A Hong Kong protester in front of a US flag singing the Star-Spangled Banner at Hong Kong University campus on September 20, 2019. Photo: AFP via Getty Images/Anthony Wallace

SINGAPORE – When China’s National People’s Congress overwhelmingly supported new national security legislation for Hong Kong on May 28, seen by many as a death knell for the city’s “one country, two systems” semi-autonomy, US President Donald Trump was quick to signal the US would retaliate in kind.  

In a broadside against Beijing, he ordered his administration to begin the process of removing Hong Kong’s special trade status under US law, which entitles it to separate treatment from the mainland in terms of customs and immigration, privileges that bolster the city’s status as the world’s third-biggest international financial center.  

Trump has also promised to impose sanctions on individuals seen as responsible for “smothering – absolutely smothering – Hong Kong’s freedom.”

Beijing’s decision to bypass Hong Kong’s quasi-independent legislature and impose a new national security law, which will punish secession, subversion, terrorism and foreign interference in the city, was “only the latest in a series of actions” undermining Hong Kong’s promised freedoms, US Secretary of State Mike Pompeo told the US Congress. 

“No reasonable person can assert today that Hong Kong maintains a high degree of autonomy from China, given facts on the ground,” he claimed.

The Chinese-ruled territory, reputed for its role as a conduit for capital flows between the world’s two largest economies, now seems destined to become an even more fraught geopolitical flashpoint as the two sides hasten efforts to decouple their financial systems. 

But with the specifics of the Trump administration’s response and a time frame for such moves yet to be articulated, some are starting to question whether the Republican president’s bark will be worse than his bite.

“The media has really emphasized the ‘bark’ – they’ve always said it would be the ‘nuclear option’ if Trump takes away these privileges,” said John Marrett, a senior analyst covering Hong Kong at the Economist Intelligence Unit (EIU). “But the actual ‘bite’ will probably be much less than people expected in the first place.”

While US measures aimed at ending Hong Kong’s special status deepen uncertainty and mark a further heightening of tensions between Washington and Beijing, it isn’t clear yet how much will effectively change in the near-term for the thousands of multinational firms and the more than 1,300 American businesses headquartered in the city.

“This won’t be a bullet to the head in terms of US business operations in Hong Kong,” added Marett. “Companies are certainly going to re-evaluate, and they’re going to be very interested in what the actual changes entail. But this alone I don’t think would push many companies out the door.”

Protesters wave US flags as they march to the US consulate in Hong Kong on September 8, 2019. Photo: AFP/Vivek Prakash

Kurt Tong, an East Asian affairs expert and partner at The Asia Group who served as US consul general to Hong Kong and Macau until last year, said in an interview with Asia Times that “the actual practical impact of the de-certification of Hong Kong in Secretary Pompeo’s report to Congress might be smaller than the psychological impact on investors.”

“There are parts of the US-Hong relationship that Washington may also be reluctant to change given the benefit to the US and the desire not to hurt Hongkongers,” he added, alluding to Washington’s trade surplus with Hong Kong, which is cumulatively the biggest among all its trading partners, totaling US$297 billion from 2009 to 2018.

Hong Kong’s government has both played down the impact of Trump’s vow to revoke the city’s special status under US law, with officials saying they had anticipated a fallout due to worsening China-US trade friction, while also labeling punitive measures as a “double-edged sword” that would see American business interests harmed significantly.

Analysts say the US is more likely to take a piecemeal approach toward ending Hong Kong’s trade privileges rather than a comprehensive repeal of the legislation on which it is based. Regardless, it is an outcome that many in the US business community have resisted over concerns that the city’s loss of autonomy could inadvertently be accelerated.

“Revoking Hong Kong’s special status is not necessarily an ‘all or nothing’ move,” said Dane Chamorro, a partner in Control Risk Group’s Asia-Pacific practice. “It can be nuanced, some trade privileges could be removed, put under annual review or simply maintained. What that policy decision looks like is the big question.”

Upon being stripped of its special status, the US is expected to treat manufactured goods from Hong Kong – which form only a minor part of the city’s economy – as originating from China and thus subject to punitive Section 301 tariffs, while putting pressure on others such as the European Union and the United Kingdom to adopt similar policies.

