On a Saturday afternoon in late November, the Tuen Mun shopping center in Hong Kong's New Territories is teeming with people. Its owner, property magnate Robert Ng, stands in the main thoroughfare, smiling wryly. "Look at this," he says in mock disbelief, pointing to wave after wave of shoppers. "Isn't it amazing?"
That it assuredly is, for to go by the stories in the local and foreign press, Hong Kong is headed for imminent extinction as a financial and commercial capital -- an Asian Alexandria. If one believes what one reads and hears, muses Ng, China's entry into the World Trade Organization is rapidly undermining Hong Kong's role as the country's trade gateway. Shanghai, meanwhile, is poised to usurp the former British colony's role as a financial center (see box, page 54). And Hong Kong's Beijing-appointed government doesn't have a clue as to how to save the day.
The 50-year-old Ng, chairman of Sino Land Co., is unconvinced of this apocalyptic scenario. To further demonstrate that Hong Kong is alive and kicking, he drives a visitor to the nearby Gold Coast Hotel. The lobby of the 450-room property, owned by Ng's Daynard Co., is buzzing with locals taking a weekend break. Ng wonders mischievously whether he should sponsor "tours of real-life Hong Kong" for journalists and economists who take it for granted that the city is washed up.
To be sure, Hong Kong is under severe stress. Chief Executive Tung Chee-hwa warned on January 8 that the city's economy is "facing difficulties unprecedented since World War II." He vowed to cut government spending and raise taxes to reduce a HK$70 billion ($9 billion) government deficit that amounts to 5 percent of gross domestic product. Details will be revealed in this month's budget. Tung also proposed closer economic ties with Guangdong province, Hong Kong's thriving neighbor on the mainland. "A city is simply not enough to compete on its own," Tung declared. "Hong Kong must pool its strengths with other cities in the region." And in a symbolic gesture, he cut his own pay 10 percent.
The contrast between Hong Kong today and at the time of its handover is indeed stark. When the U.K. ceded sovereignty over the city-state to China at midnight June 30, 1997, Hong Kong was a boom town. The economy was surging at 5.2 percent, unemployment stood at just 2.4 percent, and property prices were rising as fast as the skyscrapers in the New Territories. The Shanghai-born Tung, a former shipping tycoon, boasted that Hong Kong would be transformed into "Asia's New York or London."
Since then Hong Kong has gone into a downward spiral. The city is sluggishly emerging from its third recession in five years: HSBC Holdings forecasts growth of barely 1.6 percent this year. Consumer prices have been falling for four straight years. Unemployment has hit a near-record high of 7.2 percent. The stock market has plummeted 58 percent over the past three years. Bankruptcies last year reached 25,328, triple the number in 2001. Property values have plunged 65 percent. One of every five mortgages is worth more than the underlying property.
Hong Kong will no doubt rebound in the short term as the global economy recovers. Its immediate travails can be traced in large part to the Asian financial crisis of 1997'98: Hong Kong's fixed, U.S.-dollar-pegged currency put it at a disadvantage vis-à-vis such competitors as Singapore, Taiwan and Thailand, whose currencies fell 20, 19 and 40 percent, respectively, giving them a huge edge in global and regional trading. Always a costly place to do business, Hong Kong became prohibitively expensive, and inevitably, the property bubble burst, rattling consumer confidence.
Yet as Ng points out: "We have seen Hong Kong's economy turn on a dime many times before. All you need is a spark." He underscored his faith in the city last year by spending $1.92 billion to buy more land there.
More threatening than Hong Kong's immediate economic crisis is the prospect that the city will be discarded by China like a leaky old junk. "The rise of China has scared a lot of people," says Lau Siu-kai, head of Hong Kong's Central Policy Unit and an adviser to Tung. "There is a sense of malaise here just like there was in the U.S. in the 1970s and 1980s when it worried about losing its status in the world because of competition from Japan and Germany."
Hong Kong residents' confidence in their economic prospects and in the government and Tung, as well as their satisfaction with their quality of life, are near rock bottom, according to Hong Kongbased polling concern CEIC Data Co. The menace posed by China's rapid opening to foreign investors -- it attracted more foreign direct investment than any other country last year -- plays heavily on the local psyche. After all, serving as China's port of entry for people and capital as well as matériel was the bedrock upon which Hong Kong built its success.
