Hong Kong as a Financial Center for Asia: The Role of the China Link Olaf Unteroberdoerster IMF Resident Representative Hong Kong SAR March 2009

Motivation Background paper for 2007 IMF consultation with Hong Kong SAR Document Hong Kong’s evolving role as an international financial center in the region Identify key factors determining the success as an international financial hub Assess the scope for future financial services growth

Findings Hong Kong has long track-record as Asia’s premier financial center Special link with Mainland China Supply-side factors play a role Medium-term prospects : further financial opening of the Mainland will likely consolidate Hong Kong’s lead Longer term prospects : will depend on ability to rely less on the Mainland as hinterland as financial system there modernizes

Key trends: FDI Hong Kong’s role appears small on a global scale Percent of total bilateral flows

Key trends: FDI Within Asia, Hong Kong is only second to China Percent of total bilateral flows

Key trends: FDI Hong Kong’s leading role in Asia rests on the China- link (contd.)

Key trends: Portfolio Inv. Hong Kong again appears to be a small player Percent of total bilateral investment

Key trends: Portfolio Inv. But in Asia it accounts for nearly one third of PI Percent of total bilateral investment

Key trends: Portfolio Inv. Inside Asia, Hong Kong plays a lead role, even without China HKSAR percent share in PI within Asia

Key trends: Banking Hong Kong plays an important, but less prominent role in cross-border banking activities, both globally… Percent of international lending and borrowing

Key trends: Banking … and inside Asia Percent of international lending and borrowing

Gauging 3 rd party flows Presence in international finance due to: (1) domestic demand; or (2) services to non-residents Share in world capital flows relative to share in world GDP gives better sense of (2) HK, SGP, UK consistently stand out on this measure

Gauging 3 rd party flows (Intensity of foreign direct investment) Reminder: Share in bilateral flows, 2006

Implications Demand vs. supply Hong Kong’s presence as an IFC derives primarily from services to non- residents Yet, the China link dominates, particularly for FDI Hong Kong resembles more NY (hinterland) than Singapore or London (no hinterland)

Implications Demand vs. supply o But supply side factors are also important

Prospects for growth Medium term outlook : Combination of special relationship with the mainland and supply-side strengths would be the key growth drivers Illustration (taking FDI outflows as a benchmark) : outward portfolio investment from Mainland could amount to some US$ 200 billion This would make Hong Kong by far the dominant portfolio investment center in Asia (2005 cross-border investment at some US$400 billion)

Prospects for growth Recent administrative measures seem to underscore Hong Kong’s privileged role Mainland fund managers to establish subsidiaries here Expansion of QDII RMB deposits and trade settlement RMB bond issuance

Prospects for growth Longer term : How can HKSAR maintain its first-mover advantage? Preeminence of financial centers can last long-time But competitive strengths geared toward less China-centric model should be bolstered early