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Horatius on Hong Kong's Expensive End Game

By Dominic Armstrong

On 4 September Hong Kong Chief Executive Carrie Lam announced she would formally withdraw the extradition bill which has sparked thirteen weeks of protests and brought perhaps a third of the territory’s population onto the streets. If she hoped that conceding the demonstrators’ original demand would end the turmoil she was mistaken.

This weekend saw further protests, aimed at persuading the US Senate to pass the bipartisan Hong Kong Human Rights and Democracy Act when it reconvenes on 10 September. (This would require annual confirmation of the territory’s special trade and business privileges, and sanction Chinese and HK officials who undermine the territory’s autonomy.)

Her move also did little to curb investors’ concern about the implications of the protests for the territory’s economy. On 6 September Fitch became the first ratings agency to cut the territory’s credit rating in response to the turmoil, arguing that the latter ‘inflicted long-lasting damage’ on the foreign image of Hong Kong’s governance and ‘called into question’ the quality of its business environment. The growth of the territory’s links with the mainland would lead to ‘greater institutional and regulatory challenges’ which could only be reflected by narrowing the difference between HK’s rating and that of the People’s Republic (PRC), from two to one.

On one level this concern would seem misplaced. The extradition law would have permitted the extradition of Hong Kong residents to the mainland, thus exposing them to a judicial system whose principal function is protecting the Chinese Communist Party. Extraditable offences included those (such as insulting the CCP leadership) that are not crimes under HK’s Basic Law.

The law would thus have undermined the fundamental premise of Hong Kong’s investment appeal: that it is the only part of the People’s Republic of China that has the rule of law as it is understood in democratic jurisdictions, enforced by an impartial judiciary – thus providing a reliable legal and administrative domicile for foreign entities doing business in the PRC.

Withdrawing the law, as opposed to merely suspending it – Lam’s concession earlier this summer – means that it is dead, at least in the current political context. The basic integrity of HK’s separate legal status has been preserved. Yet on another level this concern is well-founded. Lam’s move is too little, too late.

If she had withdrawn the bill two months ago, before the protestors’ grievances widened and police brutality delegitimised the territory’s government, then the demonstrations might have ended. But now the protestors are calling for concessions, such as a wholly elected legislature, that go beyond the Basic Law and which therefore Beijing will never make. In theory Lam’s withdrawal of the bill – almost certainly at Beijing’s behest (leaked tape recordings have revealed she has never been making the key decisions during this crisis) – should mean a deal can be done. But the protestors’ wider demands are in earnest, a function of what seems increasingly to be a primal scream of rage at Beijing’s creeping erosion of HK’s separateness, the rubber-stamp legislature’s inability to address fundamental problems in the territory (such as housing), and the future residents face when the Basic Law expires in 2047.

It is difficult to see their demands being dropped if Lam or Beijing keep saying no. Beijing, meanwhile, does not understand HK; if it is minded to make more concessions, the chances are that they – like the withdrawal of the bill – will be too little, too late. The protests will continue, with violence on both sides, further undermining external confidence in HK – and, almost certainly, the integrity of that legal system.

Why? Unless one or both sides back down – which seems very unlikely – the crisis will end with a lot of bloodshed, and bloodshed will weaken HK’s institutions. For the moment, Beijing is trying to keep the violence in check, almost certainly to avoid besmirching the 70th anniversary of the PRC on 1 October, for which huge celebrations are planned; the police are not using live ammunition, and Beijing is increasingly using disappearances and arrests to try to intimidate protestors into staying home. Yet these seem to be persuading Hong Kongers not on the streets that the government is as illegitimate as the protestors say, thus providing the latter with moral support.

More worryingly, Beijing has also constructed a case for suppression that already has huge support in mainland opinion, viz: the protests are the work of foreign powers, suborning China; the protestors are increasingly turning to terrorist means to achieve their ends; and they do not represent the true Hong Kong. Of course, it would rather not use mainland forces (either military or People’s Armed Police); it is much more likely to use the HK Police, enforcing colonial-era emergency powers which survive in the Basic Law.

It might be hoped that this is as far as Beijing would go. Two main arguments would seem to suggest China should act with restraint.

- First, the political principle underpinning the Basic Law, One Country Two Systems, was devised to win over Taiwan, a much bigger prize than HK; bulldozing the Basic Law might therefore persuade Taiwanese voters that One Country Two Systems is moribund too, and end hopes of a peaceful reunification delivered through the Taiwanese ballot box. Yet support for Taiwan’s anti-reunification Democrat Party is growing anyway, whatever happens in HK. Furthermore, Beijing is reorganising and expanding its military to ensure it can take back Taiwan by force – even in the teeth of US opposition.

