Hong Kong Politics July 2020

Hong Kong

Hong Kong: Hong Kong security law comes into force, raising tensions with the U.S.

July 1, 2020

On 30 June, the new security law for Hong Kong came into force, which will increase Beijing’s hold over the territory. While the bill could contain long-running social disturbances by making it easier for authorities to stamp out protests, it will likely dampen FDI and has already led to U.S. retaliatory measures. At end-June the U.S. announced it was ending defense exports to Hong Kong and would take steps to restrict exports of certain high-tech products, a month after U.S. President Donald Trump threatened to remove Hong Kong’s special status and trading privileges. Further sanctions are possible going forward.

The export restrictions could impact Hong Kong’s research and technology sectors. However, according to Iris Pang, chief economist for Greater China at ING:

“There is some doubt about the stringency with which the US would enforce the special status on technology transfers as this would also hurt US companies and their reputation. We believe more countries will try to find alternatives to US technology from now on as a back-up plan”.

A further potential U.S. measure could be to raise tariffs on Hong Kong to match those applied to mainland China. The small weight of manufacturing in the domestic economy, which is overwhelmingly service-based, should limit the impact. Goldman Sachs noted:

“Given that most exports to the US are trans-shipments which should already face tariffs applicable to the country of origin, the impact on HK’s economy would be less dramatic than headline export figures imply.”

That said, Iris Pang argues the move could affect re-exports from mainland China to an extent:

“There is a ‘first-sales rule’ that makes Hong Kong more important to Mainland China during the trade war. […] With the first-sales rule, exports to the US that go through more than one location will be charged duties based on the price of the initial sales. […] As such, the tariff paid could be lowered when there is a throughput via Hong Kong. When Hong Kong's special status is removed, a Hong Kong re-exporter might not be treated as a ’second leg’ of the export to the US. Mainland China's exports will search for another ‘second leg’. As a result, Hong Kong's port and logistic businesses are likely to experience some decline.”

Regarding the currency, while U.S. sanctions could generate greater pressures, the currency peg is expected to hold nonetheless.

As UOB comments: “The HKD peg is unlikely to be undermined given that it is under the purview of Hong Kong government and backed by the substantial foreign reserves in Hong Kong. We expect HKD to stay strong despite elevated political risk.”

On investment, U.S. sanctions will likely increase uncertainty and reduce Hong Kong’s attractiveness as a destination for FDI—a reputation which has already taken a hit following prolonged civil unrest, as evidenced by a fall in FDI of 34% in 2019 according to UNCTAD data. A key factor to watch will be China’s policy response, which could potentially involve restrictions on U.S. firms operating in Hong Kong.

That said, Hong Kong will remain important to mainland China, and its relevance as a financial center for Chinese firms could increase given proposed U.S. restrictions on Chinese companies listing in the U.S.


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