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Will China Back Down in Hong Kong?

Sigma Investment Counselors

October 6, 2014

Hong Kong, the former British colony of 7.2 million people, has seen over a million pro-democracy protesters take to the streets in the city’s central business district over the last week.  The protesters want a universal election, “one person, one vote”, and Beijing still holds firm ground against this proposal.  The root issue of the protest is Beijing’s decision to prescreen candidates for the election of Hong Kong’s top leader.  Originally, under the Basic Law (the document serves as the constitution of Hong Kong and went into effect in 1997 when Britain returned Hong Kong to China), universal suffrage will be introduced from 2017 onward to elect Hong Kong’s top leader.  But, last month the Communist Party set down rules that candidates first have to be recommended by at least half the members of a nominating committee, and those committee members generally are loyal to Beijing.  Many Hong Kong citizens are afraid that any pro-democracy candidates considered as unfavorable by Beijing would never have a chance to be nominated and it is a sign that the Communist Party is going to tighten control over Hong Kong.

The foundation of Hong Kong as an international financial center rests on top-notch financial regulations, free capital flows, the rule of law, and a self-governing and transparent judicial system.  Should the Communist Party decide to suppress the widespread pro-democracy rallies, the intervention could cast a shadow over Hong Kong’s independent legal system. It would also undermine the world financial community’s confidence in Hong Kong’s role as a western-style business environment at China’s gate and put a dent in Hong Kong’s reputation as a reliable stable financial center.

That erosion of confidence in Hong Kong is something Beijing cannot afford at a time when economic growth in China has slowed.  Hong Kong has played a crucial role as an investment gateway to mainland China during the past three decades. Despite the rise of Shanghai as a financial hub in recent years, Hong Kong has remained a crown jewel for foreign direct investment in China and has served as the world’s largest foreign exchange center in trading the renminbi (RMB), mainland China’s currency.  Most of China’s largest state-owned banks, energy titans, and telecommunications companies are listed on the Hong Kong Stock Exchange to raise foreign capital.  

Furthermore, any violence against peaceful protesters in Hong Kong would strike a severe blow to Beijing’s long-term strategy for Taiwan; the democratic island that Beijing has long pursued to reunite. When Britain returned Hong Kong to China in 1997, Hong Kong residents were promised a high degree of autonomy for 50 years.  Communist Party leaders intended to use Hong Kong’s self-government as a showcase to entice Taiwan back to China.  Any heavy handed crackdown on Hong Kong protesters will jeopardize the genteel images the Communist Party has tried to build in the hearts of the people of Taiwan.

The Hong Kong government is waiting for the protesters to wear down and lose interest or lose support from the general public. The week long demonstration has caused inconvenience and continues to affect the general public’s daily lives. The protestors’ demand for the resignation of Hong Kong’s chief executive, Leung Chun-Ying, was rejected.  Now the question arises what is the protesters’ exit strategy?  

No matter what the outcome, in my opinion, a bloody conflict similar to the 1989 Tiananmen Square massacre at this stage seems slim. We at Sigma, will continue to monitor the situation and its impact on the global economy. 

All comments and suggestions are welcome.

Wenny Gorman, CFA®

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