- Secondly, a Tiananmen-type suppression in HK would certainly have a devastating impact on investors’ confidence in the territory and the mainland; in theory, Beijing should want to avoid this at all costs, particularly given that the trade war with the US, and the concomitant unintended slowdown in GDP growth, make the PRC’s economy look slightly fragile.

But Beijing places the absolute dominance of the CCP above all else. (The principal role of the country’s sovereign wealth fund is protection of the CCP, not return on investment.) HK is part of the PRC; the CCP has absolute primacy in China; and when HK threatens that primacy, and the political baseline of the Communist state, then restraint becomes illogical. Beijing will not want the situation to end this way; but it would be foolish to assume it will not do whatever it takes to end these protests.

What will this mean for investment?

Much will depend on the scale of the repression. In the worst case scenario China would tear up the Basic Law and end HK’s separate status. This would at a stroke destroy HK’s investment appeal, and much of the value of its bourse. Yet this seems improbable, if only because HK’s separate status is an important macroeconomic tool for Beijing. (It would also destroy the value of investments of millions of CCP members.) A more likely outcome would be the continuation of the Basic Law after an emergency period, with Beijing claiming that nothing had changed.

In this scenario it is likely that confidence in HK – reflected in everything from property prices to investment ratings and market capitalisations – would take a serious hit, with substantial divestment over the medium term as firms moved their China-facing business to other domiciles (particularly Singapore).

Yet it is also worth noting that investors do not seem overly exercised by the ethics of dealing with China, while most seem in any case to have long priced in the gradual erosion of HK’s separate status; if Beijing can offer business-as-usual claims of moderate plausibility, many will simply hold their noses and stay. What is more likely to worry them in the medium to long term is the discovery that a post-repression Hong Kong will be wholly penetrated by mainland agencies, with no commercial security, persecuted staff, and an increasingly hostile environment for expatriates. If by some miracle the crisis ends without an emergency period at all, then its effects are likely to be limited to immediate-term damage to the Hang Seng, some divestment, a shaky property market, and firms accelerating planning for what might happen in the event of HK’s separate status being compromised.

Yet in even the least damaging of scenarios, HK’s institutions will suffer. Beijing’s grip on HK after this crisis will be much tighter than before. Judges will be under increasing pressure to deliver the outcomes Beijing wants; the legislature will be even more of a rubber stamp; surveillance and intimidation of residents, facilitated by extraordinary eavesdropping and facial recognition technology, will make society and politics more opaque; freedom of speech will be severely hampered. Crucially, business will become politics, in a way that has not been the case before. Foreign corporations will be assumed to be servants of external political interests; HK firms will be potential incubators of local dissent. Both perceptions will justify levels of intrusion and surveillance beyond those known on the mainland – moves the increasingly compromised judicial system will be in no position to halt. Withdrawing the extradition bill may on the surface have preserved the integrity of HK’s separate systems, but by coming too late it has ensured the continuation of the crisis that will do much greater long term damage to those institutions.

Of course, the investment implications of the HK crisis go much wider than the territory itself.

The crisis coincides with a US-China trade war which it is in both sides’ interest to resolve. Yet they have failed. So far Hong Kong has yet to be folded into this wider dispute. But there are loud voices in Washington ready to change that, whether for trade leverage or human rights reasons. At present HK enjoys a preferential trading status under a 1992 US law, but if the Senate passes the HK Human Rights and Democracy Act then this will, at a minimum, be reviewed annually, and may well be revoked. If the Trump administration sees no real progress on its trade dispute before Christmas, it is difficult to see it avoiding the temptation to listen to an increasingly China-hawkish bipartisan chorus and turn HK’s status into a bargaining chip – a move that would almost certainly see Chinese reprisals against US corporate interests in China.

And this, of course, would play into wider tensions. The US-China trade war has attacked confidence in the global economy, but has had a smaller regional effect than expected. In large part this is because mainland-based manufacturers have rejigged their businesses to minimise US exposure, either by relocating manufacturing to other regional economies, or by rejigging their supply chains on a regional rather than global basis.

Yet loss of confidence in Hong Kong, or the introduction of conditionality to its US trade status, could strip away some of the buffers the region has built up, as the cost and dependability of everything from capital flows to investment hedges is suddenly questioned.

Factor in the current upsurge in Japan-South Korea tensions, North Korea’s continued development of strategic nuclear weapons, the US’s effective abdication as regional policeman (thus ensuring small disputes escalate), and the Chinese domestic political consequences of the US trade war, and it is easy to see Hong Kong’s difficulties feeding a very gloomy Asian narrative.

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