Hong Kong's Role As China's Wall Street

In the months leading up to the hand-over of Hong Kong from Britain to China, pundits wrote column after column warning that after July 1 the vibrancy that characterized Hong Kong would leach away, quickly transforming the city into a gray, drab enclave. Only a little more than a month has passed since that historic day, but if the month of July is any indication of what is to come for Hong Kong, the editorialists were way off the mark.

Not only did investors not flee, they have entered the market in droves, especially US mutual funds. They are recognizing a new paradigm: Hong Kong as a Chinese market. Consider the performance of Hong Kong's stock market after the handover. The Hang Seng Index surged more than 7 percent in just one month, outpacing even Wall Street. Hong Kong's pole position as the direct gateway to China makes it more valuable post-handover, rather than less.

Indispensable to China

The truth is, China needs Hong Kong as much as the United States needs Wall Street. More than 70 percent of China's annual imports and exports, which now total more than $300 billion, go through Hong Kong. Last year, foreign direct investment into China was $42 billion, but 60 percent of that came from Hong Kong companies. Over 70 large Chinese corporations now have regional headquarters in Hong Kong; and Chinese companies have invested well over $30 billion in the territory.

While Shenzhen's and Shanghai's stock exchanges have experienced strong growth, they still represent a fraction of the size of the Hong Kong market. Combined Shenzhen and Shanghai have a turnover of $3.2 billion, with a combined market capitalization of only $118 billion and almost no experience with convertible currencies. But Hong Kong, with its world-class infrastructure and reputation as a free-trade zone, boasts a total market capitalization of approximately $550 billion.

Hong Kong as comprador

Hong Kong is reverting back to its age-old role as comprador, the agent best placed to develop China's links to the global financial community, and to help it develop, in the process, its own capital market structure. Since Deng took power in 1979, China has tried various forms of privatization that have had an important - if not an altogether sweeping - effect on the economy. Evidence of China's efforts to privatize over the last 18 years can be seen in various sectors of the economy, particularly in banking and finance. We are now seeing the first private banks appear in China. And, by the end of this decade, China should have a convertible currency, several private banks with branch networks, and several foreign banks in place at the wholesale and perhaps retail level. By 2005, this nascent financial network should be robust enough to help finance China's growth.

Yet, as China pursues more open-market reforms, it still must find a way to employ 75 million new workers every four years - an annual increase nearly equivalent to the total US work force. More rapid privatization will be key to fulfilling this mandate. In all likelihood, it will take another 10 years for the private sector to grow sufficiently to provide new jobs not only for entrants to the labor pool, but also for workers from retrenched state-owned enterprises, whose employees currently total 100 million.

Selling China's assets

The process of privatization is just beginning. Of the estimated $500 billion in government-owned assets that need to be sold, only a fraction have been offered to the public markets. Most of these offerings, known as Red Chips or H shares, have been listed in Hong Kong, one of the world's largest and freest capital markets and China's natural ally in its historic transformation.

Due in part to regulatory differences, New York and Tokyo are not yet natural markets for Chinese shares, and Taiwan remains both politically sensitive for China and difficult for foreign investors. So, as Hong Kong and China become more fully integrated, and as the pace of its own modernization hastens, China will turn increasingly to Hong Kong for the funding and management expertise so critical to its modernization. Hong Kong has always had a way of leveraging change.

Despite the political wrangling, the territory has been getting on with what it knows best. Since 1984, when the joint declaration to hand Hong Kong over to China was announced, its economy has trebled and the stock market has risen more than 15 fold. The process of commercial change in the Hong Kong market has been one of evolution, not dislocation related to one particular date.

While Hong Kong's vibrant commercial environment is certainly critical for China's continuing development, the mainland's interests in leveraging Hong Kong's expertise has always been - and will continue to be - key to Hong Kong's success. By formalizing their existing relationship and expanding Hong Kong's role as China's Wall Street, the handover allows China and Hong Kong to be single-minded in their achievement of a common goal: to create an economic environment strong enough to allow the population of greater China to focus on life, personal enrichment, and the pursuit of happiness.

* Gary Greenberg is executive director and chief investment officer of Peregrine Asset Management, based in Hong Kong.