THE REAL HONG KONG HANDOVER?
ONE COUNTRY, TWO SYSTEMS, 15 YEARS
The real Hong Kong handover?
One country, two systems, 15 years-
A rainbow arches over Hong Kong's Victoria Harbour on June 19, 2012. REUTERS/Bobby Yip
Introduction
Hong Kong remains an important window on the world for China. But 15 years on from the
handover from British to Chinese sovereignty, there’s economic, social and political
unease. Leung Chun-ying, the territory’s new chief executive, will have his work cut out
restoring his credibility – battered even before taking office – and setting a direction for
the remaining 35 years of the “one country, two systems” regime.
Leung is the first chief executive who hasn’t been a colonial insider, and in some ways it’s a
moment as significant as the ceremonial 1997 transfer. This brief collection of recent
Breakingviews articles on Hong Kong covers important facets of the territory’s economy
and markets: priorities for the new chief executive; the oddities of the property market; the
pegging of the Hong Kong currency to the U.S. dollar; shifts in the investment banking
industry; and the environment for businesses, investors, and politicians.
Hong Kong’s financial sector, its tourism and its property markets have tilted sharply
towards China already, and that hasn’t always been a smooth process. There’s plenty
Leung can do, if he’s committed and permitted, to address at least some of the current
concerns. He can help ensure the dynamic trade and finance hub created from the barren
rock of folklore remains an exceptional place, even after 2047.
Richard Beales and John Foley
June 29, 2012
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Is this the real Hong Kong handover?
By Richard Beales
Hong Kong is on a long journey from foreign outpost to just another province of China. The
Special Administrative Region is commemorating one milestone, 15 years since that
storm-lashed night when Britain handed it back to China. It is also embarking on a new
phase with the appointment of the first chief executive who wasn’t a member of the old
colonial club. Leung Chun-ying, also known as CY Leung, is a local policeman’s son who is
seen as close to Beijing. It could almost be called the real Hong Kong handover.
The end of the road comes in 2047 with the expiry of Hong Kong’s SAR status – the “one
country, two systems” arrangement agreed with the UK. Then, the city-province is
supposed to emulate China’s recent exploit in space by docking gently with the
motherland. Over the next generation or so, Leung and his successors have a chance to
show that the 7.1 million people in Hong Kong, while economically already firmly hitched
to China, can still be a model for the 1.3 billion residents in the Middle Kingdom.
Leung Chun-ying is seen after winning the Hong Kong chief executive election at a vote counting station in
Hong Kong on March 25, 2012. REUTERS/Tyrone Siu
A priority should be to buttress Hong Kong’s mostly transparent and honest government –
a contrast and an example to opaque China, where the families of the elite use their
connections to amass fortunes. Leung isn’t, however, starting off particularly well on the
integrity front. He is under fire over revelations that his home has, or had, illegal additions.
But the fact that this transgression is all over the newspapers already puts Hong Kong far
ahead of any organ of the Chinese government.
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Next might be curbing the power of the old establishment. The relative outsider Leung is
well placed to do that. The goal shouldn’t be to make the rich poorer, but to respond more
broadly to Hong Kong’s politically savvy residents, who of late have been worrying about
the shortage of affordable homes and the chasm between rich and poor in the territory.
That could mean, for example, upsetting property tycoons by releasing more land for
housing.
Maintaining economic vitality is also important. As China gets richer, Hong Kong will
inevitably become less prominent. Its contribution to the combined GDP of China plus
Hong Kong has already shrunk from perhaps 15 percent in 1997 to about 3 percent now.
But the government can still cultivate the former territory’s competitive advantages: the
laissez-faire heritage of the British, coupled with consistent regulation, and the expertise
in finance gained as a trading hub and as China’s most important window on the world.
Action from Beijing, like new measures to develop the Hong Kong offshore market in the
Chinese currency, may help but Hong Kongers will need to nurture their entrepreneurial
streak, too.
Then there is the question of freedom – not just economic, but personal. Hong Kong
remains more attractive than the mainland to many expatriates and PRC nationals if they
get the chance to move (or to have their babies in Hong Kong, a practice that has some
locals up in arms). There is no mandatory family planning, the press is much less
constrained and the education system is not weighed down by propaganda. That’s an
advantage the territory should trade on for as long as possible.
Finally, Leung, his team and his successors could focus on the environment. The British
and early SAR governments didn’t completely ruin Hong Kong, but they hardly made
great efforts to protect its astonishing natural beauty. If future administrations can make
this big commercial city a better place to live, protecting its environment and heritage,
reducing pollution to the extent they can and improving living standards, it could be a
model not just for China but for the world – and give it staying power even as its economic
and financial significance wane.
