BOFIT Viikkokatsaus / BOFIT Weekly 2017/27

July 1 marked the 20th anniversary of Great Britain's return of the Hong Kong special administrative region (SAR) to China. Since then, the Hong Kong economy has become increasingly intertwined with the mainland economy. Territory's importance has diminished, however, as China has an increasing number of cities with over one million that now compete with Hong Kong. In 1997, Hong Kong's GDP was equivalent to about 20 % of China's GDP. It is just 3 % today.

Nevertheless, Hong Kong remains the main economic link between mainland China and the rest of the world. The Hong Kong economy is dominated by logistics and finance, and in both areas mainland is the main counterpart. A quarter of all China's exports went through Hong Kong 20 years ago, and today still over 10 % of Chinese exports pass through Hong Kong. The territory's role with China increasingly involves provision of financial services. Hong Kong provides foreign entities controlled access to mainland China's financial markets and China uses Hong Kong as a test lab for economic reforms and to encourage international use of the yuan. China has tightened capital controls in recent years, causing yuan deposits in Hong Kong to fall by 50 % between January 2015 and March 2017. The share of the yuan in bilateral trade payments between mainland and the SAR has also declined.

The integration of Hong Kong with China continues. Credit ratings giant Moody's characterises Hong Kong's economic, financial and political connections with the mainland as "close and tightening." Not surprisingly, China's credit downgrade in May led to a similar downgrade in Hong Kong's credit rating immediately. The Hong Kong Monetary Authority estimated in March 2017 that 28 % of Hong Kong borrowing originated from China and 26 % of loans granted by Hong Kong banks to foreigners went to mainland Chinese entities. Shares listed on the Shanghai or Shenzhen stocks exchanges can now be traded via the Hong Kong stock exchange as part of the Stock Connect arrangement.

The business environment for foreign firms in Hong Kong has recently suffered from political uncertainty, particularly China's efforts to interfere with its politically independent judiciary. The Heritage Foundation has continuously listed Hong Kong as the freest place in the world to do business after the SAR return to China. The erosion of judicial independence, however, has made firms wary. Young people in Hong Kong also have become more hostile in their views of mainland China, which is reflected in the growing popularity of democracy and independence movements.