Ongoing unrest in Hong Kong risks dragging down the global economy

HONG KONG, China — News that Hong Kong Chief Executive Carrie Lam has formally withdrawn the extradition legislation that sparked mass protests in the territory must be viewed with caution. The aims of the 13-week long protest movement in the territory have broadened beyond opposition to the extradition bill to include a push for democratic reform and investigations into police brutality.

While Lam’s concession removed the original cause of the protests, the turmoil has already inflicted serious damage to Hong Kong’s economy. Hong Kong’s Census and Statistics Department reported that GDP contracted 0.4% in the second quarter. If the societal upheaval continues, economic slowdown in the territory will likely weigh on the broader Asian economy, with wider fallout for Asia’s trading partners worldwide.

While dwarfed by the economic output of the United States and China, Hong Kong is a critical hub for global trade and finance. It was the world’s seventh-largest exporter of merchandise in 2017, according to the World Trade Organization. It is also the third leading global financial center, after New York and London, according to the Global Financial Centre Index. According to a triennial survey conducted by the Bank for International Settlements, Hong Kong with $437 billion in FX transactions in 2016 was the second-largest foreign exchange market in Asia and the fourth largest in the world that year.

Civil unrest, if it persists, will represent a systemic stress point for global commerce, which has already been weakened by the US-China trade dispute. Ongoing economic disruption in the territory would not be confined to China and other parts of Asia but would also extend to the rest of the world, including Germany and the United States.

In a rare display of bipartisan consensus, Republican and Democratic leaders in the United States have taken notice. In August, Senate Majority Leader Mitch McConnell, R-Kentucky, publicly threatened to have the Senate reconsider the 1992 Hong Kong Policy Act. This law gives Hong Kong preferential treatment in matters of trade and economics compared with mainland China by treating Hong Kong as a separate jurisdiction. In June, House Speaker Nancy Pelosi, D-San Francisco, issued a statement calling for a review of U.S.-Hong Kong trade ties over the extradition bill.

Areas of special treatment include visas, passports, law enforcement, permitted trade in sensitive technologies, customs designations and investment. The law also has meant trade between the United States and Hong Kong is not subject to the tariffs Washington imposes on China.

Lam’s withdrawal of the extradition bill should reduce the political risk to the Hong Kong Policy Act. But ongoing civil unrest in Hong Kong could rekindle proposals in Washington to undo it. Such a scenario would have ramifications far beyond Asia. International businesses and investors with activities in Hong Kong or in mainland China via Hong Kong would have to reassess those exposures if the Hong Kong Policy Act were to come under renewed scrutiny.

Hong Kong provides a significant source of funds for mainland Chinese firms by serving as a conduit for foreign investors. Examples include the Shanghai-Hong Kong Stock and Bond Connect programs that provide international investors with a gateway to purchase local Chinese stocks and bonds by reducing regulatory paperwork for foreign investment in Chinese securities. These programs show the continued importance of Hong Kong as a channel for opening Chinese capital markets.

In addition, about 70% of the world’s 100 largest banks operate within Hong Kong’s borders, according to the Hong Kong Financial Services Development Council in a May 2018 report. Further deterioration in the political situation risks triggering capital flight that would threaten the territory’s role as a global financial intermediary. Individuals may move their assets abroad, and international investors and businesses may remove money from the territory to avoid a stronger Chinese presence in the region.

Given its importance as a hub for global trade and finance, Hong Kong is integral to the global economy. At a time when global trade and manufacturing are slowing amid the trade war between Washington and Beijing, these sectors are ill-equipped to handle the shock of an economic slowdown in Hong Kong or a change to its status as a trade and financial hub for the region. Investors should keep a close eye on the economic, as well as political developments in Hong Kong. The impact from reduced activity in this important region will only add to the headwinds blowing against the global economy and markets.

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