“If Hong Kong is treated just like China, then a lot of the import license requirements for certain sensitive dual-use technologies from the US that are in place on shipments to China would also apply to Hong Kong,” said William Marshall, an export controls specialist at law firm Tiang & Partner.

That, he remarked, could “handicap” China’s ambitions to use Hong Kong as an international tech hub for its Greater Bay Area economic plan, one of the mainland’s key urbanization initiatives aimed at more closely integrating special administrative regions (SARs) Hong Kong and Macau with mega-cities in Guangdong province.

Though analysts think it is highly unlikely that the US would aim to diminish Hong Kong’s status as a leading international financial center, such as through targeting its World Trade Organisation (WTO) membership status, “you can never say ‘never’ with the current US administration and its approach to international organizations,” opined Chamorro.

US President Donald Trump arrives on Air Force One at Beijing, China, November 8, 2017. Photo: AFP/Pool

“If the Trump administration eventually does implement a broad range of punitive measures, that would certainly accelerate the economic decoupling between the US and China,” said Zhang Baohui, a professor of political science and director of the Center for Asian Pacific Studies at Lingnan University in Hong Kong.

“This will be especially the case if Beijing chooses to retaliate by not implementing the bilateral trade agreement reached earlier this year,” he told Asia Times. Trump himself, however, threatened in May to terminate the “phase one” trade deal should China fail to fulfill pledges to purchase an additional $200 billion in American goods and services.

Steven Okun, a senior advisor at trade consultancy McLarty Associates, believes Trump will likely stop short of escalating matters with China ahead of US presidential elections in November. “Anything that dims the prospects for his hoped-for economic recovery puts at risk the thing most important to him – a second term in the Oval Office,” he said. 

Trump’s announcements on Hong Kong so far constitute process steps, Okun noted, as opposed to actual decisions. “Do not expect any decisions between now and election day so long as there is the potential for China to keep it commitments under the phase one trade deal which enhance any US economic recovery.” 

It isn’t clear whether China will fully meet those purchasing pledges amid political tensions and questions of those commitments outweighing current demand, particularly in the wake of the Covid-19 pandemic. An unraveling of the phase one deal would likely reignite the US-China trade war and potentially see Hong Kong used as a bargaining chip, analysts predict.

“I am concerned that deconstructing parts of the US-Hong Kong relationship could harm US interests and Hong Kong interests, without much affecting China, even though China is the source of the policies that the United States is protesting,” said Tong, who retired from the US foreign service last June after less than three years as consul general. 

Opinions vary on how US measures toward Hong Kong could impact China’s economy. While Hong Kong’s economic importance relative to the mainland has diminished – gross domestic product (GDP) stood at 2.7% of China’s in 2019, down from 18.4% in 1997 – its financial significance has grown with state-owned Chinese banks’ increased pursuit of overseas business.

The territory is a key center for raising equity and debt for Chinese companies and the biggest gateway for international investment in mainland stocks and bonds. More than 60% of foreign direct investment (FDI) in China is channeled through Hong Kong, while international companies use the city as a launchpad to expand onto the mainland. 

Many of the mainland’s most valuable firms have similarly listed in Hong Kong as a springboard to global expansion, and the city’s seamless access to Western financial markets makes it a vital cog in China’s economy. It’s also key to facilitating Beijing’s wider ambitions for international renminbi trading and settlements.

The Bank of China Tower in Central on Hong Kong Island. Photo: Google Maps

Much of the business transacted in Hong Kong, however, is denominated in the world’s reserve currency, the US dollar, with a whopping $10.4 trillion in dollar transactions flowing through the city’s bank-to-bank payments system last year. Punitive measures by the US, some speculate, could potentially lead to a process of cutting-off access to US dollars.

“Hong Kong trade status isn’t the nuclear option,” said Tiang & Partner’s Marshall. “The nuclear option would be something involving the local currency, and any kind of restrictions or bars on Hong Kong’s access to the US dollar. That is unlikely to happen, extremely unlikely, but that would be it.”

