In recent years, I have become aware of two rather strange observations held by some people in relation to Hong Kong’s status as an international financial centre:
(i) The closer Hong Kong develops ties with Mainland China, the greater the risk to Hong Kong. In other words, as Hong Kong is rapidly engulfed by the Mainland, or what some people call "mainlandised", our uniqueness from other Mainland cities will gradually disappear, and hence our competitiveness. Or, put another way, our future is doomed.
(ii) Hong Kong has gained the position as an international financial centre on “borrowed time”. With the existing capital account controls on the Mainland, Hong Kong has been, for now, a convenient platform for the cross-border inflow and outflow of funds. As the Mainland further opens up, Hong Kong’s intermediary role will no longer be needed because financial centres like Shanghai, Tianjin, Beijing, Shenzhen and Guangzhou will conduct business directly with the outside world. Some people have even predicted the demise of Hong Kong within two or three years after the recent launch of the Shanghai Free Trade Zone.
Hong Kong people may find these observations hard to swallow, but we still have to ask the question: what are Hong Kong’s prospects? My view is that Hong Kong people must not harbour complacency or defeatism. Indeed, we must not be swayed by views that are not supported by empirical evidence or objective analyses.
The closer our ties with the Mainland, the gloomier our future becomes?
This is a fallacy. In 2000, Mainland China’s GDP was about US$1 trillion. By 2013, China had outgrown other economies to become the world’s second largest economy with a GDP exceeding US$9 trillion – an economy that is expected to grow by an annual rate of around 7%. China today is no longer the same as the China in the 1980’s or 1990’s. In fact, China with its sustained growth is now the engine of world economic growth and an important factor for global financial stability. Under the “One Country, Two Systems” principle and with the full support of the Central People’s Government, it is necessary as well as natural for Hong Kong to leverage on its unique position to increasingly strengthen its business, investment and cultural ties with different Mainland provinces and cities. Taking New York City as an example: is it possible for America’s most vibrant city to achieve single-handedly all its successes by cutting itself from the US hinterland and relying solely on its 8 million population and overseas business connections? Absolutely not. The same applies to great cities like London, Paris and Frankfurt, which have become successful international business centres and financial hubs built on ties with, and support from, a large hinterland.
The historical development of Hong Kong as an international financial centre differs considerably from those in other economies. Prior to 1979, when China launched its reform and opening up campaign, financial ties between Hong Kong and the Mainland were very limited. By virtue of the hard work of its population, its rule of law, free and open market economy and locational advantages, Hong Kong gradually grew to become a financial centre in Asia. Nevertheless, because of the small size of Hong Kong’s economy, the headroom for the financial sector’s growth was restricted. But with China’s new reform policy gathering momentum, current and capital accounts were gradually liberalised, enabling Hong Kong to quickly develop industrial, commercial and financial ties with the Mainland and to serve as the bridge between Mainland and the rest of the world. Key milestones included the listing of Mainland enterprises in Hong Kong in the 1990s and the development of cross-border renminbi business since 2004.
Since 1979, Hong Kong has been the largest source of foreign direct investments in the Mainland, representing some 50% to 60% of the total in many years and amounting to US$73.4 billion in 2013. Much of these foreign direct investment flows originated from local companies and multinational firms based in Hong Kong, which use Hong Kong as the gateway for business and investment activities on the Mainland. At the same time, Mainland companies have also significantly stepped up overseas acquisitions and direct investments since 2000. Again, Hong Kong has often been used as a springboard for Mainland enterprises seeking to reach out. In fact, over the past few years, about 50% of the total of overseas direct investments from the Mainland has been routed through Hong Kong.
Indeed, on the trade front, there were many people who could only see a doomed future for Hong Kong as new port facilities began springing up on the Mainland. So, let us look more closely at the statistical data. The trade volume in China grew nearly eight-fold from over US$400 billion in 2000 to US$4 trillion in 2013. During the same period, re-exports from Hong Kong rose 1.5 times from US$180 billion to US$450 billion. Offshore trade grew even faster, with the value of goods handled by Hong Kong firms reaching US$520 billion in 2012. The gross margin of such offshore trade rose 2 times between 2000 and 2012 to US$35 billion. In broader terms, Hong Kong's trade intermediation activities and services, covering import and export, re-exports, offshore trade, and transportation and logistics services contribute as much as 25% value-added to our GDP and employ 21% of the local workforce. These ratios are higher than those in the 1990s. Therefore, we can see that as long as the Mainland’s economy continues to grow and our bilateral commerce and trade ties continue to flourish, Hong Kong can tap into the business opportunities and play an even more active role as an intermediary, contributing further to our economic growth and employment.
Will Hong Kong’s status as an International Financial Centre become irrelevant when the Mainland has liberalised its capital account?
