Hong Kong: The Keystone in China’s Economic Statecraft

The recent decision by Hong Kong to join China in banning Japanese seafood took many observers by surprise (Reuters, August 23). At first glance, the ban seemed an overblown reaction to Japan’s handling of nuclear wastewater, which many international bodies have deemed safe and compliant with established procedures. And while it is commonly understood that Hong Kong’s government is politically influenced by the Chinese Communist Party (CCP), many still believe in its economic autonomy. Considering the significant economic reliance of Japan on Hong Kong for its seafood trade, among other sectors, the ban startled numerous stakeholders (Nikkei Asia, August 25). However, the move is less shocking when Hong Kong is viewed as an integral cog in China’s economic statecraft machine.

Traditionally, Western governments lack strategic foresight regarding Hong Kong’s long-term position. Often, this oversight stems from an inadequate comprehension of Hong Kong’s pivotal financial role relative to China, as well as an underestimation of its potential as a node for strategic leverage, both for and against China.

China’s rise as a global superpower is inextricably linked to its adept use of economic statecraft, a fusion of economic might and strategic prowess. Its pressure on South Korea to stop the production of Taiwanese military submarines provides a recent example (Reuters, October 16). Hong Kong is a pulsating metropolis at the heart of this strategy. It not only exemplifies China’s ambitions but also acts as a crucial conduit for realizing them. There are two key strands of Hong Kong’s centrality to Beijing: its function as an economic lifeline to the global financial system and its role in the clandestine acquisition of technology and intellectual assets for China from overseas. The US and its allies must focus more on Beijing’s overt and covert leveraging of Hong Kong and think harder about what the city’s function should be in an era of de-risking, geoeconomic competition, and weaponized interdependence.

A Crucial Economic Lifeline

Hong Kong acts as a gateway, enabling China to attract vital foreign capital without entirely liberalizing its own economy. Beijing has historically been cautious about opening up its capital account due to a desire to maintain stability and retain control over capital inflows. As a Special Administrative Region (SAR) of China and a former UK colony, Hong Kong offers a unique proposition: Under the promise of the “One Country, Two Systems” formulation codified by the Sino-British Joint Declaration from 1997, Hong Kong retains considerable autonomy. The world has thus treated Hong Kong differently, and continues to do so—as exemplified by Hong Kong’s independent membership of the WTO (WTO).

Hong Kong’s dynamic stock exchange and its financial infrastructure make it a hotspot for companies to access liquidity. According to the Hong Kong Monetary Authority, two-thirds of China’s inward and outward direct investments are conducted through Hong Kong. (HKMA, September 29). Official statistics from 2021 highlighted that Hong Kong was the source of a record 76 percent of all “actually utilized” FDI in China (Bloomberg, September 5, 2022), a figure that has increased since 2010 (Rhodium Group, December 13, 2022). These numbers rebut the perception that other major cities such as Shenzhen and Shanghai are replacing Hong Kong’s financial role (Sina, January 14, 2021).

Since 1997, Hong Kong has built unique channels for accessing China’s capital market, including the 2014 Shanghai-Hong Kong Stock Connect (滬港通), 2016 Shenzhen-Hong Kong Stock Connect (深港通), and mutual recognition arrangements for funds between China and Hong Kong (基金互認安排) in 2015 (HKMA, September 29). These channels have strengthened the super-connector role of Hong Kong, providing the primary avenue for foreign investors to invest in China. Indeed, even Chinese enterprises themselves consistently prefer the Hong Kong Stock Exchange (HKSE) as their destination for listing and capital accumulation over other PRC markets: Baidu, Alibaba, and Bytedance are all registered in Hong Kong (Project Syndicate, August 18). Consequently, the cumulative share of the HKSE’s overall market capitalization held by mainland Chinese enterprises stood at an overwhelming 77.6 percent in 2023 (HKEX, September 30).