Still, Hong Kong has always been manic-depressive, constantly bouncing back from one crisis or another. Secretary for Financial Services and the Treasury Frederick Ma remembers well the glum mood that enveloped Hong Kong in 1973. The OPEC oil crisis had caused a fourfold increase in oil prices, and Hong Kong's stock and property markets had plummeted. Fresh out of the University of Hong Kong, economics major Ma got a job as a credit analyst at Chase Manhattan Bank. "I was very lucky to get the job, but the mood was terrible," he recalls. "I said, 'Oh my God, I may get fired.' I had the same thoughts as some of our youngsters today."
Ma, 50, has heard Hong Kong written off numerous times before. Confidence in the thencrown colony collapsed in 1984 as negotiations began over its future as part of China. The accompanying currency crisis forced Hong Kong to peg its dollar to the greenback. Five years later Hong Kong was traumatized by China's Tiananmen Square massacre, and two years after that the Gulf War unsettled the city. In each case, says Ma, the doomsayers predicted a dark future for Hong Kong, and each time they were proved dramatically wrong. "Whenever you go through a dark tunnel, you cannot see any light," the financial services secretary says. "The setback we are going through economically is only temporary, just like we saw in the 1970s, 1980s and 1990s. Hong Kong has seen very rough times before. Will we pull through? Absolutely."
Nevertheless, this city of 7 million bustling people is at a critical juncture. Ma calls it "probably the biggest challenge Hong Kong has ever experienced." The economy is much too dependent on property and trade, so must start to attract jobs in the high-value-added services industries. As it is, Hong Kong has no new growth sectors to take up the slack as its lower-skilled jobs steal away to mainland China. Too little investment in education over the years has come back to haunt Hong Kong, because many of its workers lack the skills that multinational companies seek. Moreover, many believe that the government is exacerbating the economic problem by introducing strict antisedition laws that could stifle freedom in general.
Still, Hong Kong is a nimble, efficient and durable competitor. It comes equipped with commercial attributes that are tailor-made to capitalize on the mainland's burgeoning growth. Hong Kong's legal system -- its commercial code in particular -- is considered the most trustworthy in Asia. The city's elaborate physical infrastructure makes it an ideal springboard for companies doing business with China. Hong Kong also has a critical mass of entrepreneurs as well as professionals in finance, accounting, information technology and marketing -- concentrated expertise that China desperately needs to upgrade its own companies to compete globally.
Far from fearing China's rise, optimists like Ma believe that the mainland's proximity is the single best assurance Hong Kong has of a bright future. "Sing-apore would love to have China as a hinterland," he crows. "It's probably our biggest strength." China's economy grew about 7 percent last year and should repeat that sizzling pace this year. Beijing's goal is to quadruple China's GDP over the next two decades.
Tung adviser Lau likewise argues that Hong Kong is well-positioned to benefit from China's growth. Indeed, he contends that the Chinese Communist Party's 16th Congress in November, which fortified the role of the private sector, virtually assures further strong growth for Hong Kong. As Lau sees it, China's WTO membership guarantees that thousands of small and medium-size enterprises from Asia and the West will want to enter China -- and will use convenient Hong Kong as their launching pad. "We still have China to bank on," he says. "Hong Kong's historical role of promoting modernization in China has not ended. The Pearl River delta region [of Guangdong] remains a global manufacturing powerhouse."
Tung's government is seeking to move Hong Kong up the value-added curve by providing ever more refined services to China in finance and business, trade, transportation and logistics. It also is seeking to attract tourists from the mainland and elsewhere and is looking to carve out a niche in IT. To better connect, literally, with the manufacturing plants in Guangdong, the government has proposed building a multibillion-dollar bridge to link Hong Kong with Macao and Zhuhai.
International companies continue to choose Hong Kong as their China or Asia headquarters. Last year Philips Electronics uprooted its regional headquarters from Singapore and transplanted it to Hong Kong, to be nearer to China, its biggest Asian market. Giorgio Armani recently expanded a modest Hong Kong shop into a 3,000-square-meter megastore, the company's largest outside Milan. Declared the fashion designer, "Hong Kong is one of the most cosmopolitan and vibrant cities in the world and through its special legal and trading status is still an important gateway to China -- a market with unrivaled future potential."
