The Hong Kong Protest: What It's All About

Considering that as recently as 3 weeks ago the leader of the Occupy Central movement in Hong Kong decided to throw in the towel, after admitting that his civil disobedience movement’s pursuit of democracy had “failed” as a result of waning public support, many are shocked by how aggressively Hong Kong's students took up the baton: almost as if the mystery sponsor behind the ISIS blitz-ascent from obscurity had decided to "destabilize" yet another region. Tongue-in-cheek kidding aside, for everyone confused about the context of this weekend's at time very violent student protests, here is Evergreen GaveKal with its wrap up of the "Hong Kong Democracy Protests."

By Tom Holland, of Evergreen GaveKal

The inhabitants of Hong Kong were treated over the weekend to the unusual spectacle of police battling political protesters in the city’s streets. Baton charges and volleys of tear gas might be common enough tactics in New York or London, but not in Asia’s leading international financial center. The rapid escalation of the protests over the weekend and the police’s strong-arm response shocked locals, and triggered a -2% fall in the city’s benchmark Hang Seng stock index on Monday morning as investors worried about the impact of continued unrest on Hong Kong’s markets, its economy and its future as Beijing’s laboratory of choice for China’s financial liberalization.

Only a few weeks ago it seemed that Hong Kong’s pro-democracy movement was a spent force. After Beijing ruled out open elections for the chief executive of the territory’s government, the leader of Occupy Central admitted that his civil disobedience movement’s pursuit of democracy had “failed”. However, Hong Kong’s students and high school pupils failed to take heed. Last Friday a group of around 200 stormed security fences blocking off the ‘Civic Square’ outside the government’s headquarters to stage a sit-down protest against official obduracy. The heavy-handed police response prompted thousands more protesters to descend on the site over the weekend and on Monday morning the city woke up to find a civil disobedience campaign dismissed as irrelevant just weeks before had paralyzed the area surrounding Hong Kong’s government headquarters. With the mood highly febrile ahead of a public holiday on Wednesday to mark the Communist Party’s assumption of power in China, the fear is that the crowds of protesters could swell further over the course of the week, prompting an even more uncompromising response from the city’s Beijing-backed government.

The worst case scenario—that the Beijing government will deploy the People’s Liberation Army to restore order at the barrel of a gun—is extremely improbable. It would be a public relations disaster for China’s leaders. However, it is equally hard to envisage any lasting rapprochement between Hong Kong’s pro-democracy movement and the city’s government. Indeed, although the protesters’ overt cause may be their campaign for free and open elections, many are motivated by underlying grievances both towards the mainland, which they fear is swamping Hong Kong’s unique identity and culture, and towards the city’s own administration, which they believe to favor the interests of property and business tycoons over the aspirations of  local people.

As a result, even if this week’s protests end peacefully, the discontent will rumble on. And if slowing Chinese growth and rising US interest rates inflict economic hardship on the city, the dissatisfaction is only likely to mount. In recent years the combination of mainland money flows and rock-bottom mortgage rates—Hong Kong’s currency is pegged to the US dollar, so local borrowing costs follow US rates—have propelled the city’s property prices to record highs, up 300% from their 2003 low. While any slump would make property more affordable, it would also hammer the balance sheets of the city’s middle class property-owners, many of whom are inclined to sympathize with the weekend’s demonstrators.

Against that backdrop, an extended campaign of civil disobedience is likely to weigh further on Hong Kong’s stock market, already down -8.3% since early September. A new equity trading link between the Hong Kong and Shanghai market, which is due to go live towards the end of October, may not help much. With the valuations on Hong Kong listed-stocks bang in line with their mainland peers, there are currently few arbitrage opportunities to be exploited. And with Beijing’s ‘mini-stimulus’ to support the mainland economy running out of steam and the People’s Bank of China resisting pressure for a full-scale monetary easing, the chances that a continued rally in mainland stock prices will support the Hong Kong market look slim.

Finally, some critics have suggested that the weekend’s pro-democracy demonstrations could prompt Beijing to choose Shanghai’s Free Trade Zone over Hong Kong as the favored venue for its financial liberalization program. Possibly, but one year after it was opened with great fanfare, progress at drawing up rules to govern capital flows in and out of Shanghai’s new zone is glacially slow and almost entirely opaque. The mainland city still looks decades away from mounting a credible challenge to Hong Kong.

Even so, hopes that Hong Kong investors will benefit from a new spate of mainland liberalization measures look exaggerated. With China’s growth rate now slowing towards 7%, exposing the vulnerabilities of China’s financial system, complete interest rate liberalization and a full opening of the capital account are receding further into the future. That may preserve Hong Kong’s pole position. But along with the gathering momentum of pro-democracy protests, it will also limit future opportunities for growth.