Business as usual for Hong Kong?

Hong Kong has been the setting of some dramatic events in 2019. Proposed changes to the extradition laws saw its first protests held in March 2019; in the following weeks, the size of the protests grew, with thousands taking to the streets.

Civil unrest across the city escalated to violent scenes in the months leading to November 2019, when the landslide victory of pro-democracy candidates in the district council elections helped to restore public order. While protests continue, they have reverted to peaceful demonstrations. Despite all of this, the city has remained stoic. Business has continued, even if the cracks are beginning to show. 

Shows of stability

Throughout, Hong Kong's financial community has maintained confidence in the stability of the city as its core business sectors have continued to function, including the stock market, trade system and legal and financial services. The Hong Kong dollar, which is pegged to the US dollar, has also remained stable, and during December 2019 it firmed to 7.8105 to the dollar, its strongest level since July 2019. 

The special administrative region (SAR) has progressed with its issuance of virtual banking licences, with the Hong Kong Monetary Authority awarding eight companies the right to establish new banks, although media reports have speculated that the launch of these banks may be postponed. Internationally, there was a strong show of confidence in Hong Kong in 2019. Canada’s Fraser Institute named Hong Kong the freest economy in the world, while the World Economic Forum’s Global Competitiveness Report ranked it in third position – a rise of four places compared with 2018’s results.

The response among rating agencies has been mixed, however. While S&P has maintained its AA+ rating, Fitch has downgraded Hong Kong to AA from AA+, the first time it has downgraded the city since 1995. Moody’s meanwhile has maintained its Aa2 rating, but downgraded Hong Kong from 'stable' to 'negative'. Both Fitch and Moody’s directly cited the unrest in the SAR as a reason for the downgrade. 

Hong Kong has also been home to significant initial public offering (IPOs), with Budweiser Brewing Company APAC completing its $5bn IPO, the world’s third largest in 2019, in September. This was then topped by Alibaba’s $12.9bn IPO, the biggest of 2019. However, these figures are tempered by reports that flotations in the city declined by 42% in the year to October 2019 when compared with 2018 figures, according to financial data analyst Refinitiv. Hong Kong is likely to be the third biggest issuer in the world in 2019, falling from first place in 2018. 

Economic downturn 

While business has been continuing in Hong Kong, there is plenty of evidence to indicate the SAR has been experiencing hard times. Tao Jingzhou, managing partner at global law firm Dechert’s Beijing office, says: “[Businesses are starting to see a slip towards recession already in Hong Kong. People are starting to worry. Confidence levels will not be improved if there is continued social unrest.” 

A source from the Hong Kong Office of the Government Economist outlines just how the economy has been hit, saying: “The Hong Kong economy saw just 0.5% growth [in the first half of 2019], thanks to the sluggish global economy and the impact of the US-China trade conflict. In the third quarter [of 2019] it deteriorated due to the impact of the social unrest. Overall, the economy has contracted [in 2019] year on year for the first time since 2009. The International Monetary Fund has forecast a 1.2% decline for 2019, followed by a 1% increase in 2020.” 

There is also evidence of money moving offshore, with Goldman Sachs estimating as much as $4bn was transferred to Singapore during July and August 2019. Admittedly, this is a low amount compared with the $1500bn in deposits still held in Hong Kong at the end of August 2019. 

In some key sectors, the fluctuations have been more apparent. Hong Kong's property market, the bellwether of its economic success, has shown signs of change. In the real estate sector – known for being one of the world's most competitive and expensive housing markets – there has been some movement. Alicia García-Herrero, chief economist, Asia-Pacific, at Natixis, says: “There have been some people selling properties, with the number of available homes increasing. This is also driving prices down.” 

Christopher Yip, senior director at S&P Global Ratings, believes there has been an impact across all areas of the property market. “It is too soon to call the extent of the impact on the property sector, despite obvious pressure across all commercial properties," he says. "Rental occupancy for premium office space has barely budged, but landlords in Central [Hong Kong’s business district] are seeing waiting lists becoming shorter, and [there are] fewer Chinese financial institutions setting up larger offices in Hong Kong.” 

The long-term impact may not be felt immediately, according to Mr Yip, as office leasing contracts generally last for at least three years, and can extend as long as 10 years. “Because of the long nature of these contracts, it is likely that companies deciding to move will experience an apparent impact within the short term, but for companies drawing up longer term plans beyond the leasing cycles, there are likely a multitude of other considerations,” adds Mr Yip. 

