C.Y. Leung looks set to have a taxing time in power.
The former businessman and convener of Hong Kong’s Executive Council was ‘elected’ by 1,193 Beijing-approved industrialists and politicians to become Hong Kong’s next chief executive on March 25.
However while Leung gained the votes of Hong Kong’s elite he is not well-loved by the masses: his popularity in public polls stood at around 40% at the time the limited election process was conducted.
Starting off from such a low base, Leung will no doubt want to ensure Hong Kong’s economy enjoys some strong years, as such health would reflect well on him.
But the truth is the city looks set for a difficult time in the coming five years.
Hong Kong is, first and foremost, a service city that is beholden to the whims of China’s economic prowess and engagement with the rest of the world.
Companies set themselves up in Hong Kong rather than the mainland because they trust its politicians to be relatively non-intrusive and the legal system to be impartial, neither of which is the case on the mainland.
The Communist officials in Beijing, in the meantime, favour the south-eastern city as an acceptable conduit through which they can distribute and accept capital.
For Hong Kong to prosper, it needs to retain this relevance. But that is not assured; many Chinese cities increasingly view themselves as viable competitors.
The ability of Hong Kong to retain its appeal with businesses and financiers will depend on it remaining more trustworthy and business-friendly than its rivals. Good business means efficient infrastructure and ease of access.
These reasons are in large part behind the government’s decision to consider a third runway at Hong Kong airport, and several extensions to the city’s mass transit railway system, run by the majority government-owned MTR Corp.
They are also a rational response to the changing landscape around Hong Kong. The city cannot hope to be the financial focus of North Asia forever. Making itself as efficient as possible is a wise move.
Financial constraints
For the past two years Hong Kong has gained the most international attention for its financial services, a sector that made up 15.4% of its gross domestic product (GDP) in 2010.
In particular the city has made headlines for hosting the world’s largest volume of initial public offerings (IPOs), and becoming the hub for the offshore renminbi market.
Added to this has been the city’s traditional strength: acting as a trading hub.
But all of these areas rely entirely on the favour of China, an unreliable means by which to ensure the city’s economic future.
Hong Kong’s slew of IPOs come courtesy of Chinese companies seeking international capital at a time when the local bourses are performing woefully. Of course, such market performance can easily change, lessening Hong Kong’s appeal and the level of equities business that comes through its doors.
Meanwhile the offshore renminbi (CNH) market is an artificial financial experiment of Beijing’s. It’s a way of testing the internationalisation of its currency without affecting the capital controls that the government employs in the mainland to keep the renminbi level controlled.
The reason that Beijing has created the CNH market is indicative of its essentially transitory nature: China understands that its enormous economy has to interact more with the rest of the world; its attempts to prevent this from happening for the past decade have left it with US$3.3 trillion of foreign currency reserves, most of which is denominated in US dollars.
Beijing’s leaders want to change this, and the only way to do that is to allow its currency to become flexible.
What this means is that Beijing will – barring economic disaster – keep liberalising its economic constraints, opening China’s own capital markets and making its currency more flexible. Eventually the renminbi will become fully convertible.
At that time there will be no need for a CNH market any more – and Hong Kong’s role as the gatekeeper to the mainland will diminish – along with its leverage in the worldwide financial system. It could also undercut the city’s advantage as a trading hub.
Hong Kong could lose not just the CNH market but also its prime differentiator: being the world’s financial and trade gateway to China.
Five year window
How long will this take? Nobody knows for sure. Even China’s own experts probably have the vaguest notions of when they would like to see it happen. But most economist guesstimates vary between as soon as five years to 15 or 20. But within a generation Hong Kong’s most concrete advantage looks set to disappear.
Mark Walton, senior economist at CLSA, believes that Hong Kong may have as little as five years before this point arrives.
“It’s inevitable that Hong Kong will have to stand increasingly alone over time,” he says. “Hong Kong has had the advantage of being a Western city with a Chinese framework and for being a gateway from China to the West and the West into China. But that role won’t exist in the same way anymore.”
Instead, investors would be able to entirely bypass Hong Kong in favour of directly accessing China’s onshore market.
The city is unlikely to disappear as a financial hub – the strength of its rule of law and depth of its equity markets should help sustain it – but it could see banks and financial services firms shift some of their key resources into Shanghai or Beijing.
Walton notes that it could mean one step more than this: “at that point it might well make sense for Hong Kong to give up the Hong Kong dollar, and adopt the renminbi itself.”
The bustling financial hubs of Cheung Kong Centre and International Commerce Centre could become shadows of what they once were.
It’s fair to note however that Hong Kong’s decline as a financial centre and abandonment of its currency is not a future set in stone. As a fixed income banker notes to Asiamoney, “Europe has managed to keep the Eurodollar market going for a long time now, even though it’s not their currency. The future of the CNH market will depend more on how much they trust doing business in China versus Hong Kong.”
Reinventing itself
It’s a potentially bleak outlook for the city. But if there is one thing that Hong Kong has always been good at, it’s metamorphosising.
