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Hong Kong: Country and Foreign Investment

Economy and Currency

Hong Kong's economic success story is inextricably linked up with China, although the decisive factor forcing the transition from a trading to an industrial territory was the Korean war in 1950 and the subsequent United Nations embargo on China to which Hong Kong adhered. Hong Kong's role had historically been that of both an entrepot for trade and point of contact between China and the West. Today the territory is the crowded entry point to the Asia Pacific region and offers unique access to the fastest growing economy and the biggest potential market in the world, the People's Republic of China.

The government's policy is strictly non-interventionist. Subsidies and protection from competing imports are virtually non-existent. Hong Kong does not retaliate against countries that impose trade restrictions on its exports. The territory's biggest asset is its non-discriminatory low tax regime, a model fiscal system to which other jurisdictions should aspire.

Statistics alone give an impressive view of Hong Kong's economic future. Although the territory's population is 7m people it nonetheless ranks as the world's 3rd largest financial center (after New York and London) the 9th largest economy and the 11th largest exporter of services. Growth rates in the 30 years preceding the onset of the Asian economic crisis in 1997 averaged 7% culminating in GDP per capita exceeding that of Britain, Canada and Australia.

At the time of writing, the external assets of the banking sector are the world's 5th largest, forex turnover is the world's 6th largest and the Hong Kong stock market has the largest market capitalization in Asia outside of Japan. The territory has the largest representation of international banks in the world including 80 of the top 100 institutions and is the regional headquarters of over 1,300 multinational companies.

Since 1992 the territory has had the world's busiest container port with throughput increases of up to 20% per annum. Its shipping register is considered a quality register and ranks 14th in the world. In 2011 Hong Kong airport's passenger and cargo volume reached 53 million people and 3.9 million tonnes, respectively. In July 2012, the airport set a new monthly record when it handled more than five million passengers and 29,880 aircraft movements.

The insurance industry is substantial and growing. In 2010, total gross premiums of the Hong Kong insurance industry increased by 11% to HKD205bn, representing about 11.8% of Hong Kong's GDP. Recent initiatives have promoted the reinsurance sector and introduced captive insurance. The insurance industry has registered double digit growth for nearly a decade.

Hong Kong is also a major transshipment and re-export center, activities which in turn lead to continued strong demand for trade support services such as banking, finance and shipping. Other industries include the manufacture of garments, textiles, electronics and toys, ship-building & repair, cement, steel rolling and the export and processing of fish and fish products.

Economic growth has see-sawed somewhat since the Asian financial crisis of the late 1990s, but the SAR's economic performance improved rapidly in 2005, with GDP rising 7.3% in the year.

The economy continued to expand briskly in 2007, when GDP grew by 6.4%. Financial services recorded a spectacular performance, while many business and professional services also held up well. Exports of services continued to show distinct growth underpinned by the surge in offshore trade, buoyant financial market activities, and sustained expansion of inbound tourism. Domestically, private consumption expenditure rose supported by rising income, better job prospects and improved financial positions of households. Overall investment spending growth picked up to a strong 11.1% in real terms. Investment in equipment and machinery re-accelerated to double-digit growth amid strong business confidence, while construction and building activity saw a notable rebound, albeit from a low base.

However, not even Hong Kong's dynamic economy could escape the economic fall-out from the credit crunch, and growth slowed to 2.2% in 2008, before the economy shrank by 2.7% in 2009. The economy rebounded sharply in 2010, by 6.8%. Growth slowed to 5% in 2011. GDP growth in the first quarter of 2012 was 3.2%. The International Monetary Fund expects the Hong Kong economy to grow by 4% in 2012 as a whole.

Low Taxes Enshrined In Basic Law

During the negotiations preceding the handover of the territory in 1997 it was agreed that Hong Kong would be allowed to maintain an independent taxation system in which China would not interfere and these rights are incorporated into articles 106-8 of the Basic Law. Furthermore article 116 of the Basic Law guarantees that the territory will remain a free port and a separate customs area from the mainland.

The financial center compares very favorably with other regional financial centers such as Australia, Malaysia, Singapore and Labuan. Hong Kong does not offer the discriminatory tax breaks available through Singapore's "Operational Headquarters and Pioneer Status" corporate products, Malaysia's "Free Trade Zone" facilities and Thailand's "Industrial Estates" policy. Nor has it had to follow Malaysia in setting up a separate financial center in Labuan with a view to compensating for the negative impact burdensome local taxes on inward foreign investment.

