TOKYO/HONG KONG -- China's move to tighten its grip over Hong Kong is rocking the semi-autonomous Chinese city. Investment by foreign countries to and from Hong Kong totals $4 trillion, or more than half of the investment between China and other countries. If this flow is disrupted due to destabilization, it could pose an unexpected risk to the world economy.
The new national security law Beijing is imposing on the territory is expected to come into effect by the end of June, allowing a stricter crackdown on dissident activities. The one country, two systems political framework, which has shored up Hong Kong's prosperity, is on the verge of collapse, threatening Hong Kong's status as a world financial center.
On May 28, when China's National People's Congress approved a plan to introduce the national security law, many foreign money exchanges in Hong Kong ran out of U.S. dollars. As speculation spread on the internet that the pegged system linking the Hong Kong dollar to the U.S. dollar would be reconsidered, people rushed to exchange their Hong Kong dollars into the American currency.
An increasing number of Hong Kong residents are also preparing for an exodus from the city. Midland Immigration Consultancy, which helps with the process of emigration to other countries, is receiving some 100 inquiries a day at the moment. Tina Cheng, senior administrative manager of the company, said: "Last year, many people were just treating emigration as an alternative option. However, many people are more determined these days."
If the outflow of money and people gains momentum, a decline in Hong Kong's status as an economic hub is unavoidable.
Once part of the "Four Asian Tigers" along with Taiwan, South Korea and Singapore, Hong Kong's economic power is now eclipsed by that of mainland China which has grown rapidly. Today Hong Kong accounts for slightly less than 3% of China's overall gross domestic product, a sharp fall from a peak of 24% before the city was returned to China from British rule in 1997. Hong Kong's current economic size is smaller than those of Shanghai, Beijing or Shenzhen.
Yet Hong Kong still has a presence as a financial hub with a free capital market. The latest outstanding balance of foreign direct investments -- as of the end of 2018 -- and portfolio investments -- as of June 2019 -- between Hong Kong and the rest of the world was $4 trillion. The number increased by around 30% from the end of 2015.
The figure is above that for mainland China at $3.3 trillion, and 11 times more than Hong Kong's GDP, which is a little less than $400 billion.
Mainland China heavily restricts cross-border investment under rigorous capital control. However, about $1 trillion flows between the mainland and Hong Kong. Businesses in China and elsewhere in the world have pushed ahead with investment through Hong Kong. If the city's function as a financial hub deteriorates, it will hamper this flow.
In the long term, it is likely that mainland China will feel the pain if Hong Kong's status as a financial hub declines, since a growing number of companies in mainland China are using Hong Kong as a stepping stone to operate overseas.
According to the government of the Hong Kong special administrative region, the number of mainland Chinese companies that have regional headquarters in Hong Kong nearly doubled over five years, totaling 216 in 2019.
Many Chinese companies, including Alibaba Group and Tencent, are listed on Hong Kong's stock exchange.
But the financial markets are showing signs of future turmoil, with Hong Kong dollar interest rates rising in the short-term money market.
The three-month Hong Kong Interbank Offered Rate, or HIBOR, a benchmark interest rate, climbed to around 1.35% in late May. Its spread over the U.S. dollar London Interbank Offered Rate, or LIBOR, expanded to about 1 percentage point, the biggest since 1999.
One foreign exchange dealer in Hong Kong said that in addition to the U.S. monetary easing, concerns about capital outflow from Hong Kong is also a reason for the HIBOR increase.
The administration of U.S. President Donald Trump announced sanctions against Hong Kong in response to China's decision to implement the Hong Kong national security law. The U.S. policy has been interpreted as a risk by the financial market.
Financial sanctions against Hong Kong, such as the suspension of the U.S. dollar's convertibility into the Hong Kong dollar, are called "the nuclear option" among experts. Many think that those are options that cannot be carried out, because the impact on the world economy would be too great.
On the other hand, "Hong Kong is now on the front line of the U.S.-China economic cold war," according to Toru Kurata, a professor at Japan's Rikkyo University.
Paul Chan, Hong Kong's financial secretary, referred to a potential emergency situation and said that the territory would secure U.S. dollars using its currency swap deal with the People's Bank of China, the central bank, and keep pegging its currency to the U.S. dollar.
In the meantime, a quiet sense of tension and uncertainty is hanging over Hong Kong's financial market.