Why China Still Needs Hong Kong

Tianlei Huang (PIIE)



The political unrest in Hong Kong, provoked initially by anger over an unpopular extradition bill now been declared “dead,” has evolved into a broader movement to defend the territory’s rule of law. Beijing is watching developments cautiously, apparently careful to assert its authority while not enflaming the situation. Some argue that China’s rapid economic development has diminished Hong Kong’s relevance to the mainland over time, thus giving Beijing greater leeway in treating Hong Kong with a heavy hand. There may be some truth to this argument, but the way I see it is different: Though Hong Kong’s economy has shrunk relative to the mainland’s, it remains vital to China as a whole.

Hong Kong’s importance to the Chinese economy is disproportionate to its size. Since Hong Kong’s handover in 1997, China has developed massive economic and business interests in the territory. The Chinese leadership realizes that for the sake of its own prosperity, China still needs a capitalist Hong Kong. However, Beijing must know that preserving Hong Kong’s unique economy means more than allowing free enterprise. It entails a strong and unwavering commitment to its rule of law, the key to Hong Kong’s economic success.

Though entrepôt trade via Hong Kong has diminished with China joining the World Trade Organization, Chinese outbound investment into Hong Kong is significant in both flow and stock. According to the Ministry of Commerce of China, over 58 percent (around US$70 billion) of China’s nonfinancial outbound direct investment (ODI) flow went to Hong Kong in 2018. By the end of 2018, stock volume of China’s nonfinancial ODI in Hong Kong reached US$622 billion.[1] That amount was roughly 170 percent of Hong Kong’s GDP in the same year. A great amount of Chinese investment does not remain in Hong Kong. It is either repatriated to China as profits and funds or sent elsewhere in the rest of the world. Mainland companies take such a detour with their investments via Hong Kong to take advantage of the territory’s favorable regulatory environment and available professional services.

The mainland companies detouring through Hong Kong include a growing presence of China’s state-owned enterprises (SOEs). Currently, of the 96 central SOEs managed by the State-Owned Assets Supervision and Administration Commission (SASAC) of the State Council, three are headquartered in Hong Kong (namely, China Merchants, China Resources, and China Travel Service) and 50 have at least one subsidiary listed on the Stock Exchange of Hong Kong (SEHK), according to Wind Financial Information. Plus, of the ten largest initial public offering (IPO) funds raised by newly Hong Kong–listed companies since 1986, nine are Chinese—including eight Chinese state-owned financial institutions and enterprises.

The SEHK is now home to 250 H-share Chinese companies and another 171 red chip firms that are controlled by the Chinese state.[2] The combined 421 China-related companies have a total market capitalization of nearly HK$12 trillion (US$1.54 trillion), more than one-third of SEHK’s total market capitalization of HK$32.73 trillion (US$4.2 trillion) at the end of June 2019, compared with only 16 percent at the time of the 1997 handover.[3] Most recently, the Chinese internet conglomerate Alibaba has filed a listing that could potentially raise nearly US$20 billion for the company as soon as the third quarter of 2019.

Why do mainland companies, many of which are state-owned, opt for listings in Hong Kong? Hong Kong has multiple advantages that are missing in China itself. First, a registration-based IPO system, which enables listing to be relatively faster and easier than in the mainland.[4] Second, absence of capital controls and greater international exposure, which allows Hong Kong to serve as an anchor point for global expansion. Third, a sound financial infrastructure, which mitigates operational costs. Fourth, an effective regulatory framework, which focuses on transparency and prudent minimum standards.[5] Neither Shanghai nor Shenzhen is likely to win this competition with Hong Kong, at least over the short term.

Moreover, Hong Kong is also at the forefront of renminbi internationalization. It is now the “global hub for offshore renminbi business,” said the Hong Kong Monetary Authority (HKMA), the territory’s de facto central bank. Hong Kong’s renminbi liquidity pool (a combination of renminbi deposits and renminbi certificates of deposit), the largest outside mainland China, reached RMB634 billion (US$92 billion) at the end of June 2018.[6] The People’s Bank of China has issued renminbi-denominated central bank bills in Hong Kong through HKMA’s Central Moneymarkets Unit (CMU) four times—totaling RMB90 billion (US$13 billion)—since November 2018 to adjust liquidity and stabilize exchange rates in the offshore renminbi market.

Underlying all the advantages Hong Kong possesses over the mainland is the territory’s core strength of rule of law—the very cause that over a million Hong Kongers have taken to the streets to defend since June 2019. Beijing needs to understand that preserving Hong Kong’s capitalist system distinct from the rest of China is in its own best interests. It entails adherence to free-market capitalism and, more importantly, an unwavering commitment to the rule of law, which no one should take for granted.


1. It is interesting to note that at the same time, Hong Kong’s investment in the mainland is also significant. By the end of 2018, in the mainland, the actually utilized foreign direct investment (FDI) from Hong Kong was US$1.1 trillion in stock, accounting for 54 percent of all FDI China has received from all over the world, according to the Ministry of Commerce of China.

2. According to the Hong Kong Exchanges and Clearing Market, H-share companies are enterprises that are incorporated in the mainland and are controlled by either mainland government entities or individuals; red chip companies refer to enterprises that are incorporated outside the mainland but are controlled by mainland government entities.

3. The Hong Kong dollar is pegged to the US dollar in a narrow band of 7.75 to 7.85 per US dollar. The exchange rate used to convert Hong Kong dollars to US dollars in this post is as of July 9, 2019.

4. China has been discussing replacing IPO approval with registration for many years, but little has been done. Most recently, the newly launched Nasdaq-like STAR market in Shanghai has begun to test IPO registration, but it still remains unknown when all listings on the Shanghai and Shenzhen stock exchanges will become registration-based.

5. The Heritage Foundation has ranked Hong Kong as the world’s freest economy for 25 consecutive years since 1995.

6. The exchange rate used to convert renminbi to US dollars in this post is as of July 9, 2019.

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