With businesses and individuals paying a maximum of 16.5% and 15% tax respectively, it is not surprising that the territory has become a favorite destination for foreign investors. Low tax rates are further complemented by a policy of only taxing Hong Kong-source income, generous deductible allowances and above all the complete absence of withholding tax, interest tax, capital gains tax and VAT thereby making the territory the ideal location for companies engaged in financial services.

The World's Freest Economy

In 2012, the Heritage Foundation’s annual ‘Index of Economic Freedom’, covering 179 countries, ranked Hong Kong as the world’s freest economy for the 18th consecutive year.

Hong Kong scored a rating of 89.9 in the index, well above the world average of 59.5. Of the 10 economic freedom factors assessed, Hong Kong ranked first in financial and trade freedom, second in investment freedom and property rights, and third in business and monetary freedom.

The Heritage Foundation recognized Hong Kong’s sound fiscal management, which helped the city weather the global economic downturn. It further complimented Hong Kong for its effective legal and regulatory frameworks and openness to global commerce, while the city’s overall macroeconomic stability was said to minimize uncertainty.

It said Hong Kong has maintained its status as Asia’s second-largest destination for foreign direct investment, trailing only Mainland China. It also noted Hong Kong’s economic interaction with the Mainland has become more intense and sophisticated, chiefly through strengthened financial linkages.

Welcoming the Heritage Foundation’s high regard for Hong Kong, the government said that it is determined to uphold economic freedom in the city, which it considers to be the cornerstone of sustained economic stability, growth and prosperity. It added that it sees its role as that of a market facilitator to provide a business-friendly environment, with an appropriate regulatory regime to ensure the integrity and smooth functioning of a free market. Its strategy is to remove impediments to industries tapping into new markets, and will adhere to the 'big market, small government' principle.

From Deficit to Surplus

The SAR's overall fiscal situation deteriorated sharply in 2001 and 2002, with continuing deflation accompanied by very low growth, and a ballooning budget deficit, which the government had to admit in 2002 was becoming structural. Then Chief Executive Tung Wha-Chung ruled out the introduction of a sales tax or other new taxes in 2002 but vowed to balance the books in the course of three to five years. The SAR's budget for 2003/2004 introduced increases in personal and business taxation, cuts in public expenditure including civil service pay, and a programme of disposals of public assets.

In October, 2003, Financial Secretary Henry Tang raised the government's budget deficit forecast to a record HKD100 billion (US$12.93 billion) pushing back the government's target for eliminating the deficit by two years to 2008/2009. Strong economic growth, however, meant that in July, 2006, the Hong Kong government announced that a HKD14 billion surplus was recorded for the 2005-06 financial year, an improvement of HKD9.9 billion over the revised estimate of HKD4.1 billion announced in the 2006-07 Budget.

In November 2010, Fitch Ratings announced its decision to upgrade Hong Kong’s long-term foreign-currency sovereign rating to "AA+" from "AA", with a "stable" outlook. Fitch attributed the upgrade to the fact that “Hong Kong's sovereign creditworthiness is underpinned by its strong external financial position, solid public finances, well-regulated and capitalized banking system, its dynamic and flexible economy and strong standards of governance.” It added that “Hong Kong's low-tax and small-government economic model contributes to overall economic flexibility,” and that its “solid fiscal position underpins its creditworthiness.”

This was followed by another ratings upgrade in December, by Standard and Poor's, which was also took note of Hong Kong's large net external creditor position, the government's accumulated fiscal reserves, and the above-average growth potential for a high income economy.

Government expenditure and revenue for the year ending March 31, 2012, was HKD364bn and HKD437.7bn, resulting in a surplus of HKD73.7bn, HKD7bn higher than the government's revised estimate. Fiscal reserves stood at HKD669.1bn.

Revenue was HKD4.6bn higher than expected, largely as a result of higher receipts of stamp duties and land premiums. Expenditure was HKD2.4bn lower than forecast for the revised estimate mainly due to lower requirements.

