Worsening Sino-American relations and China’s rising authoritarianism are bound to impact how funds flow into Hong Kong.

 

Hong Kong is everything that Mainland China is not—there is freedom of speech, it has credible and independent financial institutions with a squeaky-clean track record and a fully convertible currency. All these have led to its rise as one of the three global financial centres after New York and London; and it plays a pivotal role in global finance. This stands to be altered with Chinese President Xi Jinping’s repeated efforts to undermine the treaty the CCP had signed with the UK in 1997, by subverting its democratic culture, imposing draconian rules and insisting on imposing policies of Mainland China. The US’ threat of stripping all the financial privileges it had granted to the territory has raised concern amongst several quarters about the fate of Hong Kong. Any change in its status will not just impact businesses; it will deeply hurt the ability of dubious Chinese companies to raise money and could lead to a significant dollar flight from the region.

India is a relatively smaller player in the global currency trade, due to several restrictions on full convertibility of currency and is unlikely to be actively involved in the changed international dynamics. However, the move will have larger implications for the Chinese government and its ability to repay massive amounts of its debt pile.

Of all of Hong Kong’s distinct advantages, the most significant is its role as the dominant offshore dollar funding centre in Asia. Since 1983, the Hong Kong dollar has been pegged to the greenback, underwritten by foreign reserves of about $440bn.

Firms dealing in Hong Kong’s currency assume that it is perfectly fungible with the greenback and have so far assumed (correctly so) that an American dollar in Hong Kong is perfectly fungible with one in New York. This belief has ensured most activity in the financial centre was dominated by American dollars.

Last year, 97% of foreign-exchange deals, nearly 60% of cross-border loans and over 43% of cross-border derivatives have been in US dollars (as per Hong Kong Monetary Authority).

This has allowed Chinese firms with questionable balance sheets to raise money offshore and pump billions into their transactions which would otherwise find it tough to raise capital.

Worsening Sino-American relations and China’s rising authoritarianism are bound to impact how funds flow into Hong Kong. If its financial institutions lose credibility, if its courts and Central Bank become proxies of CCP and if a dissenting note by an analyst on opaque finances of a State-run company invite sedition charges, will money still flow into the territory? No. It is a scenario that is now being factored into by all banks, companies, financial institutions and hedge funds that have so far treated the territory as a global dollar centre.

It could lead to fewer companies willing to raise money and reduce the number of public listings. While firms doing business with China would still have nowhere better to be, other activity could easily shift to somewhere less controversial and more stable. Maybe to Singapore or even Tokyo (Mumbai cannot replace Hong Kong due to a very inadequate policy framework). This will severely dent Hong Kong’s future ability to raise funds, conduct business independently, buy stakes in businesses around the world and have sound finances.

If the US decides to weaponise the global financial system and imposes sanctions and treats Hong Kong like Mainland China, it will be tough for the Chinese government to make dollar payments. More importantly, it will come at a high price. Paying an extra 0.5% on its dollar debts, could cost China at least $7 billion a year.

Of course, American interests will be impacted. Nearly 1,300 American companies operate out of Hong Kong and will witness heightened business uncertainty and may be forced to relocate or face higher taxes. But in the larger Trump vs Xi game of one-upmanship, the losses for CCP may outweigh the dent on American business. 2020 continues to be the year of shake-ups.

Gaurie Dwivedi is a senior journalist covering economy, policy and politics.