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Asia-PacificJune 1 2008

Drowning under the mainland wave

Moves to make the renminbi freely convertible, combined with the growth of rival financial centres on the Chinese mainland such as Shanghai, are chipping away at Hong Kong’s importance to international investors. Karina Robinson reports.
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Some things in Hong Kong never change, such as the Filipina maids meeting on their Sunday off in the open air to picnic and chat, or the constant speculation about when the Hong Kong dollar peg will be abandoned for the renminbi.

What has changed for the worse is the pollution and, say critics, Hong Kong’s importance to mainland China as a financial centre and a conduit to the outside world.

  Bankers such as Sandy Flockhart, chief executive for Asia at HSBC, dispute this. He argues that legal and tax certainty under the ‘one country, two systems’ motto, plus Hong Kong’s location as a springboard into the Pearl River Delta area, which has the 29th largest gross domestic product (GDP) in the world, and the government’s tax cuts in the most recent budget, make it a good place to do business.

 

Financial sophistication

However, when the renminbi becomes freely convertible, Hong Kong will become less relevant and the growth in the financial sophistication of cities other than Shanghai will also have an effect. “Will there be more than one financial centre in China? Yes, I think there will be,” says Mr Flockhart.

In the meantime, the Hong Kong Special Administrative Region, as it is officially known, is both benefiting and suffering from its dependence on China.

On the plus side, the city’s economy is being driven by mainland Chinese growth of 11.9% in 2007, dropping to an estimated 9.6% in 2008 as the ­Chinese authorities try to rein in the pace of expansion. How big an effect the US recession and the European slowdown might have has yet to be quantified. Ben Hung, CEO of Standard Chartered in Hong Kong, says that negative sentiment does not “decouple” and that although intra-Asian trade makes up more than 50% of total regional trade, it is still in double figures for the US.

The flipside

The minus side of Hong Kong’s China dependency lies in the yuan’s surge against the US dollar, to which the Hong Kong dollar is pegged. A key psychological level of 7.00 yuan to the dollar was recently breached though it has since dropped back below this ­figure. Hong Kong residents are having to pay more for the mainland-­originated food supplies and consumer goods.

Growth slump

Some economists even foresee a GDP growth rate as low as 3.9% for the city in 2008, although the mainstream estimates are higher at about 4.6%. GDP growth was 6.3% in 2007.

“Inflation is one of the big problems,” says Mr Hung. “Economically, we are more aligned with China but because of the dollar peg, rates are going down.”

The city’s underlying inflation increased to 5.3% year on year in March, mainly because of food prices – there have already been queues in the streets for rice amid tales of shortages – when the overnight Hong Kong Interbank Offer Rate was quoted at 1% in mid-April.

As a result of the negative real ­interest rates, banks have been focusing even more on fee income and with this they have been helped by the 2004 closer economic partnership agreement. CEPA, a free-trade deal ­engineered by the mainland to support Hong Kong, allows Hong Kong banks to use less capital than other foreign banks when incorporating on the mainland. Among other measures, incorporation allows them to take in renminbi deposits, giving them access to the immense savings of the population, the Holy Grail for bankers.

There is an estimated $4000bn in deposits in the financial system in China, which are mainly trapped on the mainland, because of foreign exchange controls, with limited investment possibilities. “Directionally, they need to let excessive liquidity flow out,” says Mr Hung. He and other bankers believe that Hong Kong will be the first beneficiary of the deregulation and opening up of the market because of its expertise in fund management, ­private banking and brokerage.

Investment products

In December 2007, the Chinese government announced that approved financial institutions under the ­Qualified Domestic Institutional Investor Scheme (QDII) can invest for clients in overseas stock markets by launching investment products.

However the credit crunch and the meltdown in developed markets may have given the Chinese authorities pause for thought when it comes to the pace of liberalisation.

“The natural conservatism [of the authorities] in terms of what happened may be an impediment in moving forward more quickly,” says Mr Flockhart.

In any case, mainland money is already finding its way to Hong Kong via property transactions and in other ways. Standard Chartered saw its Hong Kong operating profits rise by 34% in 2007, and Mr Hung points out that it is impossible to separate out what percentage of the business is derived from the mainland or Hong Kong.

“Every single corporate has a China element,” he says.

Chinese bidding

Standard Chartered itself may well end up being owned by a Chinese bank, following rumours of three ­Chinese banks’ plans to bid jointly for the 19% shareholding owned by Temasek, the Singaporean government’s investment company. “We’ve lived through years of rumours,” says Mr Hung, dismissively.

Meanwhile, both HSBC and ­Standard Chartered emphasise their expertise on the trade front, with the new trade corridors between China/Hong Kong and the Middle East, Africa and Latin America; and Hong Kong’s historical role as a trade middleman.

Pollution problem

With the Hong Kong government keen to expand the city’s role as an international financial centre, it must also deal with the increasing problem of pollution. Singapore has taken advantage of this in selling its merits as a financial centre with clean air. “We have to fix the pollution problem because the underlying economics [of Hong Kong] make sense,” says Mr Hung.

HSBC STRATEGY

HSBC, the bank that first brought the subprime problem in the US to the attention of financial markets in February 2007, is now the beneficiary of its exposure to emerging ­markets and Asia, even when peers such as Royal Bank of ­Scotland continue to surprise the market with bad news and exposure to weakening economies.

HSBC reported a 10% increase in pre-tax profits to $24.2bn in 2007, with over half of this coming from its Asian operations.

However, Mr Flockhart, a rumoured CEO candidate, remains relatively positive about the bank’s exposure in the US, despite the 35% drop in 2007 pre-tax profits to $2.4bn for the region. He ­considers that selling ­Household, the problematic mortgage-focused unit, would not make sense.

“We would not get high value from selling something that appears to be distressed and at present we can see that entity through its problems,” he says.

Activist investor Knight Vinke insists that Household cannot support $150bn in debt, of which $80bn needs to be repaid within three years, and that the unit’s assets are ­overvalued by $27bn.

Mr Flockhart does not rule out making an acquisition in the south of the US to build on the bank’s links to Latin ­America via immigrants and the many financial services that they require. Latin ­American pre-tax profits rose by 16% to $1bn in 2007. Mr Flockhart ran this division until July 2007.

The focus remains on emerging markets acquisitions, especially considering the bank’s stated role of doubling profits from insurance, which makes up 11% of group ­profits.

Much of its insurance ­profits in Asia come from joint ventures and alliances because of the regulatory limits on ­foreign bank penetration. Mr Flockhart adds that Indonesia is a market that “would interest us, certainly”.

In line with the usual HSBC mantra about not overpaying, Mr Flockhart is at pains to point out that Société Générale’s purchase of ­Rosbank in Russia was “quite expensive”, because HSBC has stated its interest in central and eastern Europe where it barely has a presence.

Without mentioning any names, Mr Flockhart adds that opportunities in divestments will arise when rivals realise the riskiness of international operations when economies falter.

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