Identifier
Created
Classification
Origin
07HONGKONG1579
2007-06-13 01:31:00
CONFIDENTIAL
Consulate Hong Kong
Cable title:  

HKSAR - AFTER THE FIRST DECADE: ECONOMIC OUTLOOK

Tags:  ECON ETRD PGOV PHUM PINR PREL SOCI EWWT SENV 
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VZCZCXRO3367
PP RUEHCN RUEHGH RUEHVC
DE RUEHHK #1579/01 1640131
ZNY CCCCC ZZH
P 130131Z JUN 07
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC PRIORITY 1923
INFO RUEHOO/CHINA POSTS COLLECTIVE PRIORITY
RHEHNSC/NSC WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RULSDMK/DEPT OF TRANSPORTATION WASHDC PRIORITY
RHMFISS/DEPT OF HOMELAND SECURITY WASHINGTON DC PRIORITY
RHMFISS/DEPT OF ENERGY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
C O N F I D E N T I A L SECTION 01 OF 06 HONG KONG 001579 

SIPDIS

SIPDIS

STATE FOR EAP, EAP/CM
NSC FOR TONG/WILDER

E.O. 12958: DECL: 06/12/2032
TAGS: ECON ETRD PGOV PHUM PINR PREL SOCI EWWT SENV
KIPR, TBIO, CH, HK, MC
SUBJECT: HKSAR - AFTER THE FIRST DECADE: ECONOMIC OUTLOOK

REF: HONG KONG 1551

Classified By: Acting Deputy Principal Officer Laurent
Charbonnet, Reasons 1.4 (b, d)

C O N F I D E N T I A L SECTION 01 OF 06 HONG KONG 001579

SIPDIS

SIPDIS

STATE FOR EAP, EAP/CM
NSC FOR TONG/WILDER

E.O. 12958: DECL: 06/12/2032
TAGS: ECON ETRD PGOV PHUM PINR PREL SOCI EWWT SENV
KIPR, TBIO, CH, HK, MC
SUBJECT: HKSAR - AFTER THE FIRST DECADE: ECONOMIC OUTLOOK

REF: HONG KONG 1551

Classified By: Acting Deputy Principal Officer Laurent
Charbonnet, Reasons 1.4 (b, d)


1. (U) SUMMARY: At the ten-year anniversary of its reversion
to the PRC, Hong Kong's economy is strong, led by a potent
services sectors and robust consumer demand. Over the past
decade, Hong Kong has solidified its position as a regional
transportation hub, an international interface for the
mainland's Pearl River Delta (the manufacturing region that
produces closes to 40% of China's exports) and a vibrant
financial center where mainland enterprises can raise funds.
Hong Kong trumpets its strengths as a free economy, built on
fundamentals such as the rule of law, an independent
judiciary, free flow of capital and information, and a labor
pool that has extensive international experience suited to
Hong Kong, mainland China and Asian markets. (In 2007, the
Heritage Foundation ranked Hong Kong as the world's freest
economy, an honor that Hong Kong has garnered 13 times.)
After enduring a rather turbulent period from 1997 to 2003
(reftel),Hong Kong's economy is taking advantage of the
global economic upturn as well as mainland China's continuing
growth. Over the past three years, Hong Kong has registered
GDP figures of US$166 billion, 177 billion and 189 billion,
with growth rates of 8.4%, 7.5% and 6.8%. Unemployment rates
also dropped from 7.9% in 2004 to 6.8% in 2005 and 5.6% in
2006 and is forecast to be 4.3% in 2007.


2. (C) July 1 will mark Hong Kong's reversion to the PRC and

its transition from British colony to Special Administrative
Region of the People's Republic of China. The key to the
successful implementation of this transition has been the
"one country, two systems" framework, which is established
and elaborated through two legal documents: the Basic Law of
the Hong Kong Special Administrative Region and the
"Sino-British Joint Declaration on the Question of Hong
Kong." The Basic Law was intended to ensure a continuation
of Hong Kong's autonomy and prosperity; the existence of a
free market economy; a commitment to democratic institutions,
including a free press; preservation of Hong Kong's
apolitical, independent civil service; respect for the rule
of law that protects human rights and civil liberties;
maintenance of Hong Kong's independence in fiscal and
taxation matters and cooperation between Hong Kong and
foreign states in economic, trade, financial, monetary,
shipping and law enforcement activities.