Hong Kong also constitutes the world’s largest and most vital offshore RMB business hub (HKMA, September). It is the only place outside mainland China to offer comprehensive RMB-denominated financial services, from clearing and settlement to financing, asset management, and risk management. The Chinese leadership has long aspired to elevate the RMB’s global status, a desire intensified by the 2007 global financial crisis, when nations with substantial US dollar reserves—and China in particular—grew anxious about a potential dollar collapse. [1] Responding to this, the People’s Bank of China proposed increasing the usage of the IMF’s Special Drawing Right (SDR) as a global standard, advocating for a diversified basket of currencies within the SDR to ensure global financial stability wasn’t reliant on one nation’s economic health (Reuters, September 9, 2009). To realize this plan and validate the RMB’s global acceptance, its use in international trade payments rose. From 15th position in 2011, it soared to 5th by 2015, behind only the US dollar, Euro, British Pound, and Yen. In November 2015, the IMF officially announced the RMB’s inclusion in the SDR basket. However, in 2015 it only constituted 2.79 percent of international payments, dwarfed by the US dollar’s 43.3 percent. Over 70 percent of these payments occurred in Hong Kong (SWIFT, October 6, 2015), demonstrating that the currency’s alleged global acceptance is predominantly rooted in its acceptance within Hong Kong. China, however, has still achieved part of its aim of promoting RMB influence through the IMF: In August 2023, Argentina became the inaugural Latin American nation to utilize the RMB as its currency of choice for repaying IMF loans and conducting other direct investment transactions (Reuters, August 24; Xinhua, August 31).

Hong Kong has also emerged as a linchpin for financial relief for China’s indebted regions, many of whom have turned to the city’s liquid financial market to issue offshore bonds to attract crucial funds. In November 2022, both the Shenzhen Municipal People’s Government and the Hainan Provincial People’s Government issued bonds totaling roughly $7.6 billion (HKMA, March). This is yet another instance of Hong Kong providing a gateway for foreign investors venturing into mainland onshore bond investments. As the mainland grapples with its financial dilemmas, Hong Kong’s pivotal role in facilitating transactions highlights its capacity to alleviate China’s pressing financing challenges and strengthen China’s economic resilience.

A Venue for Economic Espionage

Hong Kong’s distinct geopolitical status presents both an opportunity and a challenge for Western nations. Beijing has astutely leveraged the city’s unique position to bypass Western sanctions, thereby setting the stage for a plethora of discreet, sensitive transactions. A regulatory framework characterized by relatively lax oversight enables individuals and entities to rapidly establish shell companies. This ease of setup, coupled with limited transparency requirements, often makes it challenging to trace the origins and operations of such companies. This environment can thus be exploited for covert, or illicit activities that would otherwise attract regulatory scrutiny.

A 1998 example is illustrative. After disguising as a Hong Kong-registered travel company, the Chong Lot Group, founded by a former PLA serviceman, struck a deal with the Ukrainian government to purchase two Soviet-era aircraft carriers. While both of these warships were ostensibly to be transformed into a floating hotel and casino—along the lines of other Soviet carriers the Kiev and Minsk—the PLA acquired one and retrofitted it as the Liaoning, which became China’s first aircraft carrier (SCMP, January 18, 2015). Commissioned into the PLA Navy in 2012, the Liaoning forms part of the largest fleet of vessels in the world.

Hong Kong has also become a haven for autocrats like Iran, North Korea, and Russia. A 2022 report from the United Nations Security Council (UNSC) expert group flagged four Hong Kong-registered companies for allegedly facilitating illegal transfers of refined petroleum to North Korea (SCMP, October 16, 2022). This was a violation of international sanctions which cap North Korean oil imports at 500,000 barrels annually, requiring all such shipments to be reported to UNSC. Each of these Hong Kong-based entities had direct affiliations with mainland China, either through Chinese directors or other tangible links which, if they go unpunished, suggests China’s complicity in these violations.

