Could Hong Kong become a financial backwater?

Hong Kong's pro-democracy protesters demand government reform

Hong Kong may have more than its political future on the line, with some experts saying that surging political unrest in the city could encourage China to promote Shanghai as the country's main financial center.

"The Chinese authorities have in the past several years expressed the desire to actually limit Hong Kong's growth and to boost Shanghai," said Jack Strauss, an economist at the University of Denver's Daniels College of Business.

Indeed, Hong Kong has been something of sideshow for the Chinese economy, which has soared to become the second-largest in the world. For example, Hong Kong has its own currency, the Hong Kong dollar, which is pegged to the U.S. dollar, while the Chinese yuan is not. Hong Kong's banks also are considered more transparent and stable than those in the People's Republic.

Dan Steinbock, research director at the India, China and America Institute, noted last year that foreign direct investment in Hong Kong has dropped significantly, while the flow of money into Shanghai nearly doubled between 2005 and 2012.

"Even in the past decade of global integration," Steinbock wrote on the China-US Focus website, Shanghai "could only watch as Hong Kong served as the mainland's financial intermediary. But now it is Shanghai's turn."

The big question is whether officials in Beijing will place their political concerns over economic issues, as they have in the past, Strauss said.

Shares on Hong Kong's Hang Seng Index, the fifth-largest in the world, fell to a three-month low on Tuesday, weighed down by concerns over the massive protests sweeping the city. Financial markets across China will close for several days starting Wednesday as part of the country's National Day holiday, also known as "Golden Week."

New app helps connect democracy protesters in Hong Kong

The time off might give investors time to assess the risks in Hong Kong. Demonstrators there are upset with Beijing for not living up to political commitments agreed to when the territory, a British Crown Colony for more than 150 years, was transferred back to Chinese control in 1997.

As part of the handover agreement with China, Hong Kong was declared a Special Adminstrative Region of the People's Republic. Among other things, that meant that the political freedoms and rights in Hong Kong, begun under British rule, would stay in effect until 2047.

But ever since the handover, there have been concerns that the Chinese government have been eroding the so-called "one country, two systems" principle, while favoring Shanghai over Hong Kong as China's chief financial hub. And while the rivalry between the two cities has been going on for decades, the latest tide of protests in Hong Kong could add a new dimension.

For now, markets aren't panicking, with investors seeming to believe that the Chinese government will show restraint and eventually take steps to defuse the confrontation. But even if Beijing was to back off and acquiesce to the Hong Kong protestors' demands for more direct political representation, the economic damage may have already been done.

"If the situation isn't resolved relatively quickly, I could see stock markets reacting very negatively," Strauss said. "Capital markets are very susceptible to fear -- a lot of capital could move out quickly."

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