3. (SBU) At the time of the handover, Milton Friedman, the
U.S. Nobel Prize-winning economist, predicted that within two
years Beijing would impose capital controls and abolish the
Hong Kong dollar. Consistent with the Basic Law, however,
Hong Kong continues to maintain its own currency; the Hong
Kong Monetary Authority performs its functions without
interference from the Mainland and the central government has
not collected or attempted to collect taxes from Hong Kong
for use on the Mainland. More generally, Beijing for the
most part has respected Hong Kong's autonomy and the economic
stipulations of the Basic Law, although instances of the
Mainland meddling in Hong Kong's economic and trade affairs
have occurred, particularly when it comes to key
infrastructure industries and sensitive economic sectors,
such as telecommunications, port operations, and intellectual
property rights.


4. (SBU) Hong Kong has reaped enormous economic benefits
from closer integration with the Mainland. Strengthening
that integration to take advantage of the opportunities
offered by the mainland's rapid economic growth remains a key
priority for the HKSARG. The Closer Economic Partnership
Arrangement (CEPA),the first free trade agreement for both
Hong Kong and the Mainland, provides increased opportunities
for trade in goods, trade in services and investment
facilitation for Hong Kong and the Mainland. As a result of
Hong Kong and mainland policies, Hong Kong's foreign trade,
shipping, logistics, financial and tourism sectors are more
closely linked to the Mainland. At the ten-year anniversary,
Hong Kong-Mainland economic integration has clearly benefited
the Hong Kong economy. As one analyst wrote, "Hong Kong has
got on with the business of doing business and adapting to
events as they have unfolded. Hong Kong foresees -- and
indeed seeks to encourage -- deeper, broader and more rapid

HONG KONG 00001579 002 OF 006


links with the Mainland."


5. (C) Not all economic developments since the handover have
been positive. Recently Beijing intervened to prevent the
sale of a Hong Kong telecommunications company to foreign
interests. Similarly, Hong Kong declined to participate in
the U.S.-proposed Anti-Counterfeiting Trade Agreement (ACTA)
due to concerns over Beijing's reaction. Hong Kong now faces
sharp competition from the Mainland in areas where Hong Kong
has traditionally excelled, namely transportation and
logistics services, where its competitive advantages are
being eroded. While Hong Kong's financial sector currently
stands head and shoulders above mainland China's, Chinese
companies increasingly look to raise money domestically, with
the active direction of the PRC government to do so. Hong
Kong residents' comparative advantages in standard of living
over the "poor cousins" in the Mainland are dwindling. In
addition, pollution from the Mainland has significantly
degraded the environment in Hong Kong, despite Hong Kong's
efforts to reach cross-border solutions. These challenges
cause some Hong Kongers to question whether Hong Kong can
sustain its current economic good fortune into the future.
END SUMMARY.

(U) Note: This is the second in a series of cables examining
the state of the Hong Kong Special Administrative Region
(HKSAR) as it approaches its tenth anniversary. The first
report focused on Hong Kong's first ten years after the
reversion (reftel). This report looked at Hong Kong's
current and future economic development. A subsequent report
will look at Hong Kong's likely future courses in the
political arena.

--------------
POSITIVE DEVELOPMENTS
--------------

Services
--------------


6. (U) Hong Kong's economy is dominated by the services
sectors, which account for 90% of GDP. Hong Kong's four
pillar economic sectors are: trade and logistics (28.6% of
GDP),financial services (12.7% of GDP),professional
services (10.6%) and tourism (3.2% of GDP). According to the
HKSARG, not only are domestic services industries in good
shape but the outlook for the export of services is
promising. Exports of finance, business and other services
have been increasing at double digit rates over the past
year, increasing from US$64 billion in 2005 to US$72 billion
in 2006. As the pace of economic and financial integration
with the Mainland continues to advance, prospects for
continued growth of Hong Kong's services growth are good.