US Treasury Secretary Steven Mnuchin said on June 12 that the President’s Working Group on Capital Markets, an inter-agency group of US financial regulators, are currently reviewing various capital market responses to Beijing’s perceived clampdown on Hong Kong, including measures that could restrict capital flows through the city.

The Hong Kong Human Rights and Democracy Act, passed last year by the US Congress, allows sanctions, including visa bans and asset freezes, to be imposed by Washington on individuals in China and Hong Kong deemed to have violated human rights. The bill also places sanctions on banks that do significant business with those officials or entities.

Depending on how potential US sanctions are implemented, international financial institutions could be made to limit or sever relationships with Chinese banks subject to the same sanctions, potentially cutting those institutions off from the US dollar payments system underpinned by the Swift network, experts say.

Questions remain as to the depth and breadth of punitive measures that may be leveled against individuals or authorities by the US and the extent it could limit access to US dollars. “We don’t expect the US to enact sweeping sanctions against the government of Hong Kong or central government in this matter,” said the EIU’s Marrett.

“If it is going to sanction particular individuals, and we do expect [that] some figures in local government and in the central government [will be], it’s not going to be a sort of Iran situation where US businesses simply cannot do anything related to Iran anymore. That’s the main difference,” he told Asia Times.

A US decision to level sanctions against senior Chinese officials or Chinese financial institutions would mark “a major escalation that would compel a re-evaluation of the overall situation,” said Okun of McLarty Associates, who described that outcome as “an important directional signpost to watch for in the coming months.”

China’s banking and insurance regulator issued a statement earlier this month asserting that sanctions proposed by the US would not have “a material impact” and that Hong Kong’s separate customs area status, set by the WTO, would not be shaken. City authorities also reiterated they have no plans to alter Hong Kong’s decades-old currency policy.

The territory’s currency, the Hong Kong dollar, has since 1983 been pegged to a narrow trading band between HK$7.75 and HK$7.85 per US dollar. The Hong Kong Monetary Authority (HKMA), a de-facto central bank, intervenes in forex markets either to buy or sell as required to keep the local dollar trading within that range.

Hong Kong dollars are pegged to the US dollar, providing monetary stability to the financial hub. Image: iStock

Sustained capital flight that takes a toll on liquidity or actions that limit Hong Kong banks’ access to US dollars would put pressure on the territory’s capital reserves, which are used to maintain the peg. Most economists believe it is unlikely that near-term economic and financial pressures could force an abandonment of the peg policy.

“My sense is that there is still ample room for HKMA to support the peg, but that the situation could get harder over time if uncertainty continues,” said Alicia García-Herrero, chief economist for Asia-Pacific at investment bank Natixis. Hong Kong is believed to hold $440 billion in its reserves, six times the amount of currency in circulation.

“The liquidity in Hong Kong is draining, as clearly shown by a higher HIBOR-LIBOR spread” – interbank rates used as indicators of liquidity tightness – “but it is not clear whether this is due to outflows or the use of bank deposits for initial public offerings (IPOs) in Hong Kong,” noted the economist.

Singapore, a competitor regional banking hub and low tax jurisdiction, has reportedly attracted record capital flows, which analysts link to political uncertainty and social unrest in Hong Kong since last year. Non-resident deposits into the city-state’s banks increased 44% to $44.37 billion in April from a year earlier, data from its central bank showed.

Multinationals are also said to be eyeing the relocation of their corporate treasury operations to the Southeast Asian city-state and other locations. Singapore, seen as a favored destination for its political stability and respect for the rule of law in business matters, also fits the bill as an investment alternative for US technology firms, say experts.

Hong Kong, though, is set to remain an attractive business center owing to its low tax regime, strong commercial judiciary and skilled workforce. But with its autonomy in question amid perceptions of Beijing placing emphasis on “one country” rather than “two systems”, many see the city’s increased economic reliance on the mainland as inevitable.

“The loss of its special status will undeniably affect Hong Kong negatively,” said García-Herrero. “Leeway will be lost if the US were to treat Hong Kong as the mainland. Hong Kong can, however, still transform itself into a more regional offshore center which basically focuses on the mainland. This is something similar to Monaco for France.”

