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China and the Hong Kong Special Administrative Region (HKSAR) are two disparate economic entities, but ones that have been linked through increased capital and trade Áows over the past Àfteen years or so. They form an economic nexus that, upon closer scrutiny, deÀes any textbook deÀnition of regional economic integration. There are several aspects to this particular regional system of economic linkages that are important to our understanding of how the Chinese governments in Beijing and Hong Kong have responded differently to the Asian Ànancial crisis. First, under the “one country, two systems” blueprint (adopted for Hong Kong’s reversion to Chinese sovereignty on 1 July 1997), the Hong Kong currency , inherited from the colonial past, has remained fully convertible. This is clearly the single most important political provision for keeping the SAR intact as a separate economic system. However, as the Chinese renminbi is not convertible for capital account transactions (the current account made convertible as recently as December 1996), international currency speculators directed their attacks with full force on the Hong Kong dollar in 1997/1998, amidst the unfolding Asian Ànancial turmoil. Second, foreign direct investment from Hong Kong (which makes up around two-thirds of China’s global FDI stock) represents, for the most part, a “complete migration” of manufacturing plants from the SAR to the Chinese hinterland. Moreover, under the persistent Chinese policy dictate that foreign * Reprinted from “Financial restructuring for economic recovery in China and Hong Kong”, in Fu-chen Lo and T. Palanivel (eds.), Financial Restructuring and Economic Perspectives in East Asia, Tokyo: United Nations University Institute of Advanced Studies, 2000, pp. 127–44. 8 Financial Restructuring for Economic Recovery in China and the Hong Kong SAR* 210 Pax Sinica investors should “balance their own foreign exchange requirements”, Hong Kong FDI in China almost entirely caters to the export market rather than the Chinese domestic market. The Chinese FDI strategy represents clearly an ambitious “leapfrog to export-oriented foreign investment”. It stands therefore in sharp contrast to FDI undertaken by large multinational corporations from Japan in Southeast Asia or, for that matter, from the United States and European Union in China. This has essentially been for import substitution, and constitutes a system of vertical industrial integration, with the FDI host and recipient countries “splicing up the value chain”. Under such circumstances , the Chinese hinterland as a production base, to the extent that it has been spared from the Asian Ànancial meltdown, has actually provided a safe haven for Hong Kong export manufacturers.1 Third, with few exceptions, Hong Kong manufacturers based in China are all engaged in export processing. The overwhelming proportion of inputs are supplied from outside through Hong Kong, and the processed products shipped back to the SAR for exports to overseas markets, the United States and Western Europe in particular. Export orders or letters of credit from overseas buyers are normally received by the parent company or afÀliated Àrm in Hong Kong, not through the mainland Chinese banking system, while foreign exchange outlays on imported materials and on the necessary processing machines and equipment are also incurred outside of China. This particular mode of operation implies speciÀcally that both foreign exchange receipts and expenditure made on the part of Hong Kong investors in China are basically shielded from the volatility of the renminbi. It thus clearly Áies in the face of international currency speculators who believe that a yuan devaluation would inevitably call for the de-pegging (i.e., devaluation) of the Hong Kong dollar from the US dollar.2 Viewed this way, the repeated speculative attacks on the Hong Kong dollar since the Asian currency crisis erupted in Thailand in July 1997 seem to be essentially a matter of international hedge funds exploiting some popularly mistaken, gross perception that the value of the Hong Kong currency is invariably bound up with the Chinese renminbi, as a result of the SAR’s synergistic economic relationships with the mainland. Whatever the underlying factors, the HKSAR economy was almost brought to its knees by frequent speculative currency attacks in 1998 (the GDP was down by 5.1% compared with a 5.3% growth in 1997), while the Chinese hin- Financial Restructuring for Economic Recovery in China and the Hong Kong SAR 211 terland has basically remained unscathed (GDP still recording an impressive 7.8% growth in 1998). How did the SAR government cope with the Asian Ànancial contagion and would there have been better alternatives? This raises a number...


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