China Economy

These charts show why Hong Kong is important to China

Key Points
  • Hong Kong, a former British colony which returned to Chinese rule in 1997, is governed under the "one country, two systems" framework that allows the city some freedom that its mainland counterparts don't enjoy.
  • Such autonomy underpins Hong Kong's position as a leading global financial and business center, and China has benefited from having the territory as a gateway to connect with the world.
  • A growing number of Chinese companies are taking advantage of Hong Kong's access to global investors to raise funds, while mainland exports routed through the city to the U.S. could be subject to lower tariffs.
  • But China's recent push to implement a national security law in Hong Kong heightened worries that the city's autonomy is being compromised, which could threaten its global standing. 
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What is Hong Kong's relationship with China?

Beijing's recent push to implement a national security law in Hong Kong — a Chinese special administrative region — once again heightened worries that the city's autonomy is being compromised.     

Hong Kong, a former British colony returned to Chinese rule in 1997, is governed under the "one country, two systems" principle. The framework allows the city some freedom that its mainland counterparts don't enjoy, such as self-governing power, limited election rights, its own currency and a largely independent legal system.

Such autonomy from mainland China underpins Hong Kong's position as a leading global financial and business center. It's also a reason why the U.S., by law, treats it differently from other Chinese cities — but that so-called special status is now under threat.

Still, Hong Kong has been an important gateway between China and the rest of the world. That is likely to remain so for some time, even though the territory's contribution to China's economic growth has diminished through the years.

"I think that Hong Kong will be difficult to replicate elsewhere in (China) to be honest, and I think that it makes sense to double down on … (the) grand vision of 'one country, two systems'," Kurt Tong, former U.S. consul general to Hong Kong and Macau, told CNBC's "Squawk Box Asia" earlier this month.

Here are some charts that show several reasons why Hong Kong is important to China.

Open capital markets

One of the most obvious traits that separates Hong Kong from the rest of China is its position as a free and open economy. That allows the territory to attract money from different parts of the world more efficiently than other mainland Chinese cities which are subject to capital controls.  

As a result, a growing number of Chinese companies are taking advantage of Hong Kong's access to global investors to raise funds. That has helped Hong Kong become the world's top market for initial public offerings for seven out of the past 11 years — including in 2019 when the city was engulfed by widespread pro-democracy protests that sometimes turned violent.

Chinese companies that have listed in the territory include tech giants Alibaba and JD.com.

Increasingly, the city is also becoming a gateway for Chinese investors to invest in international companies, said Charles Li, chief executive of the Hong Kong stock exchange. That's especially so if more foreign companies can sell their shares to mainland investors through a listing in Hong Kong, he added.

"When that happens, we will see very, very sustained flows of foreign companies wanting to be listed here because they are able to directly sell into China, which is still a captive capital base," Li told CNBC's Emily Tan on Wednesday.

The exchanges of Hong Kong, Shanghai and Shenzhen are linked through a program called the stock connect. It allows investors to trade — through their home exchange — selected securities on the other participating platforms.

Chinese yuan goes global

Hong Kong's status as a global financial and business center has also helped China to promote greater global use of its currency, the renminbi or Chinese yuan.

The territory — which has its own currency, the Hong Kong dollar — is one of the few places where the yuan is traded outside the mainland.

The latest data from the Bank for International Settlements, a financial institution that serves central banks around the world, showed that Hong Kong is the world's biggest market for foreign exchange transactions involving the Chinese yuan. That gives the city an edge over other major financial centers, such as Singapore and London, in drawing investors wanting to trade the renminbi.

The average daily turnover of such transactions in the city rose by 39.6% from $77.1 billion in April 2016 to $107.6 billion in April 2019, according to data compiled by the BIS, which is published every three years.

China's overseas investments

Hong Kong's role as a middleman between China and the world doesn't stop there.

As Chinese companies expand their investments overseas, much of that money flow is routed through Hong Kong to "take advantage of the territory's favourable regulatory environment and available professional services," according to Washington-based think tank Peterson Institute for International Economics.

"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," read a PIIE report.

By 2018, Hong Kong accounted for around 55.5% of China's total overseas direct investments, according to the National Bureau of Statistics of China. Even though that proportion is lower than a decade ago, the amount of investments has grown substantially through the years, the data showed.

Facilitating trade

China's opening up and its entry into the World Trade Organization has reduced Hong Kong's importance in facilitating merchandise trade between the mainland and the world.

But that role gained some importance at the height of the U.S.-China trade war, when the two countries slapped elevated tariffs on each other's products. That's because of a "first-sales rule" which governs how the U.S. applies tariffs on its imports, said Iris Pang, chief economist for Greater China at Dutch bank ING.

Under the rule, exports to the U.S. that are routed through more than one location will face tariffs based on the transaction price in the very first leg, she explained in a note last month.

"For example, when a Chinese exporter sells goods to a Hong Kong re-exporter at a lower price, then the Hong Kong re-exporter (eg, a subsidiary of the Mainland China company located in Hong Kong) sells at a higher price to a US importer, the tariff will be based on the first transaction," said Pang.

"As such, the tariff paid could be lowered when there is a throughput via Hong Kong," she added.

In 2018 — when a trade war broke out between Washington and Beijing — around 8% of mainland China's exports to the U.S. and about 6% of mainland China's imports from the U.S. were routed through Hong Kong, according to the territory's Trade and Industry Department.

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But Pang said the "first-sales rule" might not apply anymore if Hong Kong loses its so-called special status under American law. The U.S. treats the city as a separate customs territory from China, which allows Hong Kong certain privileges including exemptions from elevated tariffs that the U.S. imposed on China in the trade war.

U.S. Secretary of State Mike Pompeo declared last month that Hong Kong was no longer autonomous from China. Following that, President Donald Trump said he would begin taking steps to revoke the city's favored trade status with the U.S. — without providing details on precisely what the process entails.