Hong Kong is symbolic of China’s emergence onto the world stage and its ability to
tolerate Western and democratic ideas. And while the SAR model might not directly
attract the Taiwanese to hand their destiny to the PRC, its failure would surely make the
prospect of that yearned-for reunification recede. So for now, most watchers in Beijing are
probably happy for Hong Kong to succeed. That gives Leung some leverage. His task is to
make the most of it and set a course to keep Hong Kong exceptional – until 2047 and
beyond.
Published on June 28, 2012
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Time for Hong Kong to kick colonial property habit
By Wei Gu
It’s time for Hong Kong to kick a colonial habit. Cash from China - more and more of it
since the 1997 handover of the territory – has helped inflate residential property prices at
the high end. And the scarcity of cheaper accommodation is causing social tensions. CY
Leung, the Chinese Special Administrative Region’s chief executive from July 1, finally
wants to release more land.
The policy of keeping land prices high dates back to British rule. The government was
sparing in its release of acreage before the handover. And for homeowners, a change in
policy was potentially painful. Tung Chee Hwa, the first chief executive, became unpopular
and eventually stepped down, partly because his effort to address the shortage of lowincome housing was blamed for bursting a property bubble.
New York Mayor Michael Bloomberg (2nd R) walks past a beggar as he goes to a subway station in Hong
Kong on November 6, 2010. REUTERS/Bobby Yip
The outgoing administration of Donald Tsang has continued the old tradition of squeezing
revenue out of land. Sales of land brought in 21 percent of the government’s revenue in
2010-2011, almost double the 11 percent seen in 2005-2006. But public spending on
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housing as a percentage of total government expenditure fell to 5.6 percent in 2010-2011
from 15.2 percent a decade earlier.
Investors from the mainland – responsible for 25 percent of Hong Kong prime property
purchases in 2011, according to Knight Frank – have meanwhile pushed prices out of the
reach of many aspiring local homeowners. Medium-sized flats on Hong Kong Island cost
an average of more than $17,000 per square meter in 2011, government figures show.
Manhattan’s average apartment price was about a third cheaper, according to Douglas
Elliman. High home prices sparked a protest a year ago, and the city regularly ranks
among the most expensive worldwide for housing. In a survey by the Hong Kong
Transition Project in February, respondents identified affordable housing as the most
urgent issue facing the next chief executive.
Official data show as much as 93 percent of land in Hong Kong is undeveloped. The
government could release more. Leung could also encourage developers to use what they
already have. The Big Four developers, Sun Hung Kai, Cheung Kong, Henderson Land and
New World, own about 10 million square meters of farmland, two-thirds of the new land
need for housing in the next six to seven years, according to Credit Suisse. Hong Kongers
have long believed a clique of a dozen or so property tycoons play the government – or
play alongside it – to maximize their profit. Leung’s plan may mean taking them on. But
an end to over-tight control of land supply is overdue.
Published on June 26, 2012
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Hong Kong, enjoy your peg while it lasts
By John Foley
Will Hong Kong pop its peg? After three decades of hitching its currency to the U.S. dollar,
many residents of the territory, including former monetary chief and peg architect Joseph
Yam, believe it is time for a change. The arrival of a new chief executive, Leung Chun-ying,
provides an opportunity. But Hong Kong shouldn’t rush. The dollar peg gives the city
stability, and a symbolic link to the values that made it an economic success story.
There are few currency systems Hong Kong hasn’t tried. Over the last century it has been
pegged to silver and sterling, freely floated and linked to the dollar twice. The latest peg,
which values the Hong Kong dollar at just under 13 U.S. cents, has been in place since
1983. The philosophy is even older: Hong Kong’s “currency board” is based on the model
Britain foisted on many of its colonies in the 19th century.
The latest dollar link has brought Hong Kong stability, but recently inflation and asset
price bubbles too. Hong Kong has to copy U.S. interest rate policy to avoid a surge in
speculative capital inflows. The U.S. bent for near-zero rates has left Hong Kong without
an effective brake on inflation. Prices rose 2.6 percentage points faster than those in the
United States in May, year on year, and 1.3 points faster than China’s. Property prices have
doubled since 2004, according to an index by property agent Centaline.
What to do? Beyond staying put, there are three options: shift the peg to a bunch of
different currencies, scrap it, or peg to China’s currency. The first is easy enough to rule
out. Introducing a basket of currencies, as Singapore has, might reduce the influence of
pernicious U.S. policy. But who would pick the basket? Would the yuan, only partially
convertible, be in it? The possibility for accusations of political meddling would be vast,
and new boss CY Leung is already unpopular with Hong Kongers.