This is another fallacy and I firmly believe the exact opposite will happen. Hong Kong as an international financial centre will have a brighter future with the further opening up of China. To illustrate this point, because of policy restrictions on the Mainland before 2004, offshore renminbi business was then non-existent in Hong Kong. But, with the breakthrough in that year and particularly in 2009 when the Mainland gradually allowed cross-border renminbi flows on a pilot basis, Hong Kong stands to make enormous gains with our close commercial and trade ties under the "One Country, Two Systems" principle. In just a few years, this competitive advantage has allowed Hong Kong to develop into the largest offshore renminbi business centre in the world. In addition, the internationalisation of renminbi is still in its early stages, and as it keeps moving towards full convertibility, combined with a further liberalisation of the Mainland’s capital account, there is huge potential for further renminbi business in Hong Kong.
Another point we often overlook is the fact that with the liberalisation of the Mainland’s capital account, the two-way cross-border flows of funds will be much more efficient. Some suggest that further liberalisation will enable Shanghai and other Mainland financial centres to take business away from Hong Kong in future as they expand their international outreach, and this may well be true to some degree. However, it will by then be much easier for Hong Kong’s financial institutions to develop their businesses, such as financing, bond issuance and wealth management services, in the onshore Mainland market. To illustrate this point, one should bear in mind that deposits on the Mainland now total RMB110 trillion while total assets of the banking system amount to RMB160 trillion. As the capital account continues to liberalise, creating the necessary policy headroom for two-way fund flows, banks in Hong Kong will be able to explore and take advantage of the countless business opportunities in this huge onshore market.
Is competition between Hong Kong and Mainland financial centres a zero-sum game?
This is yet another fallacy and let me use the US example to explain. Apart from New York City, we can look at some other major cities, such as Boston, Chicago, Los Angeles and San Francisco. The mayors of these cities often highlight the vibrancy of their financial sectors and the plans for enhancing their future development. Indeed, the financial sectors in these cities, on average, contribute around 10% to their respective GDPs, compared with New York City’s 15%. Similar to the US, China’s vast geographical area and huge economy will need to be supported by a number of financial centres, albeit in varying sizes and prominence. While funds at the wholesale level can flow swiftly across cities and regions, the sustained growth of the financial sector is closely related to the real economy. It is unrealistic to expect the millions of small and medium sized firms on the Mainland to concentrate on Shanghai or Beijing for financing and services. Similarly, the financial needs of the hundreds of millions of retail customers have to be met by financial agents and intermediaries that are located closer to where they live and work. This shows that the development of financial industry tends to follow real economic activities and their customers, which are scattered around different cities and regions. At the same time, the continuous growth in the Mainland’s economy will bring about financial deepening, which will in turn facilitate further economic development. Therefore, the major Mainland cities should promote the healthy growth of the industry to make a larger financial “pie”. And, while these cities may compete at the “wholesale” level for a bigger share of this growing pie, it will not be a zero-sum game at all.
Who will win the race between Hong Kong and Shanghai?
I have said in the past that the race among financial centres is a “battle of soft power”. While "hardware" in the form of airports, transport, IT infrastructure, and efficient offices, etc are the pre-conditions for eligibility to enter the race, they can only go so far. Funds, especially at the wholesale level, tend to flow to and stay in the more efficient and safe financial centres. Therefore, the race ultimately depends on soft power, which is contributed by a wide range of qualities and strengths that are difficult to quantify. They include, the most important of all, the legal system, the protection of property rights and intellectual property, the taxation regime, the soundness of financial institutions, the robustness of the supervisory regime, the competency and integrity of the professionals, such as bankers, accountants and lawyers, the free flow of information and the free movement of people and a favourable business environment. When all these factors are considered, no financial centre is perfect or can claim to remain the best, since every financial centre is constantly striving to improve its competitiveness and to catch up in the race.
Having said that, I do not believe Shanghai and Hong Kong are rivals. In particular, the two centres are situated in different regions and their real economies have different clientele. With capital account controls still in place on the Mainland, the further opening up of Shanghai, such as the development of the Free Trade Zone, will lead to closer and more extensive business, trade and financial links between Shanghai and Hong Kong, and this means more business opportunities for a win-win combination. The Shanghai-Hong Kong Stock Connect, announced by Premier Li Keqiang in April this year, is a milestone in the further liberalisation of China’s capital account. Under the scheme, the Shanghai stock market will basically be opened to the whole world through the Hong Kong Exchange (HKEx) because all major global brokerage firms have an account with HKEx. Once the scheme is implemented, these brokerage firms will be able to trade A-shares on behalf of their overseas clients easily, and Mainland investors will be able to trade Hong Kong stocks through the Shanghai Stock Exchange platform. Hong Kong and Shanghai are actively preparing for the launch of the scheme. I am confident that the scheme will raise Hong Kong’s capital market and offshore renminbi business to new heights, thus rebutting the notion that Shanghai and Hong Kong are in a fight that only the winner can survive. And, more importantly, the scheme is a practical demonstration of close collaboration between Hong Kong and Shanghai, which in turn will contribute in no small way to China’s reform and liberalisation.
Norman T.L. Chan
Hong Kong Monetary Authority
4 August 2014