The Hong Kong/China Closer Economic Partnership Arrangement

The Closer Economic Partnership Arrangement (CEPA) between Hong Kong and the Chinese mainland has brought considerable benefits to both business enterprises and the Hong Kong economy as a whole.

The CEPA is an ongoing project and dozens of goods and services traded between Hong Kong and mainland China have been liberalized since 2004. After signing the first CEPA agreement in June 2003 for implementation in 2004, the Central and Hong Kong governments have signed several yearly Supplements, with the ninth phase of CEPA liberalisation measures by virtue of Supplement IX due to be implemented in January 2013. Including the measures in Supplement IX, the two sides have so far announced 338 liberalization measures in 48 service sectors. The number of goods eligible for CEPA’s tariff-free treatment has expanded from 273 on January 1, 2003, to over 1,600 in 2012.

Supplement IX was signed on June 29, 2012, by Hong Kong’s Financial Secretary, John C Tsang, and the Chinese Vice-Minister of Commerce, Jiang Yaoping, and provides for a total of 43 services liberalization and trade and investment facilitation measures, strengthens co-operation in areas of finance, trade and investment facilitation, and further promotes the mutual recognition of professional qualifications in the two places.

Under Supplement IX, market access conditions will be further relaxed in 21 existing sectors, including legal, accounting, construction, medical services, computer and related services, placement and supply services of personnel, printing, telecommunications, audiovisual, distribution, banking and securities, and tourism.

In addition, in banking and securities, Hong Kong banks will now be permitted to offer custodian services regarding settlement funds of customers of securities companies and margin deposits on futures transactions; and Hong Kong securities companies that satisfy the qualification requirements as foreign shareholders of foreign-invested securities companies, and Mainland securities companies that satisfy the requirements for establishing subsidiaries, will be allowed to set up equity joint venture securities investment advisory companies on the Mainland.

With regard to financial co-operation under the new Supplement, the Mainland will amend and improve the relevant requirements for overseas listing to support Mainland enterprises that satisfy Hong Kong's listing requirements in listing in Hong Kong, and create favourable conditions for Mainland enterprises, especially small- and medium-sized enterprises, to raise capital through direct listing in overseas markets.

Furthermore, the Chinese government will actively explore ways and means to deepen co-operation between the commodity futures markets on the Mainland and in Hong Kong, to lower the eligibility requirements for Hong Kong's financial institutions to apply for Qualified Foreign Institutional Investor status in order to facilitate Hong Kong's long-term capital investing in the Mainland's capital markets, and to support qualified Hong Kong financial institutions in setting up fund management companies and futures companies on the Mainland.

The Gateway To China and Asia-Pac

While the economy has ebbed and flowed, business interest in the SAR has remained high and Hong Kong has become a favoured location for the Asian operations of multinational businesses, particularly those looking for a springboard into China. Hong Kong is also providing the platform from which Chinese firms are accessing global markets.

By June 2011, the total number of foreign parent companies with operations in Hong Kong had reached 6,948 companies, a 5.9% increase from 2010. Within that total, the number of regional headquarters was 1,340, an increase of 4.3%.

Director-General of Investment Promotion, Simon Galpin, said: "Hong Kong is the perfect base from which to access Mainland China. At the same time, Mainland companies are also using Hong Kong as a springboard from which to go global."

With regard to the country of origin, roughly half of the parent companies come from four countries. The United States tops the list with a total of 1,328 businesses operating in Hong Kong, followed by Japan with 1,150, Mainland China with 805 and the United Kingdom with 562.

The major lines of business were mainly import/export trade, wholesale and retail; financing and banking; professional, business and education services; and transportation, storage and courier services.

In the survey, when choosing a location to set up such businesses, the top five factors rated by their parent companies as most important include a simple tax system and low tax rate, the free flow of information, a corruption-free government, political stability and security, and optimal communication, transport and other infrastructure.

Mainland China is the largest source of Hong Kong's external factor income inflow, recently accounting for about one-third. The British Virgin Islands has the second largest share at about 20%. Other major sources are the UK and the US.

The Mainland and British Virgin Islands have also been the most important destinations for Hong Kong's external factor income outflow in recent years, with other major destinations including the US and the Netherlands.