Scrapping the peg would also be foolish. Hong Kong’s economy is tiny and open, so it
would be exposed to huge swings in capital flows, and the currency’s value. Sensible fiscal
policy could make it appear a “safe haven”, pushing the HK dollar up to uncomfortable
levels. Besides, the territory would need an institutional overhaul. Hong Kong has no
central bank ready to set monetary policy – its monetary authority just manages the
currency and ensures bank liquidity.
That leaves a peg to China’s yuan. One day, that will happen anyway. Hong Kong’s growth
follows China, and so does its political destiny, since from 2047 the “one country, two
systems” structure will become one country with one system, and most likely one currency.
Still, now isn’t the time. China’s currency has been pretty stable thanks to its own creeping
dollar peg, but isn’t yet ready to be the basis for someone else’s. Its central bank isn’t
independent. Sensible monetary policy is secondary to Beijing’s desire to preserve growth
and employment – which is why the money supply has roughly doubled since the financial
crisis of 2008, and real deposit rates have been negative for most of the past decade.
There’s also the problem of how to support the peg. Hong Kong’s currency board has to
hold foreign reserves that at least match its outstanding currency. In fact, the definition of
currency is quite narrow. Take M3, a broader measure, and the Hong Kong dollar is only
half-backed by the territory’s $292 billion of foreign reserves. Without free access to the
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yuan, the Hong Kong authorities could back a yuan peg with U.S. dollars, but a fall in the
greenback, or sharp revaluation of the yuan, would create a problem.
Moreover, speculators would probably latch onto the Hong Kong dollar as a proxy for the
less easily traded Chinese yuan, with volatile results.
When China’s currency is more convertible, and its policy workings more transparent, it
will be the logical partner for the Hong Kong dollar – or will replace it altogether. In the
meantime, it’s best to sit tight. Unemployment in Hong Kong remains low, and high
property prices can be addressed through other means, like releasing more land into the
market.
Besides, while the peg and currency board might be colonial throwbacks, their survival is
one embodiment of the “two systems” Beijing promised in 1997, when Hong Kong became
a Special Administrative Region of China. Hong Kongers who value their difference from
China as highly as their linkages to it should enjoy the peg while it lasts.
Published on June 27, 2012
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Bankers need to follow the money into China
By Wei Gu
China’s mainland is the new battleground for global banks. Goldman’s new vice chairman
Mark Schwartz is set to be based in Beijing, and others will follow. Mainland exchanges
account for the majority of this year’s initial public offerings in Asia. The challenge for
global banks will be finding their niche, and adequate talent.
As the mainland gains, Hong Kong suffers. Global banks are making selective cuts in
Hong Kong, especially in equities. Morgan Stanley’s mainland Chinese joint venture
already has around 150 staff despite being just a year old, according to a person close to
the matter. UBS, the only foreign bank with a Chinese brokerage license, has transferred a
managing director from Hong Kong to Shanghai to build an 80-90 person research team.
Fees are dictating the shift. China’s A-share investment banking fees almost quadrupled
since 2007 to $2.2 billion, now making up half of overall China-related banking revenue,
up from less than a fifth in 2007, according to Thomson Reuters. This trend is even more
evident this year. Three mainland exchanges have taken up 66 percent of Asian IPO
proceeds, while in Hong Kong, IPO proceeds have fallen 90 percent year on year.
A construction site for the high-speed railway, linked with Hong Kong to the southern Chinese city of
Guangzhou, is seen in Hong Kong's Kowloon November 25, 2010. REUTERS/Tyrone Siu
As the markets loosen up, China will get more attractive. Global banks have already been
told they can take up to 49 percent stakes in their joint ventures, and can apply for
secondary market licenses after two years of operations, versus five years before. Once
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Shanghai finally opens its new market for foreign companies, global banks will have a new
edge against local securities firms.
There are challenges ahead. Deals are smaller in China, and reputational costs can be
high. Local bankers may have good connections on the ground but lack technical skills.
Transferring talent from abroad is costly, and high taxes and heavy pollution make people
less willing to move to China. Still, if the money is to be made in Beijing and Shanghai
from now on, banks and bankers have no choice but to adapt.
Published on June 21, 2012
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Political flameout shows risks hidden in China
By John Foley
Twin political flameouts in China deserve investors’ attention. The tribulations of Bo Xilai
and Henry Tang teach a valuable lesson about the political risk premium.
