Hong Kong protests: could a financial crisis be the jolt that brings the unrest to a halt?

While Hong Kong’s economy fell into a worse than expected recession last quarter, financial markets have remained resilient
A run on a major bank or a serious challenge to the currency peg might push Beijing, the Hong Kong government, protesters and ordinary Hongkongers to seek a resolution

Nicholas Spiro

Published: 6:30am, 5 Nov 2019

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It was the most widely anticipated piece of economic data. Yet, when it was finally published last week, even analysts were taken aback.

The news that Hong Kong’s economy fell into recession last quarter – the first contraction in output over two consecutive quarters in a decade – came as no surprise. What was not foreseen was the scale of the decline, with the city’s gross domestic product shrinking by a whopping 3.2 per cent quarter on quarter, far exceeding the 0.6 per cent fall forecast by analysts in a Bloomberg survey.

The figures, which are preliminary, were resoundingly bleak. In annualised terms, private consumption contracted 3.5 per cent, while investment plummeted 16.3 per cent. Exports also continued to shrink as the fallout from the US trade war and the slowdown in China’s economy took their toll.

However, as the government stressed in its press release, it was only after the mass protests erupted in early June that Hong Kong’s economy registered an “abrupt deterioration”. Make no mistake, the damage was mostly self-inflicted.

Still, some sense of perspective is in order. To claim, as one economist did in an interview with Bloomberg, that the downturn is “obviously comparable to the global financial crisis” is deeply misleading.

First, the contraction in output in Hong Kong at the end of 2008 and in early 2009 stemmed from severe stresses in the global financial system triggered by the demise of Lehman Brothers. Asset prices and interbank markets in the territory came under intense pressure, undermining confidence in an economy heavily reliant on trade and financial services. In 2008, the Hang Seng Index plunged almost 50 per cent.

The current downturn, by contrast, although exacerbated by the trade conflict, is mainly the result of a domestic shock caused by the protests, which have hammered Hong Kong’s tourism and retail industries. The external environment is incomparably safer than in 2008.

The world is awash with liquidity, the banking system is much more robust and asset prices are at elevated levels, with the benchmark S&P 500 index hitting a record high last week.

A far more accurate description of Hong Kong is that it has become a tale of two halves: a debilitating political crisis that has knocked the stuffing out of the economy and a resilient financial system, buttressed by large fiscal reserves and benefiting from ultra-cheap money globally.

It is noteworthy that there have been no significant capital outflows since the mass protests erupted. Indeed, as reported by the Post last week, Hong Kong dollar deposits even increased in September, while the Exchange Fund – the financial war chest used to defend the city’s exchange rate peg to the US dollar – rose to its highest level since April.

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What is more, the Hang Seng was up nearly 4 per cent in October, its best monthly performance since June. A revival in the market for initial public offerings, led by the US$5 billion listing in September of brewer Anheuser-Busch InBev’s Asia-Pacific unit, has further accentuated the disconnect between the contraction in economic output and the resilience of the financial system.

Still, while Hong Kong’s considerable financial buffers are helping prop up asset prices, the lack of any significant pressure from markets is, regrettably, exacerbating the political crisis.

Jan Craps, chief executive officer of Budweiser Brewing Company APAC Ltd (left) and Frank Wang, executive director, general counsel and joint company secretary, strike a gong during the company’s listing ceremony at the Hong Kong stock exchange on September 30. The Asia-Pacific beer unit of Anheuser-Busch InBev gained as much as 4.8 per cent on its Hong Kong trading debut. Photo: Bloomberg

To be sure, no sensible person would wish a financial crisis on Hong Kong. Moreover, it is unclear what impact such a calamity would have on the city’s deeply polarised political environment, and, crucially, what Beijing’s response would be. Yet, the absence of severe market pressure is helping fuel the conflict by depriving Hong Kong of a much-needed catalyst to break the cycle of ever-increasing violence.

A sharp fall in the Hang Seng last quarter and downgrades from Fitch and Moody’s – which still leave Hong Kong’s credit rating firmly in upper-investment-grade territory – are not going to make the protesters think twice about challenging the government. Neither are they sufficient for public opinion to turn decisively against the activists.

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However, a sudden run on one of the city’s large banks, or a serious challenge to the peg, could change the dynamics of the crisis, significantly increasing the cost of further unrest and putting the protesters, the government and Beijing under more pressure – domestically and internationally – to ease tensions.

Right now, the stability of the financial system is emboldening the protesters, especially the militant ones, to dig in their heels. It has also reduced pressure on the government to meet their core demands by making it easier for it to claim that its hands are tied by Beijing.

China, for its part, is more inclined to let the conflict play itself out in the hope that ordinary Hongkongers will reach a point where they have had enough of the violence and chaos.

The fact that Hong Kong’s financial system has been largely insulated from the unrest is a testament to the strength of the city’s creditworthiness. Yet, the relative calm in markets does not make a resolution of the crisis any easier.

Nicholas Spiro is a partner at Lauressa Advisory

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