Hong Kong continues to be the largest external investor in the Mainland. Hong Kong's Mainland investment concentrates largely in Guangdong where industrial investment, primarily outward processing arrangements, still predominates. Nevertheless, over the years, Hong Kong businessmen have extended the scope of their investment from industrial processing to other sectors such as hotels and tourist-related services, real estate, retail trade, infrastructural construction and various business and communications services.

Hong Kong has maintained large flows of foreign direct investment (FDI) in recent years, despite the weak economic climate. According to the United Nations Conference on Trade and Development's (UNCTAD) World Investment Report 2012 (WIR) 2012, FDI flows into Hong Kong exceeded US$83bn in 2011, an all-time high and up by 17% over 2010. FDI stock remained stable at US$1.14 trillion compared with US$1.09 trillion in 2010.

Globally, Hong Kong ranked fourth in terms of FDI inflows, after the US (US$227bn), the Mainland (US$124bn) and Belgium (US$89bn). The city also topped UNCTAD's Global FDI Attraction Index 2011 with "an attractive investment climate and important hinterland". The Index is an annual measure of an economy's success in attracting FDI.


The official currency is the Hong Kong dollar (HKD) which is pegged to the United States dollar at a rate of US$1 = HKD7.75 to HKD7.85 under the Linked Exchange Rate system (LERS).

In June 2012, the Hong Kong government published a statement confirming that it considers that the LERS should not be changed because, since its implementation in 1983, it has been the cornerstone of Hong Kong's monetary, financial and economic stability.

The Financial Secretary, John C Tsang, pointed out that "the link has served Hong Kong well over the years. The link is still the most appropriate system for Hong Kong as a small and open economy and an international financial centre. The government is fully committed to maintaining the LERS of Hong Kong. There is no need for a change and the Government will not change it."

The HKMA’s Chief Executive, Norman Chan, noted that "the HKMA has conducted detailed studies and analyses on various views on the LERS. Our conclusion remains that the LERS is still the most appropriate system for Hong Kong. Hong Kong has weathered well and shown its resilience in the global financial crisis in 2008. The new uncertainties and potential shocks facing the world economy and financial system as brought about by the eurozone debt crisis underscore once again the importance of monetary and financial stability. The HKMA considers that the link should not be changed."

In time however, it is possible that the Hong Kong dollar will gravitate towards the Chinese currency, the renminbi. Although the RMB is not yet fully convertible, China's State Council has eased restrictions on the trading of the Chinese currency in Hong Kong in a number of ways in recent years, allowing Hong Kong to become a platform for offshore RMB businesses including RMB trade settlement services, bank financing, bond issuance and wealth management.

Under a pilot scheme announced in April 2009, Hong Kong importers are allowed to settle direct import trades from the Mainland in renminbi. In December 2010, the People's Bank of China and the relevant Mainland authorities announced that the list of Mainland enterprises that can settle merchandise exports in renminbi had swelled to 67,359 - up from just 365.

Initially, the trade settlement scheme allowed business in five Chinese cities - Shanghai, Shenzhen, Guangzhou, Zhuhai and Dongguan - trading with businesses in Hong Kong and Macau to settle trades in the renminbi. In March 2011, China's State Administration of Foreign Exchange indicated that it would extend the trial of yuan-denominated cross-border trade settlement to all cities in China by the end of the year. These settlements reached a total of more than RMB506bn (US$77bn) in 2010 and almost RMB1 trillion by the end of 2011. By the end of 2010, more than 67,000 Chinese companies had joined the yuan settlement programme.

Financial institutions in the Mainland can now issue renminbi financial bonds in Hong Kong. The first renminbi bond issue took place in 2007. Then, in August 2010, the People's Bank of China announced that eligible institutions outside the Mainland could take part in a pilot scheme to make use of their renminbi (RMB) funds to invest in the Mainland's interbank bond market. Other recent RMB liberalization initiatives have included the RMB Qualified Foreign Institutional Investor (RQFII) scheme for qualified Chinese fund managers and securities companies, to allow their Hong Kong subsidiaries to channel RMB raised in Hong Kong to invest directly in the China bond and equity markets (including the inter-bank bond market and the exchange-traded bond market). RMB currency futures, designed to provide a way for investors to hedge RMB exposure, is for launch in the third quarter of 2012.



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