Hong Kong’s economy enjoyed a cyclical rebound in 2023. But wounds from COVID-19 policies, external headwinds from decelerating Chinese growth, and high interest rates have spoiled the party. With on-and-off multi-year recessions, Hong Kong’s economy is struggling, falling short of its pre-pandemic GDP levels. These cracks reflect structural economic and geopolitical challenges.

A rebound in consumption is behind the recovery in 2023, but structural pressure is hindering optimism. This is not only about the slow return of visitors, but also changes in consumer preferences. Chinese tourists, forming 80 percent of total visitors, now seek more unique experiences beyond shopping. Against the backdrop of elevated mortgage rates and a strong Hong Kong dollar — which is pegged to the United States Dollar — domestic residents have prioritized outbound tourism and weekend trips to Shenzhen over local spending.

The dwindling financial and real estate markets are also bleeding wounds. In 2023, Hong Kong’s initial public offerings and property transactions plunged to their lowest levels since 2003 and 1991, respectively. China-related policy risk is the top concern among investors after the regulatory storm in real estate and internet platforms, both important sectors in Hong Kong’s financial market. Weak confidence, driven by high interest rates and economic uncertainties, has also placed pressure on house prices and sales.

In 2024, some of these trends will ease — but some may worsen. As global inflation decelerates, Hong Kong will benefit from the US Federal Reserve’s anticipated rate cuts. The problem is it may not be rapid enough to boost disposable income growth and consumption. Given its enlarged fiscal deficit, the Hong Kong government will no longer have the same firepower to support consumption with cash handouts. Visitors will gradually return, but the economic boost will be muted. The city has no clear plan to revive its former glory, especially as Chinese consumers become hesitant to dip into their pockets.

After years of weakness, investor sentiment will remain key for finance and real estate. The good news is global monetary conditions will become accommodating regardless of domestic challenges. More firms are testing the water for initial public offering demand and valuation, but progress has been cautious so far.

Given its heavy exposure to China, the magnitude of Hong Kong’s recovery will depend on whether investors believe the city will recover. But the lack of clear direction on monetary and fiscal stimulus has failed to reassure investors so far. The government wants to diversify through building connections with Southeast Asia and the Middle East, offering more products in the Chinese renminbi, and easing listing rules for specialist technology companies. Yet none of these will work without better investor sentiment and firm valuation.

It is also doubtful whether demand for Chinese firms to pour capital into offshore markets and foreign currencies will pick up quickly. As the Chinese renminbi has stayed low and there are greater hurdles to invest overseas, demand may only recover slowly.

In the long term, it is inevitable that Hong Kong will face tough challenges. First, domestic policy uncertainties about future economic roles and growth engines are weighing down investors’ confidence. A good barometer is the mere 40 percent success rate in recent land auctions, a level never seen even during the SARS outbreak in 2002–03 and the Global Financial Crisis in 2007–08.

This uncertainty is linked to a lack of vision to untangle Hong Kong’s current economic dilemma. Band-aid solutions can confuse businesses. With three consecutive years of fiscal deficit, it is uncertain how the government will cope with a severe aging problem, labor shortages, and a bold plan to simultaneously finance two mega-infrastructure projects. 

Second, China’s slowing growth will also drag Hong Kong’s economic prospects. Weak global sentiment towards China-related assets will pressure Hong Kong’s financial sector and asset prices unless there is a significant U-turn in investors’ risk assessments.

Third, geopolitical risks will remain if the world decouples. As global firms reassess their exposure to China, the number of foreign regional headquarters and offices in Hong Kong has fallen by 5.2 percent since 2019. The epicenter of tensions — semiconductors — form 39 percent of Hong Kong’s total trade in 2022, a significant increase from 16 percent in 2012. While Hong Kong does not produce any chips, it is a key hub in re-exporting integral components to destinations such as Russia.

Despite ongoing efforts to diversify and attract firms in Southeast Asia and the Middle East, Hong Kong will need to justify why firms need it as a hub — not only as a gateway in and out of China, but also for alternative markets.

While there will be tailwinds for Hong Kong’s economy in 2024, both immediate and long-term challenges remain. On a positive note, Hong Kong’s unique structural advantages will continue to be the cornerstone for growth. Its location, free capital flows, low and simple taxes, abundant liquidity, and internationally aligned compliance and legal frameworks all matter. But Hong Kong’s status will be affected by domestic policy decisions, China’s economic deceleration, and US-China strategic competition.

Alicia Garcia-Herrero is Senior Research Fellow at the Brussels-based think tank Bruegel and Adjunct Professor at the Hong Kong University of Science and Technology.

Gary Ng is a Research Fellow at Central European Institute of Asian Studies (CEIAS), specializing in economic and thematic research.

This article was first published by the East Asia Forum.