China: Demonstrations in Hong Kong likely to stay local

How concerned should investors be about the current demonstrations in Hong Kong? After significant demonstrations on Sunday, it appears that demonstrators are dispersing this morning. Hong Kong could face another challenge on Wednesday, 1 October – public holiday in Hong Kong and National Day in Mainland China.

The main political issue: In connection with the agreement between the UK and China on handing over sovereignty of Hong Kong to China in 1997, it was agreed that, with the exception of defence and security, Hong Kong should be able to maintain its existing political system for at least 50 years. In addition, it was decided that at some stage the chief executive position should be decided either by election or consultation and that the legislature should also at some stage be decided upon in an election. As a follow-up to this agreement, China’s Standing Committee of National People’s Congress (China’s parliament) in 2008 issued a declaration that the election of the chief executive in Hong Kong may be implemented by universal suffrage in 2017 and that the election for the legislature in 2020 might also be decided by universal suffrage. Hence, Hong Kong is currently in a heated discussion about the election laws for the 2017 chief executive election. The current turmoil has to a large degree been prompted by another statement from the Standing Committee of China’s National People’s Congress in late August in which it demands that all candidates for the chief executive position are approved by a nomination committee where Beijing is expected to have considerable influence. Effectively this means that Beijing will be able to block unwelcome candidates. The current protest movement in Hong Kong including the Occupy Central movement believes that the public should be able to nominate candidates for the chief executive position or at least the bar for standing in the chief executive election should be lower.

While the new Chinese leadership under Xi Jinping has signalled accelerated economic reforms, it has also suggested unwillingness to accelerate political reforms. While there will without doubt be considerable nervousness within the Chinese Communist Party (CCP) about possible spill-over to Mainland China, the likelihood that this will actually happen is, in our view, quite low. While it is admittedly difficult to judge, the current CCP leadership – not least CCP leader XI Jinping personally – appears to be relatively popular in the broad population in the wake of its frugality and anti-corruption campaign. In addition, today’s youth in Mainland China appear to be more characterised by being nationalistic than having an imminent urge for democracy. The broad public in China will probably tend to see the current demonstrations in Hong Kong as resistance to unification of China after ‘100 years of humiliation’ by the colonial powers.

A more imminent concern is that the ‘one country, two-systems’ political model could be severely discredited in Hong Kong and potentially worsen the relationship with Taiwan. It has been the Chinese leadership’s hope that the successful application of the ‘one country, two systems’ model in Hong Kong could eventually open up for using the same template for a gradual peaceful unification with Taiwan. In a situation with increasing political tensions in both the East China Sea and the South China Sea, the easing tensions between Mainland China and Taiwan have been a major positive. An intensification of the political crisis in Hong Kong could put an end to a closer relationship between Mainland China and Taiwan.

The most likely outcome is that the political crisis in Hong Kong stays local. In our view, both the Chinese leadership and the opposition in Hong Kong including Occupy Central have an interest in not letting the crisis get out of control. The Chinese leadership does not want to discredit the ‘one country, two systems’ political model and the opposition in Hong Kong does not want to alienate the majority of the Hong Kong population that is concerned about stability. Some negative spill-over to the relationship between China and Taiwan is probably unavoidable. The worst-case scenario is that demonstrations in Hong Kong get out of control and China uses its troops stationed in Hong Kong to suppress the demonstrations. In this scenario, some negative spill-over to Mainland China would be unavoidable. This could include a higher focus on political stability and a slowdown in economic reforms as happened in the wake of the Tiananmen Square incident in 1989. However, we underscore that this is a low probability scenario.