Relative to most markets, Hong Kong stocks have performed poorly over the last two years. However, since Jan 1, 2022, Hong Kong stocks have been doing surprisingly well, beating US markets by far. This signals confidence in the Hong Kong economy among investors. Of the components comprising Hong Kong’s GDP, consumption will likely continue to be relatively weak in 2022, but all the other components should do well.

The main worry for investors today is inflation. The latest headline inflation rate in the US is now over 7 percent, which is the highest rate since 1982. All the talk about the uptick in inflation being temporary has now lost credibility. The fact is that the various bottlenecks in the supply chains for multiple products have significantly disrupted production and delivery across many industries. Bond yields are heading north, and the Fed is expected to raise interest rates and roll back quantitative easing. This is why US stock markets have plummeted significantly over the past few weeks.

If inflation continues to flare up, the US will be caught in a major crisis. It will face increasing pressures to reduce tariffs and abolish sanctions, which will ease bottlenecks in supply chains

The US fiscal deficit as a percentage of GDP reached 14.9 percent in 2020 and the Congressional Budget Office expects the 2021 figure to have fallen to 13.4 percent, and to fall to 4.7 percent this year. But if interest rates rise, the US fiscal position will be besieged on many fronts. First, interest payments on the national debt will rise. Second, declining stock valuations will weigh down on consumption and corporate incomes, leading to lower tax revenues. Third, as the economy weakens, transfers to help the poor and the unemployed will increase. The potential for a crisis cannot be dismissed.

Interest rate increases of course will also adversely affect the Hong Kong economy. But Hong Kong’s stock market has already factored in many unfavorable factors and its valuation is still very attractive. Many stocks actually offer yields that are very attractive. In any case the resilience of the Chinese mainland’s economy, the Guangdong-Hong Kong-Macao Greater Bay Area plan, and the official launch of the Regional Comprehensive Economic Partnership agreement on Jan 1 are all very positive for the Hong Kong economy. It is important to note that Hong Kong attracted $119.2 billion in foreign direct investment in 2020, and, contrary to the story about capital fleeing Hong Kong after the introduction of the National Security Law for Hong Kong in June 2021, FDI is projected to have risen to $178.5 billion, according to Trading Economics. In general, long-term capital flows are unlikely to be much affected by short-term cyclical interest rate movements.

There is indeed the worry that the recent wave of emigration will adversely affect Hong Kong’s competitiveness and weaken Hong Kong’s domestic demand. The latest data on the housing market does show some weakness, and the recent retail sales data also point in the same direction. The recent public health measures to combat COVID-19 further add pressures on Hong Kong’s consumption demand. But all this is short term. Hong Kong is one of the world’s most open economies, and as long as it is attractive to professionals, entrepreneurs and investors, capital and talent will continue to come. While the downward pressures on the domestic economy are expected to bog down the economy for some time, when the borders are finally opened up, the economy will immediately strengthen.

Hong Kong’s exports have done very well in recent months, in tandem with the mainland’s strong performance. This is expected to continue, especially since RCEP has helped eliminate or significantly reduce tariffs for member economies. A recent research report, entitled “GBA-ASEAN: Bridging the Gap”, from the Hong Kong Trade Development Council, found that many companies see Hong Kong as playing a very important role in facilitating trade and investment between the Guangdong-Hong Kong-Macao Greater Bay Area and ASEAN countries. Indeed the importance of Hong Kong in facilitating their current trading and investment activities in ASEAN was rated at 7.33 out of 10, with nearly half (47.2 percent) giving a score of 8 to 10.

Hong Kong, as one of the core members of the GBA cities, is expected to play an important role in contributing to the technological innovations of this dynamic region. The SAR government’s northern metropolis development strategy will significantly boost Hong Kong’s capability in research and development, as our neighbor city Shenzhen is ranked top in the entrepreneurship and innovation index among all cities in China. Over the years, China has established itself as a global innovation leader in the Global Innovation Index. Today it boasts 19 of the top science and technology clusters worldwide. The Shenzhen-Hong Kong-Guangzhou cluster is in second place, ahead of the Beijing innovation cluster. The government’s infrastructure investment to boost Hong Kong’s R&D and innovation capability will in the short run stimulate Hong Kong’s economy and over the longer run will drive Hong Kong’s industrial upgrading.

Although most people are pessimistic over US-China relations, with the US imposing sanctions on three more companies just last week, I am relatively optimistic that relations should ease later in the year. If inflation continues to flare up, the US will be caught in a major crisis. It will face increasing pressures to reduce tariffs and abolish sanctions, which will ease bottlenecks in supply chains. 

The author is the director of Pan Sutong Shanghai-HK Economic Policy Research Institute, Lingnan University.

The views do not necessarily reflect those of China Daily.