Last month, China’s took a major step to redefine its relationship with Hong Kong by enforcing the ‘Law of the People’s Republic of China on Safeguarding National Security in the Hong Kong Special Administrative Region’ (the National Security Law).
What raised the hackles of the international community were the controversial provisions of this law aimed at “preventing, suppressing and imposing punishment for the offences of secession, subversion, organisation and perpetration of terrorist activities”. This objective is a direct fall-out of the pro-democracy protests that the city has been witnessing, especially against the controversial extradition Bill, suspected of quelling the voices of dissent in Hong Kong against Beijing.
Ever since China’s National People’s Congress took the decision to introduce the security law, the United States administration has been threatening to redefine its relationship with Hong Kong, which was broadly framed by the United States-Hong Kong Policy Act of 1992. On July 14, US President Donald Trump issued an executive order on ‘Hong Kong Normalization’ ending the special status that was hitherto extended to the city. Here on, Hong Kong will be treated at par with the mainland, which implies that US sanctions will now be applicable to entities from Hong Kong as well.
The change in Hong Kong’s status effectively means that the US no longer recognises the ‘One Country, Two Systems’, which has been the tagline that Beijing has used to convey to the world that Hong Kong enjoys a ‘high degree of autonomy’. Hong Kong’s special status benefitted the mainland in three significant ways. First, as a financial hub Hong Kong helped the mainland to attract foreign direct investment (FDI) in volumes that was could be matched only by the US. China’s post-reforms development processes, the special economic zones in particular, were direct beneficiaries of such FDI inflows.
Second, Hong Kong played a critical role in the internationalisation of the Renminbi (RMB), leading to its eventual recognition as an international currency after it was added to the basket of currencies backing the Special Drawing Rights (SDRs) of the International Monetary Fund (IMF).
Third, as an entrepot, Hong Kong has been playing an important role in distributing products manufactured in the mainland to the rest of the world by using it special relations with most of the major economies.
Analysts have been arguing that Hong Kong has been playing a vital role as the mediator between the market economies of the West and Communist China. The most obvious evidence in this regard has been Hong Kong’s contribution in FDI inflows into China. Official statistics show that between 1983 and 1998, FDI inflows from Hong Kong into China were about $142 billion, which was more than 53 percent of its total inflows.
In recent years, Hong Kong’s importance as a source of FDI has gone up further: in 2017-18, more than 59 percent of total FDI flows into the mainland came from Hong Kong. It is widely expected that the political unrest in Hong Kong would stymie inflows of FDI into China and given the importance of the city in total inflows into the mainland, China’s position as a major destination of FDI could also be adversely affected.
The process of internationalisation of the RMB began through a pilot project of trade settlement via Hong Kong in 2009, and over the past decade, this process has progressed significantly. In recent years, the RMB trade settlement handled by banks in Hong Kong has seen exponential growth, increasing to 5.38 trillion in 2019, which was 89 percent of total RMB cross-border trade settlement during the year.
Hong Kong has also been playing a crucial role in offshore RMB settlement, as the city handled a large share of the world’s offshore RMB payment, remittance and settlement transactions. In 2019, RMB Real Time Gross Settlement system recorded an average daily turnover of RMB1,100 billion, which was 55 percent higher than the level in 2014. Alongside, Hong Kong’s contribution in offshore RMB settlement has also grown significantly. Estimates provided by the Society for Worldwide Interbank Financial Telecommunication (SWIFT) show that the city has been accounting for about 75 percent of RMB activity outside the mainland.
While Chinese authorities would be looking for further strengthening of the RMB in the post-COVID-19 world, whether Hong Kong will be able to play its part under the changed political circumstances will be watched with interest.
Hong Kong has long served as the gateway for the distribution of China’s products to the rest of the world by importing products from China and then re-exporting them to their final destinations. Its special status recognised by major economies had played a major part. Between 1988 and 1998, more than 50 percent of China’s exports were distributed via Hong Kong. This figure has not changed much in recent years, since there are added motivations like tax avoidance of routing Chinese products through Hong Kong.
With the US withdrawing the special status, and the likelihood that other western countries may follow this lead, Hong Kong’s ability to remain a vital entrepot could be seriously undermined.
Biswajit Dhar is Professor at Centre for Economic Studies and Planning, School of Social Sciences, Jawaharlal Nehru University. Views are personal.