise has been dramatic and caused by the interaction of weak demand for loans in Hong Kong and the rapid rise in yuan deposits following partial liberalization.
But other factors have played a role: the promise of bigger lending margins on mainland loans, and the once seemingly inexorable rise in the value of the yuan against the US-dollar-pegged Hong Kong dollar.
But the “free lunch” for Hong Kong’s bankers apparently provided by this carry-trade contains some bacteria. Most obviously, the yuan has recently gone into reverse which will certainly embarrass the many who had been betting on appreciation or at least stability.
Meanwhile the condition of many non-bank mainland borrowers looks sure to be tested as monetary conditions tighten everywhere and some property prices fall. Even if property can be stabilized, the ability of local governments to generate revenue from land sales will be impaired and hence the ability of their off-balance sheet entities to service debts to lenders that include foreign banks and bond holders as well as mainland trust companies, themselves an opaque sector.
The magnitude of international banks’ exposure to China can be glimpsed through the statistics of the Bank for International Settlements. China’s net borrowing from BIS members rose from around US$150 billion in 2012 to US$350 billion in mid-2013, China accounting for almost all the increase in credit to Emerging Market countries in that period.
For sure, at the national level China has no problem of net debt. However, how far bailouts of failing trust companies and semi-official entities will go remains a great unknown. Many lenders, caught up in the China euphoria, may have forgotten the 1999 bankruptcy of Guangdong International Trust and Investment Corporation (GITIC) a provincial state-owned enterprise. Foreign creditors suffered more than others.
China’s financial system is now more developed, but the stakes are much higher, particularly for Hong Kong lenders. Cross-border lending has long been at the root of many financial crises as it is almost invariably riskier than domestic loans where creditor recourse is easier and currency risks minimal.
Hong Kong banks’ domestic business could also be hurt by any exodus of mainland money whether due to tight conditions on the mainland, or a genuine crackdown on illicit flows.
As for Hong Kong’s stock market, it remains to be seen whether the through-train will bring more than a short term boost to business unless there is a large scale liberalization of flows into and out of the mainland. That looks unlikely while Beijing faces worries about financial stability following years of excessive credit creation. Meanwhile Hong Kong’s market has become so dominated by mainland listings, and to a lesser degree by Macau casino stocks, that its wider regional and international role has been neglected.
Mainland weight on the scales of what should be open markets is being felt in other commercial quarters. There is certainly room for more competition in electricity generation in Hong Kong, now controlled by two regulated monopolies. But handing over a chunk of supply to a Guangdong state company, as proposed by the government, is no way to achieve it.
Likewise changes in licensing of mobile phone spectrum are being driven not by an urge to increase competition but simply to hand over a chunk of business to state-owned China Mobile.
In another direction, the Hong Kong government’s own capital spending is increasingly driven by projects with scant commercial justification but to promote physical links to the mainland. Hence it is spending at least HK$50 billion on a road bridge to Macau and Zhuhai and upwards of HK$67 billion on 27 kilometers of high-speed rail track to link to the mainland system. Half of the rail cost is accounted for by taking the line deep into the heart of Kowloon rather than having a terminus in a less central location – which is deemed sufficient in Beijing and Guangzhou.
Every step that Hong Kong takes to integrate commercially and financially with the mainland not only undermines its own autonomy but at some point will place it in danger of losing its position as a free port which gives preferences to no one and expects none in return. If China continues to open up its financial and other markets, Hong Kong will prosper modestly -- but is threatened with gradually losing its special appeal.
If China’s liberalization is at a high water mark and faces some stormy financial weather, Hong Kong badly needs to keep its distance – including not only its own currency but its complete fiscal autonomy, not least by investing its HK$1.5 trillion in fiscal reserves only in convertible currencies. Or will it be required to do “national service” for the One Country by investing heavily in mainland bank bail-outs?