For more than three decades, the world economy has become accustomed to China serving as the main contributor to global growth. During the 2008 crisis, the Chinese economy contributed to a third of global growth, while the US economy collapsed, as did the European Union due to its sovereign debt crisis.
As for Hong Kong, China has become increasingly important as source of growth, whether through the arrival of a huge number of visitors from the mainland or the very rapid development of its financial market. As for the former, the share of mainland visitors to Hong Kong has hovered around 77% of total visitors and reached a maximum of 51 million in 2018.
As a financial market, Hong Kong’s offshore center has grown both in terms of banking assets and its capital markets. In terms of portfolio flows, China has had a growing share of Hong Kong’s financing and investing activities. In 2020, 71% of mainland China’s inward FDI came through Hong Kong. The stock market in Hong Kong today is 3.5 times bigger than in 2008 and the corporate bond market has also boomed, both thanks to the increasingly relevant presence of Chinese institutions. With the expanded interconnection mechanisms, including Bond Connect and Swap Connect, capital flows should continue to grow between Hong Kong and mainland China.
The reality is that Hong Kong now confronts a different situation in the mainland than it did a decade and a half ago. The memory of China saving international markets has long passed. China’s economy started to slow down after experiencing peak growth in 2010 and even faster after 2015, due to excess supply, deflationary pressures and the collapse of the overall stock market. In 2016, as China’s economy started to recover, Trump came to power in the US and, with him, the trade war further slowed China’s growth. Finally, the Covid-19 pandemic and three years of zero-Covid policies weakened the Chinese economy even further, up to until the end of 2022.
Against this backdrop, 2023 was expected to be a wonderful year for the Chinese economy, as all mobility restrictions were lifted by the end of 2022. However, this has not been the case. In late 2022, high inflation in the rest of the world, fueled by high energy and food prices, had pushed central banks around the entire world to act aggressively, reaching interest levels not seen in decades. Such high interest rates were expected to bring the US and European economies to their knees, once again accelerating the convergence of growth between China and the West, as happened in 2008. This very favorable outlook for the Chinese economy led to strong capital inflows in the last few weeks of 2022 but only lasted until March 2023, when current data began to show that neither China’s consumption nor investment were recovering as expected.
A key problem has been the lack of confidence of Chinese consumers and investors, despite having emerged from the pandemic. On the consumer side, households have faced stagnating disposable income and very high youth unemployment. As for investors, they simply do not believe that demand will be there to justify their investment, especially in the real estate sector. As if this were not enough, even exports have begun to slow down very quickly, reaching negative double-digit growth in June and July. This is clearly worrying, as external demand was a major contributor to growth during most of the Covid pandemic and even into early 2023. The reason for this change of direction in Chinese exports is attributed by some to the weakness of the North American and European economies, but the reality is that Chinese exports into Southeast Asia, a region which is still growing fast, fell as much as Chinese exports to Europe (both down by 20% in July).
The heavy burden of Chinese public debt, especially that of local governments, and the persistent financial troubles of real estate developers have pushed the People’s Bank of China to increase the liquidity in the system by cutting the reserve requirement ratio and reducing interest rates. Both, together with the now negative portfolio flows into China, have weakened the yuan. Investors are waiting for China to announce a big fiscal stimulus, but it does not seem likely. By now, the worries are not only about growth and/or deflation but also about the systemic risk embedded in a deflating real estate bubble, especially for the financial sector.
A key question is how much the rest of the world, which has long benefited from China’s huge contribution to global growth, will suffer from its structural slowdown. If only for symmetry, one would tend to think that the global economy will suffer greatly, as the reverse happened in 2008 when China lifted global growth thanks to a massive stimulus. Instead, all signs to date suggest that China’s economy is far more isolated from the rest of the world than one might imagine, even though it is much larger now than it was in 2008. The reason for China’s smaller influence, at least so far, might be related to China’s self-reliance policies. By substituting imports for domestic production, China has been cutting imports for almost a decade, especially for industrial goods. This means that many exporters, especially those of industrial goods such as Germany, Korea and Japan, have become accustomed to the reality of a weaker demand from China for their products.
As for Hong Kong, the number of visitors from the mainland remains at 70% of the pre-pandemic level and is not fully back, which is a drag on growth. The financial sector is being hurt by heightened geopolitical risk but also by the difficult situation of the export sector in the mainland which has been hurting Guangdong province, as a key export engine generating 22% of total exports of the Mainland and, with it, 57% of the Greater Bay Area.
All in all, the Hong Kong economy is navigating complicated waters given the evolution of the economy in the mainland, which also has a bearing on the Greater Bay Area, a key project determining the future of the Hong Kong economy. Down the road, innovation will be key to mitigate structural deceleration in the mainland. Guangdong and the Greater Bay Area, as a whole, are very well placed within the mainland, to use innovation as a lever. However, some degree of structural deceleration seems unavoidable based on the experience of the past few years, even before Covid-19.
Alicia García Herrero is Chief Economist for Asia-Pacific at NATIXIS and Senior Fellow at the European think tank Bruegel, a non-resident senior fellow at the East Asian Institute of the National University of Singapore, an adjunct professor at the Hong Kong University of Science and Technology and an advisor to the Spanish government on economic affairs. She is an independent board member of AGEAS, the Brussels-based insurance group, a board member of the Center for Asia-Pacific Resilience and Innovation (CAPRI), a member of the advisory board of the Berlin-based Mercator Institute for China Studies (MERICS), an advisor to the Hong Kong Monetary Authority’s research arm (HKIMR) and a member of the Council of the Focused Ultrasound Foundation (FUF). She holds a PhD in economics from George Washington University and has published extensively in referreed journals and books.