In mainland China, there’s a political mystery. Bo, a rising star in the Communist Party,
was seen as a shoo-in for the nine-member Politburo Standing Committee. But he has
suffered an embarrassing setback – his right-hand man Wang Lijun apparently tried to
defect. The motivations of Wang, who helped Bo rid Chongqing of several organised crime
gangs, are unclear, but the affair is an embarrassment for the city’s party chief.
Meanwhile, Hong Kong’s problems are an example of political mundanity. Would-be
leader Henry Tang’s campaign is crumpling because he built an illegal basement,
reportedly including a Japanese-style spa, under his house. He then publicly blamed his
wife. His election campaign may be done for.
Tang has made the sort of mistake that trips up politicians in democracies. Bo’s problems
are harder to explain. The son of a leading revolutionary, he has rarely put a foot wrong.
He introduced innovative economic incentives and reforms of subsidized housing and
household registration. His fall, if that is what’s happening, follows 16 percent GDP growth
in China’s most populous municipality in 2011.
But sudden political upheavals are nothing new in the People’s Republic. The purges of
the Mao era saw close confidantes sent to the provinces, or worse. Some, like Deng
Xiaoping, recovered and rose to greater heights. Others, like Liu Shaoqi, came to dismal
ends. More lately, misdemeanours and scandals often emerge around the time of the fiveyear party conference, possibly as rivals throw one another under the bus.
Investors should take note of the difference between the two systems. Tang’s misstep
hardly matters, because Hong Kong is transparent and the system is stable. Political risk is
low. In China, by contrast, it’s incalculable. Investors are effectively buying an option
without knowing either strike price or volatility. They can only assume the best or the
worst. Chongqing’s mystery is a vote for the latter.
Published on February 17, 2012
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Hong Kong still haven for tycoons – and investors
By John Foley
Is the tide turning for Hong Kong’s tycoons? It may feel like it for Raymond and Thomas
Kwok, two property moguls arrested by the city’s corruption watchdog on March 29 over
suspected bribery. But the billionaires can relax: Hong Kong remains a low-risk haven for
the one percent, and those who invest in them.
The Kwoks, who co-chair Sun Hung Kai Properties, are the biggest fish the corruption
watchdog has tried to fry since it was founded in 1974. But Hong Kong remains pretty
clean, ranking above the United Kingdom for corruption, according to Transparency
International. Scandals do occur – even outgoing chief executive Donald Tsang was
criticised for ill-advised private jet trips – but when they do, the rule of law prevails.
A bigger worry for investors is political meddling. Hong Kong’s unpopular chief executive
elect, CY Leung, is seen as a conduit for the views of Beijing. But the investigation against
the Kwoks had been in the pipeline for months before Leung won the elections of March
25. Besides, while Beijing can easily manipulate Hong Kong’s access to mainland markets
or tourists, it can’t touch the legal system. The city’s judiciary is independent; its chief
prosecutor is an Australian.
Hong Kong tycoon Li Ka-shing attends a news conference announcing the annual results of his company
Hutchison Whampoa in Hong Kong on March 29, 2012. REUTERS/Tyrone Siu
One thing that should worry the tycoons is their diminishing usefulness to Beijing. When
Hong Kong was handed from the UK to China in 1997, the support of Cheung Kong
founder Li Ka-Shing helped ensure a stable transition. Now he and his peers, like the
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Kwoks or New World Development founder Cheng Yu-tung, stand for very little, except
maybe the conspicuous inequality that politicians everywhere claim to oppose.
But there are more effective ways to unseat the oligarchs. Prices of residential property in
Hong Kong are at levels last seen in 1997, because the government limits land supply,
which inflates the income of a handful of developers like Sun Hung Kai. Create new
supply, as CY Leung has suggested he might, and prices would fall, depriving the moguls
of some of their magic. By contrast, a politically motivated graft crackdown would
probably create sizeable capital flight.
The time for a tycoon takedown may yet come. Many of Hong Kong’s super-rich will be
nervously fingering their Canadian passports. Still, the Kwoks’ predicament should be
seen as what it probably is: an independent watchdog doing its job. Hong Kong remains as
investment-friendly as ever.
Published on March 30, 2012
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Chinese President Jiang Zemin (L) and Prince Charles (R) look on as British and Chinese soldiers march past
during the handover ceremony on July 1, 1997, marking the return of Hong Kong to Chinese rule.
REUTERS/Kimimasa Mayama
Front cover image: Workers continue on July 6, 1997 to remove scaffolding which formed the site of the
British forces' farewell ceremony to Hong Kong on the night of June 30, as Hong Kong's new "Bauhinia"
symbol graces an office tower nearby. REUTERS/David Gray
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