From being a minor British outpost, to the producer of cheap goods and toys, to becoming the world’s largest port terminal, to its latest iteration as North Asia’s largest trading and financial hub, the city has been constantly reinventing itself.
The major infrastructure projects that the city’s government is now embarking on promise to underscore Hong Kong’s traditional strength as a trade hub, while ushering in a new strength: outright tourist trap.
Tourism only made up 4.4% of Hong Kong’s GDP in 2010. But this figure is likely to grow substantially in the coming decade or so, and Hong Kong’s infrastructure investments will only make this easier.
The Hong Kong government’s recognition of tourism’s potential is evident from its decision to designate it as one of four key industries, alongside financial services; trading and logistics; and professional services and other producer services.
Chinese tourists lie at the heart of Hong Kong’s tourism appeal. According to the Hong Kong Tourism Board 28.1 million Chinese tourists visited in 2011, four times the population of the entire SAR. They spent US$14 billion in the city, equivalent to 6% of Hong Kong’s US$233 billion GDP in 2011, and a 35% rise on the amount they had spent the year before.
Little surprise then that the government is pushing a set of infrastructure links, the most important of which would effectively expand Hong Kong’s ability to funnel with people and goods in and out of the city – especially Chinese tourists.
A bridge to somewhere
Firstly there is a new planned railway from Sha Tin, in northern Hong Kong, to Admiralty, a station next to Hong Kong’s business district on the island.
The cost of this project is set to be HK$79.8 billion (US$10.28 billion), a hefty sum. However it is hoped that this will improve the ability of people living near the border with China to get to Hong Kong’s commercial and financial heart – a boon for tourists and businessmen alike.
Then there is a major upgrade to Hong Kong’s airport. The Airport Authority of Hong Kong (AAHK) has been, in consultation with several advisers including HSBC, considering how best to expand the airport to meet projected increases in air passenger numbers.
According to guesses the city’s award-winning Chek Lap Kok airport will only see more flights in and out as people either visit Hong Kong (and nearby Macau) for business or leisure, or use the convenient geographic location of the city as a hub to fly to other locations.
Maintaining such accessibility and logistical importance is crucial if Hong Kong is to retain its preeminence in eastern Asia. But the AAHK has predicted that based on current growth rates Chek Lap Kok airport will be unable to handle any more flights by 2020.
That’s bad news, particularly given that other cities such as Shenzhen would love to steal Hong Kong’s advantage.
The AAHK’s response to these needs has been to request permission to build a third runway – something that the government approved on March 20.
It promises to be very expensive. Best estimate projections place the cost of reclaiming more than 650 hectares of land off of Lantau Island’s north-eastern coast line and then the creation of a new runway and terminal at around US$11 billion over 10 years.
It would make the project the most expensive infrastructure investment since the initial Chek Lap Kok airport was constructed between 1992 and 1998 for a cost of US$20 billion. The expense of the airport extension is likely to be funded through a mixture of government spending, public debt, and possibly equity (see box on page 36).
But even this project is being dwarfed in terms of ambition by a plan to link Hong Kong, Macau, the former Portuguese colony that sits on the opposite side of the Pearl River Delta, and the Chinese city of Zhuhai, via a series of interconnected bridges and tunnels.
The Hong Kong government gained court permission to proceed with these projects, which has almost 30 years in the running, in December 2011. The cost of this 50 kilometre project, which will be shared by the three cities, is set to be US$10.7 billion, or HK$83 billion, and it is expected to be completed by 2016.
Again, the primary motivator behind this is ease of travel of people and goods. Macau’s casinos are a big money spinner, and popular with the increasingly affluent Chinese population. But it lacks a world-class airport, while Hong Kong enjoys a better class of restaurant and overall shopping experience.
Link the two together and both cities can potentially enjoy increased numbers of tourists and visitors. Added to this is Zhuhai, which could benefit from the improved trade links and offer more tourists to Hong Kong and Macau in its own right.
Finding the future
The hope of Leung and his new political secretaries is that these infrastructure projects will ensure that Hong Kong retains a crucial edge over other ambitious southern Chinese cities, and will underpin its appeal as a hotspot for tourism, conventions and international business headquarters.
Combined with the city’s continued international levels of transparency and rule of law, the hope is that Hong Kong will have some definitive advantages for decades to come.
It’s hard to say whether such hopes are realistic or not. Certainly the gap between Hong Kong and Chinese rivals is closing. But the perception of Hong Kong as a genuinely cosmopolitan, welcoming and reliable place to visit and do business depends on more than just its current CNH advantage.
Add in an attractive tax rate and freedom of speech (of which a rambunctious press takes full advantage) and it’s evident that Hong Kong does have some inherent advantages that Shenzhen or even Shanghai would find hard to emulate.
Hong Kong’s future as the financial gateway to China might be limited, but don’t be surprised if the city’s infrastructure investments help ensure that it retains at least some of its cachet with Chinese tourists and international businesses alike.
Leung, the city’s chief executive-elect will certainly hope that this is the case; otherwise his re-election chances in 2017 look slim indeed.