Investment, Trade and Logistics
--------------


7. (U) Hong Kong industries have taken advantage of the
opportunities offered by mainland China's economic growth.
Hong Kong businesses have invested US$280 billion in the
Mainland and it is estimated that Hong Kong funded
enterprises have established over 80,000 manufacturing
enterprises in the Pearl River Delta, employing some 10
million workers. At the end of 2006, 45% of all
overseas-funded projects in the Mainland were tied to Hong
Kong interests. Of Hong Kong's 2006 total merchandise exports
of US$315 billion, US$298 billion originated in the Mainland
and was re-exported through Hong Kong, while only US$17
billion originated in Hong Kong. Hong Kong's air and sea
ports are major beneficiaries of mainland China's merchandise
production and trade growth. Through 2006, Hong Kong's
airport was ranked #1 in the world in cargo volume and its
seaport was ranked #2 in the world behind Singapore, as the
largest container shipping port in the world based on
container through-put. However, 2007 may see Shanghai snatch
second place from Hong Kong.

Financial Center
--------------


8. (U) Hong Kong is one of the world's leading financial
centers, with an extensive banking and services industry that

HONG KONG 00001579 003 OF 006


is regulated non-intrusively and transparently. Seventy of
the world's top 100 banks operate in Hong Kong and 180
insurers from around the globe serve Hong Kong. Hong Kong's
stock market capitalization has quadrupled over the past
decade to reach US$1.8 trillion, making it the second largest
in Asia and eighth largest in the world. Hong Kong is a key
offshore capital-raising center for Chinese enterprises; 375
mainland companies are now listed on the HKEx, with total
market capitalization of more than US$900 billion. Over the
past ten years, mainland companies have raised more than
US$200 billion in Hong Kong. In 2006 alone, Hong Kong raised
over US$42 billion through IPOs, the second largest fund
raiser worldwide after London.

Consumerism/Tourism
--------------


9. (U) Private consumption (tourist and domestic) is a main
driver of Hong Kong's growth. Hong Kong's reputation as a
world class tourist destination is well-known. A total of
25.3 million visitors, or 3.7 times the local population,
came to Hong Kong in 2006, an 8% increase from 2005; 54% or
13.6 million came from the Mainland. Domestic demand with
3.3% growth in 2005 and 5.1% growth in 2006 is also playing
an important role in the current economic upturn. Continued
strong employment growth, tax rebates, greater access to
public housing, and rising equity and property markets have
resulted in greater demand for goods and services. The
combination of tourist and domestic spending increases has
driven retail sales up by 6.8% in 2005 and another 7.3% in

2006.

Infectious Disease Preparation
--------------


10. (SBU) Hit hard by the SARS epidemic in 2003, Hong Kong
has now emerged as an international leader in the monitoring
of and preparing for pandemic outbreaks of emerging
infectious diseases. Hong Kong's geographic location and its
role as a shipping, transportation, and tourist center
increase the territory's risk of an outbreak. Hong Kong
recognizes the devastating impact that an epidemic would have
on the local economy. GDP dropped and unemployment rose in
2003 as the SARS outbreak killed 299 people in Hong Kong
alone and crippled the local aviation, tourism and restaurant
industries. Hong Kong's Avian Influenza (AI) preparedness
plan is on par -- if not better -- than that of Australia,
New Zealand and the United States. Hong Kong will soon reach
its target in stockpiling enough antivirals for the entire
population and conducts continual training for front-line
responders, including health care workers, school employees
and airline/airport staff. Hong Kong has also improved its
communication with health officials in mainland China and
continues to urge transparency in the Chinese public health
sector as the most effective way to manage an epidemic. Two
of the world's leading infectious disease researchers are
based at Hong Kong University, while the city's other
universities contain additional research centers. The city
hosts a World Health Organization AI testing center. Hong
Kong-native and former HKG official Margaret Chan, who
spearheaded the HKSARG response to the 1997 AI outbreak and
SARS, now serves as Director General of the World Health
Organization. The HKSARG takes a more proactive and
independent role regionally by offering technical expertise
and advice to mainland China and southeast Asian countries.
HKSARG hopes that its preparations will help mitigate
infectious disease outbreaks and the associated problems.

