[Analytics] Gloomy outlook for Hong Kong’s economy

Hong Kong is caught in a perfect storm. Internally, peaceful protests against a controversial extradition bill in June gradually escalated into violence, which destabilised the city politically and economically. Externally, intensifying trade tension between the United States and China is weighing on the Hong Kong economy. Paul Luk, Vera Yuen specially for the East Asia Forum.

Even before the protests broke out, the Hong Kong economy grew sluggishly by 0.5 per cent in the first half of 2019 — its worst performance since the global financial crisis. Since mass protests began, the economy has deteriorated precipitously, with retail sales, food and beverages and the tourism sector hit the hardest. In September, retail sales were down by around 20 per cent and tourist arrival by a whopping 34 per cent year on year.

So far, other industries such as professional services and the financial industry have remained relatively resilient. Overall unemployment remains stable and low. And residential property prices have only fallen by around 5 per cent since the beginning of the protests, due to tight housing supply and low interest rates.

Political unrest has persisted for over four months and shows no sign of abating. The government has not come up with effective measures to calm the situation, let alone to tackle the underlying structural issues — the salient ones being high property prices, heightened inequality and the mandate of the Chief Executive. Worse still, the recent enactment of emergency laws to ban masks ignited another wave of violent protests. The city has been under de facto curfew since the beginning of October, with the subway system closed early for more than two weeks.

With no resolution in sight, the Economic Policy Uncertainty Index for Hong Kong, a leading indicator of the future state of the economy, has risen sharply over the last four months. Uncertainty and collapse in confidence are likely to induce widespread cutbacks in business investments and domestic consumption in the near future. The risk of a prolonged and full-blown recession is rising quickly.

The long-term outlook for Hong Kong is no less worrying. The city’s success as an international hub relies heavily on the ‘one country, two systems’ principle. This allows Hong Kong to have its own governmental system, legal system and trade relations with the rest of the world. In good times, Hong Kong is a place where the East works collaboratively with the West; in bad times it becomes a place where the East clashes with the West. A remarkable example of this was Hong Kong’s failure to detain Edward Snowden in 2013 despite a US extradition request.

On the one hand, Beijing takes advantage of Hong Kong’s strategic position, using it as a controlled testing ground to experiment with financial reforms. Recent reforms initiated in Hong Kong, such as the ‘dim sum bonds’, offshore renminbi deposits and Stocks and Bond Connects represent important steps towards renminbi internationalisation — a Chinese strategic goal. Hong Kong, as the middleman, also benefited from being the largest offshore renminbi business hub.

On the other hand, the ‘one country, two systems’ principle is being constantly challenged. This has been the crux of Hong Kong’s problems since at least 2014. The Occupy Central movement in 2014 was triggered by a reinterpretation of the Basic Law — Hong Kong’s mini-constitution — that installed extra hurdles in the long-promised popular election of the Chief Executive. To some, Beijing’s decision reneged on the promise of universal suffrage in the territory.

More recently, a number of popularly elected opposition lawmakers were ousted from the legislature for not taking their inauguration oaths properly. Other candidates were barred from running for the election for their localist political stance.

The chaos the extradition bill inspired exposed further evidence of Beijing’s meddling in Hong Kong affairs. For instance, in a leaked speech, Chief Executive Carrie Lam confessed that she could not resign from her position, nor did she have room to manoeuver. The bill was withdrawn in late October amid increasingly violent protests.

In the face of an escalating US–China trade conflict, China would want to use Hong Kong as a buffer to circumvent trade barriers and restrictions to the transfer of sensitive technology. But for this strategy to work, China has to make the case to the rest of the world that Hong Kong still maintains a high degree of administrative autonomy.

Recent developments seem to indicate that Beijing did not have a coherent Hong Kong strategy. Now that the protests have brought so much international attention, the city’s relationship with the mainland will be closely scrutinised by the rest of the world. The US House of Representatives recently passed the Hong Kong Human Rights and Democracy Act, which would require the United States to review Hong Kong’s special status every year. This leaves Chinese leaders little time to make up their minds about Hong Kong — whether to oppress or to accommodate.

Prolonged unrest has widened the divide between Beijing and the business sector in Hong Kong. In September, credit rating agency Fitch downgraded the city’s rating, and Moody’s changed its outlook to negative. Once trust is shattered it is hard to regain — even accommodative measures may not lure the businesses back.

For Beijing, the benefits of honouring the ‘one country, two systems’ framework are shrinking. More severe oppression is increasingly likely.

Paul Luk is Assistant Professor of Economics at Hong Kong Baptist University.

Vera Yuen is an Assistant Lecturer in Economics at the Faculty of Business and Economics of The University of Hong Kong.