Features | Economy | East Asia

Hong Kong’s Business Climate

Hong Kong’s strong institutional framework, location and flexible workforce have positioned it as an ideal place to do business in Asia, particularly as an entry into mainland China.

By Dougal Crawford for

Hong Kong’s strong institutional framework, location and flexible workforce have positioned it as an ideal place to do business in Asia, particularly as an entry into mainland China. These factors will ensure Hong Kong continues to experience a high potential growth rate, belying its status as a developed economy. However, this will be of little comfort at present. As one of the most ‘open’ economies in the world, focused on finance and trade services, the global financial crisis is hitting Hong Kong hard.

Financial markets have been battered. Hong Kong’s lending markets have not been immune to the ructions in global capital markets. There was even a run on the Bank of East Asia on rumours of liquidity problems and large losses on international exposures. Assets prices have also fallen sharply. The Hang Seng Index has halved, while property prices are reversing, falling by 12 per cent in the last quarter of 2008. The authorities have been quick to limit the financial contagion, boosting liquidity in the financial system, placing a two-year guarantee on bank deposits and establishing a contingent bank capital facility.

While these policies have calmed the financial market, the effects on the ‘real’ economy are only just beginning. GDP fell by two per cent in the final quarter of 2008, its third consecutive quarterly decline, to be 2.5 per cent lower over the year. With more recent economic releases remaining downbeat, the economy is expected to contract a further two to three per cent this year – Hong Kong’s worse performance since the 1997-98 Asian financial crisis.

No sector of the economy will be immune, with exports, investment and private consumption all expected to fall further. Worse, downside risks dominate the outlook, with prospects for a turnaround hinging on a rebound in global activity. Even the most optimistic forecasters believe this will not occur until late 2009 at the earliest.

A systemic crisis is unlikely, however. Despite the uncertain global outlook, Hong Kong should weather the current storm better than the Asian financial crisis. Unlike in 1997, the economy has no major economic or financial imbalances. Households are not overgeared, while the banking sector is well capitalised, enabling it to withstand declining credit quality and falling asset prices. Extensive stress testing by the Hong Kong Monetary Authority confirms this.

Enjoying this article? Click here to subscribe for full access. Just $5 a month.

The government balance sheet is also strong, enabling it to implement a sizeable fiscal stimulus. Even better, the ultra-loose monetary policy in the US is flowing into the territory through the linked exchange rate. Growth in China, where there are already some preliminary signs of stabilisation, should also provide a buffer. Hong Kong can also expect more ‘official’ support from Beijing to help it through the downturn, for political as much as economic reasons.

Developments to Watch

Longer-term retrenchment in the financial sector. Global downsizing in financial intermediation may affect Hong Kong’s financial services sector, which together with trade services has contributed the majority of employment growth in recent years. Its sizeable asset management and hedge fund industries are most at risk. Then again, continued demand for more traditional financial services from mainland China will provide an offset. While the gap is closing, Hong Kong has a considerable lead over mainland financial centres, including Shanghai, due to its superior financial infrastructure, regulatory environment and workforce.

Political tensions. The recession could lead to rising demands for more meaningful political reform in Hong Kong, creating frictions with Beijing. The popularity of the territory’s chief executive Donald Tsang is already starting to wane. Realistically, though, there is no likelihood of a change in the status quo in the near term. It was only recently that the National People’s Congress decided that universal suffrage for the chief executive will not be implemented until at least 2017.

Exchange rate regime. The Hong Kong authorities have reaffirmed their commitment to the US dollar peg. In fact, the low US interest rates are very welcome given the sharp reversal in activity. The peg also provides a source of stability against heightened volatility in global financial and foreign exchange markets. The authorities’ large foreign exchange and fiscal reserves and the entrenched current account surplus will enable the peg to withstand any speculative attack.

Pearl River Delta. Hong Kong-owned factories in the delta and trade service providers are being severely affected by the drop in global demand. Even before that, these factories were getting squeezed by rising labour costs, stricter enforcement of labour rights and more rigorous environmental standards. If Hong Kong is to leverage further growth from the delta, much will depend on the success of the government’s strategy to transform the area into a centre for high-tech manufactures, with further integration of Hong Kong as the trade and financial services hub. On this front, plans for advanced transport links between Hong Kong, Macao and the mainland are a positive development. The recent opening up of China’s domestic market to goods produced by Hong Kong-owned factories should provide more immediate support.

Dougal Crawford is Senior Economist for the Export Finance and Insurance Corporation (www.efic.gov.au)