--------------
HONG KONG STILL FACES SERIOUS CHALLENGES
--------------


11. (C) Not all economic developments since 1997 have been
positive. Prior to the handover, many observers predicted
that mainland authorities would take an active role in the
political, economic, and commercial affairs of Hong Kong.
For the most part, however, mainland China has not interfered
directly in Hong Kong and has allowed the HKSARG and Hong
Kong businesses to function relatively independently.
Recently, however, incidences have occurred that point to
Beijing's meddling in Hong Kong's affairs. In 2006, PCCW, a
local telecommunications provider, considered buyout bids

HONG KONG 00001579 004 OF 006


from Australian and American suitors, but China Netcom, a
mainland telecom giant and the second largest shareholder of
the Hong Kong company, was opposed to the deal, in line with
Beijing's opposition to the sale to foreigners of a key
strategic infrastructure in Hong Kong. PCCW's primary
shareholder, Richard Li, later accepted a rival bid from
Francis Leung, an associate of Hong Kong tycoon Li Ka Shing
(and Richard Li's father),for PCCW's telecom assets. This
deal eventually fell apart due to regulator concerns over
nepotism, lack of transparency and a high level of
independent shareholder opposition. Consulate contacts have
since confirmed that Beijing, through Li Ka Shing, helped
block the sale to foreign investors. Local Hong Kong
legislators and analysts have expressed concern over Mainland
meddling in this commercial transaction and its repercussions
for Hong Kong's reputation as transparent financial center
with strict rule of law.


12. (C) Instances of indirect mainland influence over Hong
Kong policy makers also have emerged. In January 2007, the
Office of the United States Trade Representative (USTR)
invited Hong Kong to join its new Anti-Counterfeiting Trade
Agreement (ACTA). Hong Kong officials reviewed the proposal
in detail and expressed satisfaction that USTR rated Hong
Kong's intellectual property rights (IPR) regime high enough
to participate as a global partner in the fight against IPR
theft. After careful consideration, however, Hong Kong
officials told us that they were not able to participate in
ACTA out of concerns that Hong Kong would be held up as a
model of IPR protection in contrast with mainland China.
HKSARG officials also expressed concerns that Taiwan might at
some point also be invited to participate in ACTA; and the
possibility of both Hong Kong and Taiwan (but not the PRC)
entering an international agreement could put Hong Kong in a
difficult position with Beijing. In addition, HKSARG
officials have deferred sponsoring joint IPR and law
enforcement training programs with the USG out of concern
over mainland sensitivities. They expressed concern in
winter 2007 over the USG's impending WTO case against China
for IPR violations. Beijing does not appear to be directing
Hong Kong's decisions in these matters, but local authorities
clearly are considering the repercussions their actions might
have on Beijing before making final decisions.

Environment
--------------


13. (SBU) Hong Kong air quality continues to deteriorate.
Pollutants hang heavily over Hong Kong, often obscuring one
of the world's most stunning vistas - Victoria Harbor, the
Hong Kong cityscape and the mountains in the background. Air
quality is so poor, that the HKSARG advised people with
asthma or cardiovascular disease to stay indoors on 41 days
in 2006. The HKSARG states that 80% of Hong Kong's pollution
comes from mainland sources and is working with the
government of Guangdong to create cross-border air quality
monitoring schemes, joint emission reduction goals and a
pilot emissions trading scheme. But, commentators have
questioned these emissions reduction targets and trading
schemes due to lack of transparency and enforcement in
Guangdong and the high prevalence of corruption in the
Mainland. Civil society groups remain critical of Hong
Kong's environmental policies, claiming that the HKSARG uses
the assumption that the majority of pollution comes from
Guangdong to justify the lack of local action in addressing
Hong Kong emissions from the transportation sector, the port,
and electricity production.


14. (SBU) Hong Kong also struggles with high levels of water
pollution. Though possessing its own reservoirs, Hong Kong
has traditionally been dependent on the Mainland for drinking
water. As river pollution increases in mainland China and
the PRD population expands, Hong Kong will face future
challenges to its water security. Furthermore, Hong Kong's
Victoria Harbor remains extremely polluted. Despite its
status as a developed global city, untreated waste water
still flows into the Harbor from the western side of Hong
Kong Island. The failure to address sewage and other forms
of water pollution could impact Hong Kong's image as a
holiday destination, since Hong Kong's waterways and beaches
play an important role in its tourist industry.