In September 2023, the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) imposed sanctions on a network of entities and individuals, including some in Hong Kong. These entities were accused of procuring sensitive components for Iran’s offensive unmanned aerial vehicle (UAV) program (OFAC, September 27). Central to this network was Hongkong Himark Electron Model Limited, which reportedly completed several orders for servomotors—crucial for UAVs—exceeding $1 million for an Iranian entity. The evidence suggested that Fan Yang, the employee representing Himark in these sales, took steps to falsify invoices to obscure the identity of the Iranian end-user. Both Fan and Hongkong Himark were implicated in supplying servomotors to Houthi rebels in Yemen. These Iranian UAVs were also allegedly supplied to Russia for its ongoing illegal invasion of Ukraine. Russian entities, relocating to Hong Kong to avoid sanctions imposed in February 2022, executed 3,292 semiconductor import transactions in the first year of the invasion, of which 75 percent were routed through Hong Kong or mainland China. These transactions involved significant deals with American chip giants, including Intel, AMD, and Texas Instruments (Nikkei Asia, April 12).

China’s efforts to bypass recent US regulations on semiconductor exports can be observed in remarks made by Chenghui Ye, CEO of the Hong Kong Applied Science and Technology Research Institute (HKASTRI) in 2022. Ye explicitly pointed out that since mainland Chinese chip companies might face difficulties hiring Americans due to the restrictions imposed by the United States, relocating these experts to Hong Kong could sidestep regulations while transferring cutting-edge semiconductor knowledge to the mainland in order to continually boost China’s semiconductor industry (NOW, October 18, 2022). Interestingly, Ye’s speech illustrated precisely how Hong Kong perceives its role in assisting the mainland in clandestinely acquiring the technology it desires. A HKASTRI research center, the National Engineering Research Center for Application Specific Integrated Circuit System (Hong Kong Branch), founded in June 2012, is endorsed by the PRC’s Ministry of Science and Technology. It is the first national engineering research center branch located in Hong Kong (CNERC, Accessed October 10), and is actively engaged in research, talent cultivation, and technological transition in areas such as three-dimensional integrated chips, third-generation semiconductors, and low-power wireless connection chips. Its research is targeted to address the techno-blockade imposed by the US. Clearly, sanctions and regulations crafted with the PRC in mind are insufficient to encompass the specific conditions in Hong Kong. Ironically, even as concerns mount about Hong Kong’s dwindling political autonomy, Beijing continues to exploit the perception of its economic autonomy to their benefit. This blind spot comes at the expense of the interests and principles of the West.

Conclusion

Hong Kong stands at the confluence of China’s global ambitions, where the lines blur between economic autonomy and political subservience. As China’s domestic economy has struggled in recent months, Hong Kong’s unique geopolitical status has been increasingly leveraged by Beijing as a strategic instrument to bypass global restrictions and exploit loopholes—often clandestinely. Recognizing and navigating this nuanced relationship will be critical for nations aiming to safeguard their interests in this rapidly evolving geopolitical landscape. When the Trump administration took steps to publish the Executive Order 13936 to normalize relations with Hong Kong on July 14, 2020, it revoked the region’s special customs status in response to the perceived erosion of its autonomy and the apparent failure of the “One country, Two systems” principle (National Archives, July 14, 2020). The Biden administration upheld this policy (White House, July 11). However, this does not comprehensively address core issues; loopholes remain, and a structured, long-term solution is still elusive. China’s recent legislative actions further accentuate these concerns. The promulgation of laws such as the Foreign Relations Law and the Anti-Foreign Sanction (State Council, June 10, 2021; State Council, June 28), reveals Beijing’s strategy of leveraging its economic statecraft as a retaliatory mechanism against the US and its allies.

While Hong Kong is still Asia’s premier international asset management hub, and accounts for approximately two-thirds of initial bond issuances in Asia (HKMA, Accessed October 10,), it provides the keys for China to perfect its economic statecraft. The international community must now grapple with this possibility, and decide what Hong Kong’s future role on the global stage should be. Can Hong Kong, on its current trajectory, maintain its stature as a leading financial hub? And what are the implications of the weaponization of an international financial center which has a vast repository of Western assets? If the United States and possibly the EU are now prioritizing de-risking from China, then reevaluating Hong Kong’s and considering de-risking from Hong Kong should be on the agenda. Unfortunately, only a handful of policymakers recognize this challenge, and the clock is ticking.

Notes:

[1] Ho-fung Hung, “City on the edge: Hong Kong under Chinese rule”, Cambridge University Press, May 2022.