However, there has been more of a response from the retail sector, where rents are shorter and the impact of the public unrest on purchasing habits has been felt more acutely. “The retail space is bleaker. The impact of declining tourism and consumer spending is taking its toll, with retail sales down by double digits,” says Mr Yip. “However, we believe the magnitude of impact on rent will remain quite divergent between street-front shops and shopping centres, with the latter continuing to be more resilient.” 

China and Trump 

While the slowdown in gross domestic product (GDP) is clear for all to see, the exact causes cannot be pinpointed to one event. As well as dealing with the social unrest, the macroeconomic environment has also been a problem for Hong Kong. Edward Yau, secretary for commerce and economic development in Hong Kong, says: “The headline story of the past year is the US-China trade war. Hong Kong has been hurt. GDP growth halted, with a 0.6% change in the first half of 2019.” 

A source from the Office of the Government Economist adds: “The decline has come from external influences, especially after the [US-China] conflict escalated and caused a decline in exports. In the near term, Hong Kong faces further downward pressures. The outlook for 2020 depends on Donald Trump, and what he decides to do with the trade talks.” 

The impact of the trade conflict is a recurring theme, but it is not the only external pressure on Hong Kong. Margaret Fong, executive director of the Hong Kong Trade Development Council, says: “I would say that the US-China trade tensions, slowing global economic growth and the rise of protectionism around the world pose a greater challenge, since these developments create barriers, which immediately affects businesses and the global supply chain.” 

Trying to navigate such problems is not an issue that is unique to Hong Kong, as they are prevalent even in places enjoying social stability. Ms Garcia-Herrero says: “Hong Kong has felt the same problems that have [made their impact felt] across Asia. South Korea has not seen growth, and Singapore was in recession in the first quarter of 2019. We are not expecting a pick up of business in China [in 2020], which will have a downward effect on Hong Kong.” 

Ms Fong believes there is the opportunity for something positive to come from these challenges. “Admittedly, Hong Kong is now facing internal and external issues, including dealing with the impact of the US-China trade war, and tackling complex political, economic and social issues," he says. "But this is also a chance to continue evolving and reinventing our city and ourselves to prepare for the future.” 

Searching for an alternative 

If this opportunity is to become reality depends largely on how comfortable the markets are about remaining in Hong Kong over the long term. The scale of the unrest, and the reasons behind it, has made some feel uneasy. But the reality of upping sticks and moving to another location is not a simple prospect. 

“The choices to move to business elsewhere in the region is limited,” says Ms Garcia-Herrero. “It is not possible to run business into China from South Korea or Japan. Opening a branch in Singapore would be too expensive. Neither Shenzhen or Macau has the scale to be able to take on business in a meaningful way.” 

Dechert’s Mr Tao agrees, saying: “Hong Kong is in a unique position in the region. Business could move to Singapore but it doesn’t have a backyard like mainland China. Japan is not an option for Chinese investors and the companies wanting to do business in mainland China. I cannot see how we could replace Hong Kong with any Asian city, at least in the medium term.” 

The need for highly skilled staff to run the operations is another reason a mass relocation seems unlikely. Ms Garcia-Herrero says: “Hong Kong is home to a huge pool of talent that is not replicated anywhere else in Asia. People could be looking to leave, but they don’t know where to go.” 

Taiwan option

Despite this, in some quarters there has been suggestions of moving business to Taiwan. With its close ties to China, a highly educated workforce and a central geographic location for the south-east Asia region, it does have a number of attractive features. 

There are however some sizeable drawbacks. Ms Garcia-Herrero says: “We are not seeing a move to Taiwan for a number of reasons. Taiwan dollars are not convertible, which impacts business. There are higher operation costs than in Hong Kong, which can impact along the length of the global value chain.”  

Taipei is, however, keen to onshore its domestic companies that have decided to run their operations from Hong Kong. It is a mutual relationship, as Hong Kong is dependent on Taiwanese business, according to Ms Garcia-Herrero, who adds: “If Taiwan was to take any steps against Hong Kong, it would be to repatriate the funds rather than create its own financial centre.”

Dr Thomas Huang, vice-chairman of the Financial Supervisory Commission (Taiwan), says there have been changes made to entice companies to return to Taiwan. “In response to Taiwanese businesses’ appeals for the need to adjust their investment framework and global operations, and channel overseas funds back home for investment, there has been policy introduced to attract Taiwanese businesses back home. Bringing funds back to Taipei would create a strong cash flow for Taiwan. New tax legislation was introduced and took effect in August 2019,” he adds.

This has already created some success. Mr Huang says: “During the third quarter of 2019, deposits and total assets in the offshore banking unit increased by 6.43% and 6.79%, respectively. Overall, Taiwan’s banking industry’s pre-tax profits reached $8.8bn in the third quarter of 2019, representing a 6.87% increase on the same period of 2018.” While clearly good news for Taiwan, it is not demonstrably bad for Hong Kong. 