The government is taking short-term measures to shore up the property market and along with it citizens' sagging spirits. In November Tung suspended all land sales until the end of this year. Property accounts for almost one quarter of Hong Kong's GDP, and before halting land sales, the government had forecast that property taxes would contribute nearly 12 percent of state revenues in the fiscal year through March 2003. The suspension will exacerbate the deficit by about HK$8 billion this fiscal year and by more next year, but Ma contends that the measure will help revive the economy. UBS property analyst Franklin Lam agrees, predicting that depressed property prices will rise 20 to 40 percent by the end of 2004. Others, however, are skeptical. Citigroup/ Salomon Smith Barney analyst Joe Loe estimates it will take two years for 60,000 empty apartments to be absorbed.
The critical longer-term fix of restructuring Hong Kong's economy to cure its overreliance on property and trade -- which together accounted for nearly 50 percent of GDP in 2001 -- won't be achieved overnight. Much of the city's workforce is not prepared to fill the new jobs for higher-skilled workers envisioned by planners. Only 23 percent of Hong Kong adults have tertiary education, compared with 39 percent in Singapore and 43 percent in Japan. The government estimates that by 2005 Hong Kong will have a shortage of 120,000 people with higher education -- and a surplus of 160,000 with just a secondary education or less. Tung has accordingly increased spending on education by more than 50 percent and is opening Hong Kong to professionals from China and elsewhere.
What Tung has described as the "quick-money mentality" and "superficial prosperity" of the pre-1997 bubble must now give way to sustainable prosperity based on a symbiotic relationship with China. The adjustment will be neither easy nor painless.
As the gloom-mongers warned, China's reduction of barriers to investment following its admission to the WTO is siphoning investment away from Hong Kong. Net foreign direct investment in the city started to turn negative in 2000, calculates HSBC Holdings chief Asia Pacific economist Geoffrey Barker. Despite a trade surplus of HK$29 billion in the first half of 2002, a net HK$20 billion flowed out of the economy, HSBC estimates, because foreign direct investors cut back their Hong Kong presence. Harsh economic conditions and Hong Kong's steep costs were key drivers of the trend. Considering that business costs in Guangdong can be 40 percent lower, it's no surprise that a number of companies are moving back offices there. The bank whose very name once embodied Hong Kong, HSBC Holdings, shifted its headquarters from Hong Kong to London back in 1993. It has opened a back office for 1,200 staffers in Guangzhou, and another for 500 in Shanghai.
But it's not just low-end activities that Hong Kong is losing: A number of multinationals have shifted their regional and China headquarters to the mainland. French telecommunications giant Alcatel and the mobile phone division of German conglomerate Siemens shifted their China headquarters from Hong Kong to Shanghai because, both said, they wanted to be closer to the fastest-growing telecom market in the world: mainland China. Coca-Cola Co. and Citigroup are two other notable names that have transferred their China headquarters from Hong Kong to Shanghai.
Such corporate defectors (including his own bank) prompt HSBC senior economist George Leung to warn that Hong Kong is facing a divestment-induced contraction that "threatens the survival of the economy." Not only will "jobs be lost amid falling direct investment, which in turn dampens consumption," says Leung, "but future productivity gains will also be forgone without today's investment."
Leung says Hong Kong is unlikely to experience a rebound like that of 2000. That year GDP surged 10 percent on the back of robust trade growth. Hong Kong did create 21,000 jobs in the first half of last year, again because of trade gains, but that was more than offset by the loss of 20,000 jobs in finance companies and 14,300 in restaurants and hotels.
Leung paints a bleak picture overall. He compares Hong Kong's recent pattern of recurring recessions to Japan's: cyclical swings obscuring a long-term downtrend. "The case of Hong Kong may even be comparatively worse, as unlike Japan, there is no powerful fiscal policy to help smooth out the dip," Leung wrote last September.
The government's attempt to soften the pain of the recessions through public works projects and other countercyclical spending has generated a nasty by-product: a swollen budget deficit. In his January policy address, Tung warned that the deficit was beginning to compromise Hong Kong's credit rating. "If not dealt with properly," he said, "the stability of our financial system could be jeopardized." The projected shortfall of HK$43 billion for the year ending March 2003 is now expected to come in at more than HK$70 billion. In October Standard & Poor's revised its outlook on Hong Kong's AA- currency rating from stable to negative. S&P associate director Ping Chew noted that the government was hamstrung in reining in the deficit because of its need to adopt a countercyclical stance. UBS senior economist Vincent Chan has called the deficit "unsustainable" and says it could "herald a fiscal crisis." He urges tax hikes. Still, with its fiscal reserves of HK$315 billion and virtually no debt, Hong Kong is hardly pressed for cash.
