China approves decision to enact Hong Kong national security law

Hong Kong (CNN Business)The United States may soon terminate its special economic and trading relationship with Hong Kong. Experts say losing the status won’t cause an immediate exodus of big western companies from the global financial hub, but it could further erode what made Hong Kong so attractive in the first place.

The latest blow to the city’s reputation came after US Secretary of State Mike Pompeo said Wednesday that the country no longer views Hong Kong as sufficiently independent from China, which for more than 20 years has governed the city as a semi-autonomous region with freedoms not available on the mainland.
Pompeo says Hong Kong is no longer autonomous from China, jeopardizing billions of dollars in trade
Pompeo’s announcement is not a surprise. He warned last week that a new national security law China has planned for Hong Kong — which is expected to ban sedition, secession and subversion against Beijing — would be a “death knell” for the autonomy the former British colony was promised.

    The declaration doesn’t change anything right now, though it does suggest that Washington could revoke the special status it granted the city in 1992. Late last year, US lawmakers passed legislation that linked the arrangement to an annual review of Hong Kong’s unique political and legal freedoms.
    The status has its economic perks: During the US-China trade war, for example, it allowed Hong Kong to avoid the tariffs that Washington imposed on Chinese goods.

    But the trading relationship between Hong Kong and the United States is far less valuable than the other business opportunities the city affords foreign firms, such as the ability to operate without restrictions encountered elsewhere in China. Beijing regulates everything about how a foreign company does business in the mainland, from how much capital they can invest there to how large of an ownership stake they can hold in their own business ventures. That makes Hong Kong a more suitable staging ground for firms that have an interest in the region.
    “Hong Kong has become one of the latest battlegrounds for the US-China power game,” said Ronald Wan, chief executive of Partners Capital International, a financial services firm based in Hong Kong. “Trade is just a small part of the story.”

    Trade is only part of it

    The United States imported nearly $17 billion in goods and services from Hong Kong in 2018, while exporting $50 billion — a trivial amount compared to the nearly $740 billion in goods and services traded that year between the United States and China.
    Applying Chinese tariff rates to Hong Kong exports would “have a limited direct impact on the US firms operating in the territory” because of how little is exported, wrote analysts from Eurasia Group in a Wednesday research note.
    A US-China trade war is the last thing the world economy needs now
    They added that it’s unlikely the United States would ditch its relationship with Hong Kong in full, though.
    “US companies are invested in Hong Kong as an access point for the region,” the analysts wrote. “Losing its special status would also hurt Hong Kong more than Beijing, further straining an already struggling economy while doing little long-term damage to Beijing’s plans.”
    A more troubling risk is that the loss of that special status could lead Washington to restrict Hong Kong’s access to sensitive American technology, according to Capital Economics.
    Such products comprise only 5% of Hong Kong’s total imports, researchers at the firm wrote last November. But they said that “restricting the ability of Hong Kong-based firms to source sensitive products would remove one of Hong Kong’s distinct advantages as a business location relative to mainland China.”
    That concern also points to a broader fear: If the United States starts treating Hong Kong as it treats China on trade, it eventually could reconsider the way it looks at the city entirely.
    “The short-term economic damage would be manageable,” the Capital Economics researchers said. “But it would accelerate the erosion of Hong Kong’s status as an international business center.”

    Pedestrians wearing protective masks cross a road during the morning rush hour in the Kwun Tong district of Hong Kong on May 6.

    Turbulence ahead

    There are some signs that investors are nervous about the city, which has already endured months of clashes between police and pro-democracy protesters. The city’s benchmark Hang Seng Index (HSI) suffered its worst day since 2015 last Friday after news of the national security law broke.
    “We see turbulence ahead as US-China relations are set to deteriorate further,” wrote strategists from New York-based financial services firm Brown Brothers Harriman in a recent research note.
    The strategists warned that the Hong Kong dollar could face pressure, even though it is pegged to the US dollar and can only trade within a narrow band. If the Hong Kong currency weakens, interest rates could spike. Investors might also be prompted to move their money elsewhere.
    “While we expect the peg to hold, a run on the [Hong Kong dollar] would [be] very destabilizing to the economy,” they added.
    Any significant amount of instability could also prompt foreign companies to reconsider Hong Kong as a hub for their business in Asia. More than 1,300 US companies alone operate in the city, according to Citi.
    “Recent surveys by the American Chamber of Commerce show that US firms already plan to scale back their investments in the city,” wrote the researchers from Capital Economics. “Much of Hong Kong’s success is based on its ability to attract [foreign direct investment] and enjoy the productivity dividends that come from hosting internationally-competitive firms.”

    A complicated relationship

    Despite recent fears, business leaders and analysts have stressed that Hong Kong’s relationship with the West is long and complicated. Completely unraveling it would be difficult.
    The Eurasia Group analysts noted that re-defining Washington’s treatment of the city would “touch on complicated issues of regulatory cooperation, tax treatment, and legal cooperation.”
    Businesses fear the worst for Hong Kong's future
    “These will not unfold quickly,” they said. The analysts added that President Donald Trump is unlikely to immediately sanction Hong Kong in a way that hurts its financial stability, such as making it harder for Hong Kong authorities to clear US dollar transactions.
    “Businesses may relocate. Capital could flee,” said Wan, the Partners Capital executive. “But it could take years.”
    And though US firms have been “evaluating the situation” in Hong Kong, that doesn’t necessarily mean that they will rush for the exits, according to Tara Joseph, president of American Chamber of Commerce in Hong Kong.
    Beijing also likely considered the impact that introducing its national security law would have on business in Hong Kong, according to the Eurasia Group analysts.

      “Chinese officials likely determined that the majority of firms would not leave the city and that any risks to key elements of Hong Kong’s financial system, such as the Hong Kong dollar peg to the US dollar, were controllable,” they wrote. “For Beijing, the imperative of tightening political authority over Hong Kong trumps the risks of the territory’s longer-term economic atrophy.”
      — Akanksha Sharma and Kristie Lu Stout contributed to this report.
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