What's in store for Hong Kong?

It's a done deal: Hong Kong is part of China again. Read what to expect in the next few years.

With the handover of Hong Kong to China finally completed, the frenzy of speculation over potential repercussions to the regional business environment can finally subside. It is not that such speculation was misplaced. With any geopolitical change of such magnitude, it is rational to ponder potential changes, both anticipated and unforeseen. What does seem misplaced is the prevailing assumption that the change will somehow unleash chilling forces that will inevitably restrain the region's burgeoning businesses. So far, there are few signs of those forces, and they are not likely to cause significant problems for business, either in the short term or the long term. While the months leading up to the handover saw some instances of government involvement in business, in each case, the government backed off, and Hong Kong's regulatory structure remained intact.

Consider, for example, the flap this spring concerning initial public offerings (IPOs) on the Hong Kong Stock Exchange. While mainland China now has many public companies listed on its two stock exchanges, Beijing's regulatory priorities are somewhat more restrictive than those of the Hong Kong Stock Exchange. Earlier this year some mainland officials expressed dismay that companies were going public on the island's exchange without seeking Beijing's approval. There were even comments that one particular flotation would have to stop until Beijing worked with the local authorities to sort things out. But after reconsidering the situation at a higher level, the government realized it had nothing to gain by interfering and permitted the IPO to continue.

On the other hand, many critics do not accept the premise that the mainland government will follow through with its hands-off policy on Hong Kong business activities, citing the highly publicized McDonald's Beijing franchise affair in 1995. McDonald's had a very successful franchise in one of the most desirable locations in Beijing. As reported in the business press, the company's lease on the property was broken and the business shuttered. The local government had "rezoned" the neighborhood in favor of a large development.

However, thanks to McDonald's international profile and a savvy public relations strategy highlighting the government's perceived capriciousness, the company was able to secure an alternative property on presumably attractive terms. By all accounts, the company is flourishing in China and now has 35 restaurants in Beijing. But this does show companies need to be very wary of the complexities of the Chinese legal system. If your company lacks experience in China, consider a joint venture with a Chinese firm that can guide you through Chinese laws and regulations, as well as the government approval process.

A more serious concern is that a few Chinese companies have been able to buy shares in Hong Kong blue-chip securities at below-market prices. Last year, a Chinese company bought shares of Dragon Air, a subsidiary of Cathay Pacific, at a discount. More recently, Cable and Wireless, a British company, sold shares of Hong Kong Telecom at a discount to a Chinese company. But there was a tradeoff involved: an understanding that Hong Kong Telecom would receive increased access to the Chinese market.

In this case, the Hong Kong company was "paying" for improved access to the Chinese market. It seems likely that such instances will be limited to large, highly visible Hong Kong companies and will be less frequent as overall Chinese trade barriers drop. They do demonstrate that the Chinese government expects foreign companies to make concessions to gain access to the market, either in terms of capital or technology. Boeing and McDonnell Douglas, for example, both committed to sharing technology and locating assembly and manufacturing plants in China. But despite these examples of government involvement, China is unlikely to significantly dilute the regulatory underpinnings that have made Hong Kong Asia's leading dynamo.

LOCATION, LOCATION

Many companies have also been trying to decide whether they should continue to think of Hong Kong as their focus for doing business in China. Historically, foreign companies have entered China through Hong Kong because they simply couldn't do it any other way. Right now, Hong Kong is superior in infrastructure and services to any mainland city. Shanghai's port is slightly bigger in terms of tonnage, but Hong Kong ships 10 times more in containerized goods, and its airport handles four times the number of passengers. And while Shanghai has about twice the population of Hong Kong, it employs only about 15 percent of the finance professionals Hong Kong does. But Shanghai is bursting with growth and will close these gaps before long. In recent months, the daily volume traded on the Shanghai and Shenzen stock exchanges on some days has been more than $2 billion, eclipsing the dollar value traded on the Hong Kong Exchange.

Even as recently as five years ago, it made sense for a company to gain access to the Chinese market through a Hong Kong office, but clearly the choice is now more complex. For financial companies, the sources of expertise in the financial industry are still superior in Hong Kong, but in most other industries, Hong Kong does not necessarily offer more advantages than Shanghai. For example, comparable accounting, consulting and legal services are available in Shanghai and Beijing - even from the same Western firms. And for manufacturers, land and labor are cheaper in China than in Hong Kong or its neighboring province, Guangdong. By almost all considerations, Hong Kong now is better justified as an Asia-Pacific headquarters than as a window to the mainland. In fact, more than 70 large Chinese companies now use Hong Kong for their regional headquarters!

For many companies that already have operations in Hong Kong, the questions linger: Just how serious is China toward maintaining its free-market policies, and how much freedom will it permit Hong Kong? The government has gone a long way toward demonstrating its resolve. As China has reformed its financial sector, it has been nurturing the underlying health of its currency and banking system. At the same time, the central bank's foreign reserves have become very substantial, totaling more than $100 billion. These efforts have not gone unnoticed by the international financial ratings community: China bonds were recently upgraded to BBB+ by Standard & Poor's.

The cultural climate is also changing, reflecting an ongoing Westernization of Chinese business practices. Everyone wears Western suits and hands out business cards. Titles and positions in corporate or bureaucratic hierarchies are gradually becoming more clear. More importantly, many Chinese companies list shares on the Chinese stock exchanges, and they are learning accountability to shareholders. International accounting standards are required for all listed companies, and Beijing has announced plans to license foreign accounting firms. The government has also stated it wants all the large state-owned firms to accede to these practices by the year 2000.

The government is attempting to address lifestyle issues for Western businesses, too. Recently, China announced an 800-unit housing development will be built in ShanghaI for foreign business people and their families. Each house will be constructed with the amenities an executive would expect to find in lodging in Stamford, Conn., or Shaker Heights, Ohio. The development will be served by a special school system, a water treatment plant, a hospital and a shopping mall.

These developments suggest the Chinese government has shown an ability to accommodate tremendous growth in commerce and to address the concerns of Western businesses. Therefore, it is very unlikely American companies will find it any more difficult to do business in Hong Kong than they did before July 1.

That is not to say companies will not see some subtle changes in a few years. For example, the Hong Kong currency is now tied to the U.S. dollar. Perhaps in a number of years, when the Chinese government is convinced its efforts to stabilize its currency have succeeded, it will be more closely linked to the yuan. Such linkage makes sense for business efficiencies within the region.

The last several years have demonstrated that China is on a clear course to be a huge market and trading nation in the next century. In a few years' time, the absorption of Hong Kong into its swelling headwaters will be remembered as merely a ripple.

For More Information ...

* FEI's 66th Annual Conference will include a presentation by Chas. W. Freeman Jr., co-chairman of the U.S. China Policy Foundation and chairman of Projects International. Ambassador Freeman will offer his insights into Asian business practices and analyze how economic trends in Asia will affect the rest of the world.

The conference takes place Oct. 15-18, 1997, at the Fairmont Hotel in San Francisco. Call FEI's conference department at [phone] for more information.

* The China Analyst: China, Hong Kong and Taiwan

An independent monthly forecast and analysis of economic conditions and an assessment of investment opportunities and risks. Published by the Bank Credit Analyst Research Group in Montreal, Canada; phone [phone]; fax [phone].

Mr. Jan Van Eck is emerging markets strategist at Van Eck Global in New York. Van Eck Global recently entered a joint venture with Shanghai-based Shenyin & Wanguo Securities to create a fund management company in Hong Kong. You can reach Van Eck at [phone].