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HK protests set to stress-test China’s priorities

China wants more foreign investment but this ambition could be crippled if it chooses the Tiananmen path in Hong Kong.
HK protests set to stress-test China’s priorities

There was a cold rationale behind China’s top leaders authorising its military to violently crush pro-democracy protestors in Tiananmen Square on July 4, 1989: no cost was too high to maintain control.

Hundreds (possibly thousands) were killed, and the international backlash was so severe that China’s rulers have attempted to internally suppress all mention of the massacre ever since. Instead, they prioritised improving the country’s economy to justify their vice-hold on power and stifle dissent.

It has been a very successful strategy. The World Bank notes that China’s export-and-investment-fuelled industrialisation drive, which began in 1978, has raised over 850 million Chinese people out of poverty. It's led the country to build the world’s second-largest economy.

But over the past decade China’s approach to growth has come under strain, courtesy of rising wages, an ageing population and a massive expansion in debt. So President Xi Jinping and his administration have encouraged more consumption among its expanding middle class instead.

One consequence of that has been that China’s current account surplus has shrunk and could yet slip into deficit – potentially even this year.

To counteract this, the country needs higher foreign capital inflows, which explains its decision to slowly let more foreign investors and asset managers participate in its capital markets and in its investment industry. Most recently, Beijing said it would accelerate the timetable for foreign fund houses to wholly own local fund operations to 2020.

TENSIONS ARISING

Two factors now threaten to choke China’s burgeoning appetite for financial liberalisation.  

First is the trade war with the US, the world's biggest economy.

For almost two decades China has benefited from being a member of the World Trade Organisation while employing non-tariff barriers at home. In the eyes of some of its rivals, that helped it to game the global capitalist system to take a great leap forward. 

Hence, many foreign companies that partnered with mainland firms to enter the country say they had their intellectual property purloined, while many now-leading Chinese technology companies began by effectively copying the business models and products of international rivals.

That intellectual property and copyright theft was named as a key reason why the US government of Donald Trump placed tariffs on approximately $250 billion of Chinese exports to the US. The country is being called out as a cheat and an adversary by the US at exactly the time it wants more foreign investment.

The second threat lies closer to home: the increasingly unruly protests taking place in Hong Kong.

Protests in the city began became really noteworthy in June, when around 1 million people and then 2 million took to the streets over subsequent weekends to protest a proposed extradition bill that would have allowed the Hong Kong government to hand over people that China had said broke its laws.

AsianInvestor and others have previously warned that this legislation would damage the city’s status as an international financial centre. 

The Hong Kong’s government’s incompetence has exacerbated tensions. Chief executive Carrie Lam has refused to withdraw the original legislation, spurring more protests and rising violence. That included an assault on some homebound protestors by armed gangs that the police seemed strangely slow to respond to on July 21.

Further enraged, protestors now include an investigation into police actions and free elections among their demands (35 of Hong Kong’s 70-member legislative council are picked from generally pro-China business sectors).

It’s caused a headache for Beijing. The ruling Communist Party instinctively fears mass protests, especially for democracy, and yet under the city’s One Country, Two Systems agreement, Hong Kong is meant to be largely autonomous when it comes to local rule.

However, there are signs that Beijing won’t remain on the sidelines for long. On Wednesday, the commander of the People’s Liberation Army (PLA) garrison in Hong Kong declared that the army was “determined to protect national sovereignty, security, stability and the prosperity of Hong Kong”.

Beijing no doubt knows it would be a dangerous escalation to deploy Chinese soldiers for the first time on Hong Kong’s streets. Doing so would effectively shred any pretence that it continues to respect the One Country, Two Systems agreement. It could also result in fatalities – offering a distressing parallel to the Tiananmen Square massacre of 1989.

FOREIGN REACTIONS

A troop deployment, violent or not, would also pressurise foreign governments and investors to react, despite Trump's apparent reluctance while trade talks are ongoing.

It’s entirely possible that the US would use such an escalation to strip Hong Kong of its special status as a trading partner, while further raising tariffs on China. It could even seek to deploy sanctions. Needless to say, the flow of foreign capital that Beijing is so eager to encourage would also suffer – with potential consequences for the country's economic stability.

Thirty years ago, the Communist Party had to choose between making concessions to peaceful protestors or paying a butcher’s bill to ensure it maintained control. It chose the latter.

Today China depends a lot more on foreign goodwill and capital inflows. But will this need be enough to quell its instinctive desire to suppress dissent? Hong Kong appears set to find out over the coming weeks and months. 

Investors interested in the strategies of China’s asset owners can learn more at AsianInvestor's 6th Institutional Investment Forum China, to be held on September 18th in Bejing. Please click here for more details. 

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