HONG KONG 00001579 005 OF 006


Trade and Logistics
--------------


15. (U) Greater China's trade and logistics sectors continue
to develop and expand; however, Hong Kong's share of the
market is not keeping up with mainland ports. During the
first quarter of 2007, Shanghai's Port surpassed Hong Kong's
Port to become the world's second busiest container port -
Shanghai shipped 5.88 million containers while Hong Kong
shipped 5.5 million containers, potentially putting Hong
Kong's status as the second largest global port in jeopardy.
Hong Kong Port's container throughput volume continues to
grow, but the growth rate is both low and decreasing. Ports
in Shanghai and Shenzhen are beating Hong Kong's Port on both
port costs and associated land transportation costs. For
example, trucking a 20-foot container from a factory in
Guangdong and shipping it from Hong Kong costs US$333 more on
average than moving it out of Shenzhen, according to a study
commissioned by the HKSARG. Hong Kong's Port claims a
competitive advantage in efficiency and customs clearance
time, but in 2006 Hong Kong's container throughput grew only
4%, against 14% for competing ports in Shenzhen.

Financial Center
--------------


16. (U) The Hong Kong stock exchange (HKEx) bills itself as a
world class financial services platform offering a wide
spectrum of financial services. It acts as a bridge between
China and the international financial markets for raising
capital for mainland enterprises and serves as a launch pad
for outward-bound mainland investors. The two capital
markets -- China's and Hong Kong's -- are at different stages
of development, operate on separate structures, and also have
dual listings. Hong Kong has been counting on the
superiority of its financial markets to retain its leading
position as a financial center within China and the region
for decades to come. However, in April, 2007 the combined
market capitalization of the Mainland's Shanghai and Shenzhen
Exchanges surpassed that of the HKEx for the first time ever
with mainland exchanges reporting a total market
capitalization of US$1.765 trillion, marginally higher than
the US$1.756 trillion recorded by the HKEx. Furthermore, on
just one high-volume day (April 11),Shanghai and Shenzhen
reported a record volume of transactions, worth US$29
billion, nearly four times greater than HKEx's US$7.5
billion. Increasing numbers of mainland firms are now
choosing to list in Shanghai and Shenzhen, and China's
Securities Regulatory Commission is directing mainland
companies to list in the Mainland rather than on the HKEx.
There is increasing concern among Hong Kong's financiers
about Hong Hong's future financial role. Even a merger
between the Mainland and Hong Kong stock exchanges, which
seemed a very remote possibility prior to this year, has
emerged as a topic of conversation. A former Hong Kong
Financial Secretary and former HKEx President both opined in
news articles in June 2007 that a merger of the Mainland and
Hong Kong markets would be inevitable if the Mainland moved
to a convertible currency. In the meantime, analysts warn
that a burst of the mainland stock market bubble would have
very serious negative impact on the HKEx.

"Poor Cousins"
--------------


17. (U) Long-time Hong Kong residents note that during the
1960's and 1970's, Hong Kongers donated money and foodstuffs
to support their "poor cousins" on the Mainland. In the
1980's, Mainlanders no longer needed donated foodstuffs, but
Hong Kongers still kept up their generosity and donated money
to their "poor cousins." In the 1990's, Hong Kong's
donations to the "poor cousins" tapered off as Mainlanders
began traveling to Hong Kong to spend some of their
increasing incomes. Now the "poor cousins" have become key
drivers of Hong Kong's tourism and retail sectors. In terms
of currency, the Hong Kong dollar was highly sought after in
the Mainland before 1997. At that time, Hong Kongers in the
Mainland could pay in Hong Kong dollars and obtain more
favorable exchange rates than the official rate. The RMB now
has appreciated to match or exceed the value of the Hong Kong
dollar. Mainland tourists in Hong Kong can pay their bills
at the exchange rate of 1:1 and the Hong Kong dollar is no

HONG KONG 00001579 006 OF 006


longer popular in the Mainland. The steady erosion of Hong
Kongers' comparative advantages over their mainland
counterparts has generated some uneasiness and
dissatisfaction among local residents. Long accustomed to
viewing Mainlanders with a mixture of disdain and pity, proud
Hong Kongers now feel the pressures from a strong and rising
China. It has become much more difficult now for local
residents to look down upon the throngs of PRC nationals who
pump cash into the city's shops, restaurants, and tourist
attractions.
Cunningham