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Hong Kong Politics June 2020

Hong Kong: U.S. threatens sanctions on Hong Kong; exact measures still unclear

In late May China’s National People’s Congress (NPC) approved a new security law for Hong Kong which will increase Beijing’s hold over the territory. The NPC Standing Committee will now work on the detail of the proposed law. In response, U.S. President Donald Trump threatened to remove Hong Kong’s special status and trading privileges, although gave few concrete details on the exact measures that will be taken.

One key implication could be that the U.S. raises 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.

As Goldman Sachs states:

“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.”

However, Iris Pang, chief economist for Greater China at ING, argues the move could impact 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.”

Export controls on U.S. firms selling to Hong Kong are another possible U.S. move, particularly concerning technology exports with both commercial and military applications. This would hit Hong Kong’s technology and research sectors.

The degree of implementation of such measures has been questioned, however. Iris Pang, for example, noted:

“Because the impact could be very damaging, 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.”

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

As UOB states: “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 would 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.

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