18 November 2019
Thanks to the Hong Kong dollar peg to the greenback, the domestic market has been largely immune to shocks from the ongoing democracy protests. Photo: Bloomberg
Thanks to the Hong Kong dollar peg to the greenback, the domestic market has been largely immune to shocks from the ongoing democracy protests. Photo: Bloomberg

What holds the Hong Kong market together amid protests?

Investors seem to be taking the Hong Kong protests over universal suffrage in their stride.

There has been no attack on the Hong Kong dollar peg and Hong Kong’s risk premium has hardly risen.

The bad news is Hong Kong’s economic fundamentals have deteriorated significantly for more than 10 years. 

If the protest movement were to trigger capital outflows, Hong Kong’s cushion against such a systemic shock is very thin, as seen in its excessive private debt build-up and sharp drop in its current account surplus to only 1.6 percent of gross domestic product.

If capital outflows were to force a sharp deleveraging process, that would risk plunging Hong Kong into a deep economic recession.

The billion dollar question is what has been holding the Hong Kong market together?

Hong Kong’s fundamentals have deteriorated steadily for over 10 years.

Productivity growth of its key economic sectors such as financial, trade and logistics and overall investment returns have fallen or remained stagnant for more than a decade.

But many people still seem to be in denial of this economic reality. This is reflected in the attitude of those protesters who think Hong Kong still has the bargaining power to push Beijing.

This structural decline is a wake-up call for Hong Kong to upgrade and re-invent its economic strengths in cooperation with the mainland.

It is an economic reality that Hong Kong now needs China more than China needs Hong Kong. Hong Kong’s role as a trade route into China has diminished while its dependence on Chinese trade has significantly increased.

In 1997, Hong Kong’s economy was estimated at 18 percent the size of China’s. Today, it is only 3 percent. Hong Kong’s gross mainland exposure, in terms of company assets in China, was equivalent to 315 percent of  GDP as of June 2014, up from only 70 percent in 2008.

As for Hong Kong’s role as the prime offshore renminbi centre facilitating China’s financial reforms, it will simply disappear when the yuan becomes fully convertible (but I am not predicting this to happen in the short term).

From a market perspective, this structural erosion of Hong Kong may not catch the world’s attention in the short term but its macroeconomic deterioration will, especially if the protests trigger massive capital outflows.

Hong Kong has the most extended property market and private (individual and corporate) debt build-up in Asia. It also has the fastest deterioration in current account balance in recent years among regional economies.

These problems have been buried under a sea of excess liquidity since 2008. They will become salient when liquidity is squeezed.

I am not saying that Hong Kong’s macroeconomic fundamentals have deteriorated to unsustainable levels.

Its current account is still in surplus (albeit by a small amount of 1.6 percent of GDP in 2013 versus more than 10 percent just a few years ago); its rapid private debt-growth is, to some extent, a result of multinationals raising funds in Hong Kong for deployment elsewhere in the region.

But the rapid deterioration of these fundamentals implies that the financial cushion for Hong Kong to weather a liquidity shock has been worn very thin.

Under the Hong Kong dollar peg, significant capital outflows would lead to surging interest rates as happened during the 1997-98 Asian financial crisis.

This would trigger a disorderly deleveraging process, wreaking havoc on the local property market and the local economic system.

The protest movement has the potential risk of inflicting significant damage to Hong Kong. If and when it causes capital outflows, Hong Kong’s deteriorated fundamentals would become obvious targets for speculative attacks on its financial markets, aggravating the damage caused by capital outflows.

Thanks to the Hong Kong dollar peg, the local asset market has experienced no shocks.

Try taking the peg away, Hong Kong’s risk premium will most likely soar, crushing the local financial system.

The key fundamental factor that makes Hong Kong uniquely different from the rest of China — and makes it one of the premier financial centers in the world — is its laissez-faire economy backed by rule of law that respects intellectual property rights, transparency and integrity.

The Hong Kong dollar peg protects these core values by eliminating foreign exchange risk stemming from international market volatility and political noise in Hong Kong and elsewhere.

So it is the Hong Kong dollar peg that upholds international confidence in Hong Kong in the face of its deteriorating fundamentals and its biggest political challenge since the mid-1980s when China and Britain were jointly deciding the future of Hong Kong.

– Contact us at [email protected]


Senior economist of BNP Paribas Investment Partners (Asia) Ltd. and author of “China’s Impossible Trinity – The Structural Challenges to the Chinese Dream”