To many critics, the Tung government is a large part of the problem. The unelected administration is pilloried for its lack of vision and direction and ineffective execution. "There is one overriding concern in the Hong Kong economy -- the government," wrote outspoken CLSA Emerging Markets chief economist Jim Walker in September. "People question the administration's competence." Even Chinese premier Zhu Rongji admonished Hong Kong and its leaders in September 2001 for always "discussing without deciding and deciding without acting."
High on the bill of indictments, Tung is accused of straying from Hong Kong's laissez-faire philosophy. Government intervention has increased dramatically and was given an official imprimatur in financial secretary Antony Leung's budget speech last March (Institutional Investor, May 2002). Leung said the government should invest in "projects beneficial to our economy as a whole when the private sector is not ready to invest in them." The government has already used this so-called proactive market-enabling to heavily subsidize construction of a Hong Kong Disneyland. When it decided Hong Kong needed a Silicon Valley, the government simply granted land to Richard Li, son of powerful tycoon Li Ka-shing, to build Cyberport, a development designed to attract high-tech companies. Scheduled for completion at the end of this year, it is to have 120,000 square feet of office and retail space, a conference center, a five-star hotel, an IT training institute and 2,700 apartments. Critics worry that the government's Singaporelike excursion into venture capital will cost a lot of taxpayer money without a commensurate benefit in growth.
Other policies have appeared capricious, further damaging public confidence. In June the government issued a law banning Hong Kong residents from gambling outside the city -- a move transparently designed to protect the horse-racing monopoly of the Hong Kong Jockey Club. Then there was a proposal to impose a HK$500 tax on some of the lowest wage earners in the city -- maids -- to help reduce the deficit. This is not the Hong Kong that economist Milton Friedman once called a paragon of laissez-faire capitalism.
More recently, a typhoon has blown up over the government's plan to enact strict laws to prohibit, in the words of so-called Article 23, "treason, subversion, sedition and secession." In mid-December 60,000 demonstrators rallied against what they see as an assault on Hong Kong's freedoms. It was the big-gest public protest in the city since the 1997 handover.
But the concern of opponents isn't only that basic civil liberties will be compromised. Corporations are also worried that the rules could stifle the press and generally inhibit the free flow of data so vital to commerce in the Information Age. The American Chamber of Commerce in Hong Kong has warned that enactment of Article 23 would have a "chilling effect" on business. Foreign banks and companies joined with opposition politicians in demanding that the government publish a "white bill" revealing the particulars of the laws.
The government has refused to be that forthcoming, but it has made concessions. It is scrapping proposed prison terms for those possessing seditious documents and exempting foreign nationals from treason charges. Obtaining unauthorized government information is to be considered a criminal offense only if it was done through theft, bribery or computer hacking, not merely by being handed a document by a bureaucrat.
FOR ALL ITS TROUBLES, HONG Kong may be about to embark on a new boom. Or so believes CLSA's Walker, who sees the city's comeback propelled by its return to price competitiveness and the resurgence of Asian markets -- especially a China that is "on fire." In Walker's analysis prices for Hong Kong goods and services have fallen so far with deflation that they're just 10 percent above pre-Asian-crisis levels and should be back to pre-1997 equilibrium within the year. Asia is, in his estimation, on the brink of a five- to six-year expansion that will make it the engine of the global economy. "There is no reason for Hong Kong to be a laggard in this resurgence," he wrote last fall.
Walker's thesis is bolstered by recent growth in trade and even GDP. The economy grew 3.3 percent on a year-on-year basis in last year's third quarter. The chief impetus came from exports: Goods shipments rose 11.4 percent, while exports of services grew even more -- 14.1 percent. Sales to East Asia saw double-digit growth in the quarter, compared with the same period a year earlier. Exports to Malaysia, the Philippines, South Korea and Thailand were robust. Tourism was a bright spot, with arrivals in 2002 rising 20.7 percent over the previous year, to a record 16.6 million.