Government reaction 

Throughout the protests, Hong Kong’s government and its leader, Carrie Lam, have come under intense scrutiny both in Hong Kong and China, from plans to change the extradition laws to the response of the police to protestors. However, there have also been measures taken to ensure the city continues to function and to keep employment levels high. 

“There is quiet confidence that the Hong Kong government will be able to improve the situation,” says Mr Tao. “Importantly, it is in the interest of the banking business and of the Hong Kong government to find a solution. The Hong Kong government may have to provide incentives in the future to create more confidence for businesses remaining in Hong Kong in the future.” 

Ms Fong adds: “I would say that the direct impact of the social unrest in Hong Kong has been felt most keenly by our domestic sectors, such as retail, tourism and hospitality. To address these issues, the Hong Kong SAR government has introduced multiple measures to support enterprises especially in these sectors, and to safeguard employment.” 

The Hong Kong government has been focusing its efforts on supporting the smallest companies. A fourth wave of relief measures worth HK$4bn ($513m) was issued in early December 2019 to buoy the economy. Since August 2019 there have been other government measures rolled out involving more than HK$25n-worth of measures to support enterprise, especially small and medium-sized enterprises employing fewer than 50 people to safeguard jobs. 

The hardest hit sectors have been the consumption and tourist sectors, specifically retail, catering and hotels. The Office of the Government Economist says the social unrest accounted for at least two percentage points of the 2.9% contraction in the third-quarter economic performance results. The labour market has been easing because of the economic downturn, but overall unemployment is still low at 3.1% in the three months to end of October 2019. 

Where now?

Since the results of the district council elections in November 2019, the level of unrest in Hong Kong has died down. While there are still mass protests taking place across the SAR, the level of violence seen in the run-up to the elections has subsided. Many in Hong Kong are breathing a sigh of relief. 

The markets are taking notice. Despite earlier downgrading Hong Kong, in December 2019 Fitch released a note stating there was little evidence so far that the social unrest had affected Hong Kong's role as an international business centre. However, due to the impact on the tourism sector, Fitch expects the overall economy to shrink by 1.5% in 2019. 

Ms Garcia-Herrero says that broadly Hong Kong is in a good position globally. “It is time to reflect on the next steps," she adds. "Business has not pulled back, and the level of confidence is the same. The situation in Hong Kong is not that unusual when you look internationally. Brexit is causing issues in London that are impacting business sentiment.” 

Assessing the situation for the banking sector, S&P released a note in October 2019 concluding the political risks were unlikely to have a negative impact for businesses. It noted how Hong Kong’s banks have boosted their financial buffers in recent years, giving capacity to absorb losses. “We consider Hong Kong's banking industry risk to be the lowest among its peers, mainly aided by prudent regulations and proactive supervision,” the report stated, with Hong Kong placed in the same Banking Industry Country Risk Assessment grouping as Singapore, Germany and Switzerland. 

Mr Yau adds the rule of law has been maintained, which increases confidence. “There has been no erosion of the One Country, Two Systems policy over the past year. Any challenges can be managed, and the business sector agrees,” he says. He also notes that Hong Kong is a member of the World Trade Organisation in its own right, which he believes will give greater levels of confidence to international trading partners. 

Hong Kong holds an essential position in Asia to facilitate growth, according to Mr Yau. He explains that the city is perceived as a professional services hub across the Association of South-east Asian Nations (Asean) member states and people want to come to Hong Kong for business connections. “The level of investment from across south-east Asia into Hong Kong is huge – Thailand invested twice as much into Hong Kong as Hong Kong invested in Thailand [in 2017]. Asean is of huge importance to Hong Kong, and is the second highest trade partner, surpassing both Europe and the US. Hong Kong is seen as a place for work not only in the business-to-business space but also in government-to-government business.” 

Ms Fong is also optimistic about what the future holds for Hong Kong. “Despite the trade war and social unrest, I can see Hong Kong’s two-way platform role expanding, as investment and trade flows intensify, between, for example, Central Asia and east Asia or between China and Asean,” she says. 

As long as Hong Kong maintains the same strong level of local governance, it will continue to be perceived with confidence. “Overcoming these complex challenges will take time, but with a solid foundation based on the rule of law, a robust, open society and a supportive international community, we are confident that Hong Kong will address its issues, ride out this storm and come out stronger,” says Ms Fong. “Hong Kong will continue to thrive, and by doing so continue to contribute to the development of the region and the world.”