Former top US diplomat Tong described the Chinese-ruled territory as “a very efficient conduit for investment flows between China and the rest of the world, in both directions.”

“If Hong Kong no longer succeeds in being attractive to both Chinese and foreign investors, that role could diminish,” he postulates. “The most important factors in shaping that future will be China’s policies and Hong Kong’s policies, with other nations’ policies being a secondary factor.”

Beijing’s imposition of tough national security laws on Hong Kong has been widely interpreted as a heavy-handed manuever by Chinese President Xi Jinping to suppress sentiments among Hongkongers who wish not be assimilated into China’s authoritarian system, a thread common to past and present protests over the last two decades.

Mass protests in Hong Kong, such as this rally on June 16, has illustrated the depth of feeling for political change in the city. Photo: Nile Bowie

2019 saw the city’s largest political demonstrations and worst scenes of violence since the end of British colonial rule in 1997. Months of social unrest followed mass public opposition to a now-withdrawn extradition bill that would have allowed for fugitives to be sent from Hong Kong to the mainland, where they would arguably not be guaranteed a fair trial.

The issue brought to light existential concerns around the maintenance of “one country, two systems”, through which the territory is supposed to be governed until 2047, and stoked fears in business and diplomatic circles that Hong Kong’s reputation for judicial independence, widely touted as its greatest remaining asset, would be undermined.

Protests this year have eased to some degree owing to social distancing measures to slow the spread of Covid-19, though assemblies have gone ahead without police permits in recent weeks, such as when thousands converged for a June 4 vigil to victims of the Tiananmen Square massacre that authorities banned due to the coronavirus pandemic.

“It’s very apparent that to Beijing, Hong Kong is clearly a problem,” said Hong Kong-based author and publisher Simon Cartledge. “What they’ve seen over the last year is deeply troubling, with unrest and protests going on and on, and the inability of the government here to help the situation even with policing as strongly as they have.

“The leadership in Beijing has been trying to figure out what to do, and their mission is to sort this out by doing whatever is necessary,” he remarked, pointing to a Hong Kong police crackdown in April that ensnared more than a dozen pro-democracy activists and opposition politicians on charges of organizing and participating in “unlawful assemblies.”

Apart from the national security law approved by China’s top legislative body, which could see mainland security and intelligence agents stationed in the city for the first time, pro-establishment lawmakers in Hong Kong passed another controversial bill earlier this month that would make disrespecting China’s national anthem a criminal offense.

“At the moment, the vast majority of businesspeople see this as the central government desperately trying to maintain the business environment in Hong Kong, and just clamping down on dissent against the central government and against the local government, and any sort of hint at breaking away from the Chinese state,” said the EIU’s Marrett.

Survey results released this month by the American Chamber of Commerce in Hong Kong (AmCham) showed more than 80% of US firms in the city are concerned over Beijing’s move to impose national security legislation on the territory, while 60% of the 180 companies surveyed thought the law would harm their business operations in some way.

A masked protester walks past a vandalized Starbucks shop in Hong Kong. Photo: Facebook via WikiMedia

While some American firms said they were re-evaluating their future in the former British colony after the Trump administration vowed to rescind Hong Kong’s trade privileges, 70.6% of survey respondents said their companies don’t have plans to move capital and 62.2% said they were not personally considering leaving the city.

“Hong Kong’s continuing advantages do remain, but they don’t look as compelling as they did five or ten years ago and people are wondering whether this is the right place to be,” said Cartledge. “There are people looking at it and not so much pulling out now, not so much moving their money now, but maybe thinking what the other options are.”

As the central government and local authorities tighten their grip, “various investors and business leaders are going to be thinking in the back of their minds whether this will eventually lead to a clampdown on business or on rights and freedoms that could effectively be damaging for businesses in Hong Kong,” said Marrett.

“And when protests arise in response, they’ll be clamping down very forcefully with the help of new tactics from local security forces and with harsher penalties for those who express anything that’s deemed to be seditious, or a secessionist or separatist viewpoint,” said the analyst. 

“This strategy is not guaranteed to work, and it could actually result in something much more disastrous in the ultimate outcome in terms of political stability.”