Walker maintains that this is, in fact, a good time to accumulate Hong Kong stocks. A "wall of money" is just waiting to come back into the market from Hong Kongowned businesses in China, he says, and domestic liquidity is building up to an all-time high. "It would take little to spark a spending spree or equity-buying binge," says Walker. And he's apparently not alone in being tentatively bullish. Merrill Lynch reckons that last October a big swing -- "a major inflection point" -- occurred in fund managers' attitudes toward Hong Kong.
Be warned, however, that Hong Kong is famous for its roseate false dawns. And the Hang Seng index, like so many other of the world's stock market benchmarks, has been disappointing investors for three straight years, falling 13 percent in 2000, 24 percent in 2001 and 18 percent in 2002.
Property developer Ng's multibillion-dollar bet that Hong Kong will come roaring back is based primarily on the government's huge investments in education, together with the benefits from greater integration with China. "Hong Kong is like a hardball," he declares. "When you throw it down, it bounces back higher." But how high?
Shanghai: The great pretender
Shanghai's Lujiaziu district is the gleaming glass box that a world-class financial center could theoretically come in. More than 400 ultramodern buildings house 50 foreign banks and insurers. The majestic 88-story Jinmao tower, China's tallest building, is home to a Grand Hyatt hotel as well as American International Group, Citibank and HSBC Holdings.
What's more, Shanghai functions as a commercial nerve center for the Yangtze river delta, where more than 200 of the world's top 500 companies have facilities, according to Shanghai vice mayor Zhou Yupeng. Among them: Intel Technology, Kodak (China) Co., NEC Corp., Shanghai Bell Co., Shanghai Siemens Communication and Shanghai General Motors. The populous provinces along the Yangtze account for 50 percent of China's output.
Could Chinese premier Zhu Rongji's prediction that Shanghai will become China's New York, and Hong Kong its Toronto come true? Not necessarily, or at least not right away. Mike Rowse, head of Invest Hong Kong, a government agency that promotes the city overseas -- and admittedly not an impartial source -- nevertheless makes a sound case when he points out that before Shanghai can attain financial center supremacy, it needs at least three things: a convertible currency, an independent judiciary and free-flowing information. "No city on the mainland has these attributes or can acquire them probably for a generation," Rowse contends .
China's yuan is unlikely to be made convertible for at least another three or four years because of concerns over potentially volatile capital flows, says Qu Hongbin, China economist with HSBC Holdings in Hong Kong. As for an independent judiciary and press, Beijing does not seem disposed to grant such provocative freedoms to Shanghai. Hong Kong, by contrast, inherited a free press and the rule of law from its British overlords: Under the terms of the 1997 handover, Hong Kong was promised "a high degree of autonomy" and an independent judiciary for at least 50 years under a formula dubbed "one country, two systems." Beijing's current effort to restrict civil liberties in Hong Kong is worrisome but would still leave the city with comparative freedom as a business center (story).
"Shanghai will grow into a significant financial center over the next five years, and a small part of that will be at Hong Kong's expense," maintains Stuart Gulliver, global head of treasury and capital markets for HSBC Holdings. "But the two things that will remain Shanghai's Achilles' heel in terms of becoming an international financial center are freedom of the press and the rule of law."
Just the same, the speed of Shanghai's rise is understandably frightening to Hong Kong. Shanghai's financial sector has doubled in size since 1990 and now accounts for 20 percent of the city's output. Founded little more than a decade ago, the Shanghai stock exchange, with a market capitalization of $300 billion, is already half the size of Hong Kong's. And if the cities' economic growth rates are projected forward, Shanghai will catch up with Hong Kong in 15 years.
Adding to Hong Kong's angst is the prospect that Shanghai's raw economic power could be combined with enlightened policymaking. China's five-year plan for 20012005 gives top priority to turning Shanghai into a financial hub, and China's entry into the World Trade Organization means that it must open its financial markets to the world over the next four years.
"There's no doubt that Shanghai's time is coming, but it's at least 20 or 30 years away," says CLSA Emerging Markets chief economist Jim Walker. "Shanghai is a natural competitor and is probably even better positioned than Hong Kong. But I don't see why Hong Kong people should be getting so gloomy about the city's prospects in 2002. Maybe in 2022." -- K.H.
