Hong Kong’s economy is still important to China
Focusing on GDP masks Hong Kong's financial relevance to China, which includes being offshore centre where the majority of Chinese banks' overseas assets are held
Discontent is running deep in Hong Kong, currently facing the most severe political crisis since the handover almost two decades ago. The turmoil prompted analysts to review Hong Kong’s economic importance to mainland China and many concluded the city is no longer vital.
It is true that the share of Hong Kong’s GDP to the rest of China declined from 16% in 1997 to 3% in 2018. Statistics seem to provide a clear view of Hong Kong’s waning relevance but this is not the full story. A narrow comparison solely focusing on GDP masks Hong Kong’s financial relevance to mainland China and the world.
To gauge Hong Kong’s real relevance, we need to consider the key soft spot for mainland China. This is Hong Kong’s financial acumen and, in particular, its offshore centre status. The city’s economic foundations are based on free capital movement while mainland China still maintains a relatively close capital account.
This means Hong Kong can facilitate China’s access to foreign capital. Hong Kong’s role has helped mainland China in keeping its financial sector insulated without suffering the negative consequences of such isolation, i.e. limited access to finance or difficult access to global assets. In essence, Hong Kong is China’s financial firewall.
The second aspect to consider is that Hong Kong’s financial system is increasingly dominated by mainland Chinese banks. At the same time, overseas bank assets held by mainland Chinese banks are also heavily concentrated in Hong Kong.
The large exposure means that the destiny of Hong Kong as an offshore financial centre affects China even more than it affects those from the rest of the world.
Finally, Hong Kong’s offshore financial sector has been extremely successful, at least when measured by the increase in size. Bank assets-to-GDP ratio expanded from 462% in 2002 to 846% in 2018. Since the introduction of the currency board, Hong Kong managed to keep the peg and stability amid political risks from time to time.
There is no doubt that the current HK dollar regime has helped Hong Kong build a massive offshore financial centre, but it does not offer any respite if a negative shock affects the economy, which is exactly where we are today.
And the same huge size of China’s offshore centre can become a problem if Hong Kong experiences capital outflows as a consequence of recent events.
Not only is Hong Kong important to the rest of China, especially in the financial sector, but its intrinsic risk is also even higher than that of other financial centres as it sits on a very rigid monetary regime. Beyond Hong Kong’s financial institutions, those who will be the most affected by the arising risks are the mainland Chinese banks in town.
Alicia Garcia Herrero is chief economist, Asia-Pacific, Natixis.
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22 Aug 2019