Recent socio-political turmoil has prompted investors to ask the ultimate question about the Hong Kong dollar peg: Does China still need Hong Kong and, consequently, the HKD peg?
- Hong Kong still matters to China
- Open capital account allows it to be an alternative funding source
- Special status justifies support for HKD peg
Data appears to support the view that China can do without Hong Kong: the mainland economy now dwarfs the city’s and rivals are usurping Hong Kong’s status as a global financial hub.
Before its 1997 handover to China, Hong Kong was a channel for entrepot trade, but after China joined the WTO in 2001, it lost much of this function and now less than 15% of China’s foreign trade goes through the territory.
Recently, Beijing’s vision for Hong Kong seems to have changed dramatically to one in which the legal system is ultimately subservient to the Communist Party, in an approach it might see as preferable to chaotic Western democracies.
This shift appears to have contributed to the eruption of the turmoil which has shaken public confidence in the city and raised questions about the political will to keep the HKD peg.
This is a valid concern. But many observers seem to have missed aspects that still make Hong Kong important to China.
Exhibit 1: Hong Kong’s role (2010-2018 data unless stated otherwise)
Source: BNP Paribas Asset Management; August 2019
Hong Kong is also the prime offshore renminbi centre, accounting for the bulk of renminbi foreign trade settlement and almost two thirds of all offshore renminbi deposits.
Still a crucial role for Hong Kong
The territory still plays a crucial part for China to access foreign capital. But why is that important when China has surplus savings amounting to over 45% of GDP?
Hong Kong’s open capital account fills a void. In China, most capital is channelled to inefficient companies, while the efficient ones are starved of credit. China’s closed capital account does not allow the credit-poor companies to access foreign capital as an alternative funding source. This is where Hong Kong comes in. Its financial structure and legal and institutional frameworks command a level of international trust that mainland China does not enjoy.
Furthermore, Hong Kong with its big population and a highly-skilled labour force, free-market mechanism, open capital account, hard currency and rule-based framework allows Beijing to do experiments under its national reform framework. This role is not replicable on other Chinese cities in the medium term.
In my view, a rational policy consideration should translate into a political will to support the HKD peg.
 H-share companies are firms that are incorporated in mainland China and are controlled by either mainland government entities or individuals. Red-chip companies are enterprises that are incorporated outside of China, but are controlled by mainland entities or individuals. Data as of mid-2019
 The three state-owned enterprises are China Merchants, China Resources and China Travel Service.
 See “Chi on China: The Conundrum of China’s Excess Capacity”, 14 September 2016
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