Foreign passport, who needs one?

By July 1 next year Hong Kongers who have the means will have bought insurance policies called foreign passports. A government source reckons close to a million already have them and could leave tomorrow. Over the coming months there will be no shortage. The prime minister of Tonga in the South Pacific wants to sell 7,000 passports at around US$20,000 apiece before the transfer of sovereignty. He is even sending over his police force to organize the sales.

Under the joint declaration signed by the UK and China in 1984, Hong Kong will become an "inalienable" part of China on July 1. However, under Deng Xiaoping's one-country, two-systems model, it will be governed autonomously under a capitalist system with supposedly minimal interference from Beijing. This has produced an atmosphere of hope mixed with trepidation. Henry Tang, the outwardly positive chairman of the Federation of Hong Kong Industry (his own company, Peninsula Knitters, employs 12,000), frankly admits: "One country, two systems looks great on paper. I've never seen it done anywhere else in the world."

Will Hong Kongers need those passports? There are two versions of the future that visitors to Hong Kong hear or read about: the optimistic and the pessimistic. First the bad news.

It is June 4 1998. Every year since 1989 a vigil has been held for the victims of the Tiananmen Square massacre. Between 2,000 and 10,000 people have turned out each year to demonstrate and hold placards hostile to the rulers in Beijing, an exercise of the right of free expression. On this occasion, however, it's treason. The world's televisions show pictures of arrests, with protesters being frogmarched out of Victoria Park.

Far-fetched? Perhaps. But the leadership in Beijing has hinted that such demonstrations will not be tolerated. China's unofficial embassy in Hong Kong has traditionally been the Xinhua News Agency. Its deputy director, Zhang Junsheng, this year made a specific reference to the Tiananmen anniversary: "It's up to the laws passed by the post-1997 government to determine if these events continue. But I tell you one thing: this certainly is not a patriotic activity. It also disturbs public order."

The muzzling of the press is perhaps the pessimists' most realistic fear, and if it occurs it will certainly change the atmosphere in Hong Kong. China's information minister, Zeng Jianhui, commented in July: "Hong Kong's press can do what it does now, namely report what other people say. But if the press says we should do something [deemed harmful to China], that's different. No country would allow that." He also suggested that local writers should look to the mainland press for guidance on how to cover sensitive issues such as Taiwan.

Press under pressure

Hong Kong has two major English-language papers and 12 Chinese ones. The standard of journalism is high and often independent in tone. Journalists who fear for the future often refer to the case of Xi Yang, a journalist in China who was given a 12-year jail sentence for disclosing the alleged financial secrets that the central bank planned to sell off part of its gold reserves and that interest rates would not rise for a third time that year. He was kept in custody for seven months, his trial held in secret and his informant jailed for 15 years.

Mak Yin Ting, chairman of the Hong Kong Journalists Association, is mindful of the incident: "I don't think reporters should have to think: 'Is this confidential information that I cannot report?'" She adds: "I don't think reporters will give up without a fight. But some journalists think they will stay in their job until 1997. They have a wait-and-see attitude."

But the pre-eminent fear of the business community is less the move towards a self-censoring press than the growth in corruption ­ although the two will tend to go hand in hand. In last year's New York Times corruption index, China was found to be the second most corrupt country in the world after Indonesia. In contrast, Hong Kong's staggering growth has been aided by its lack of corruption ­ the index found it less corrupt than Japan and on a par with the US.

This has been the case since 1974 when the Independent Commission Against Corruption (ICAC) was set up. Between 1974 and 1995, 54,059 corruption allegations were received, 30,928 of which were directed against public servants. A total of 7,674 prosecutions resulted, 1,523 involving public servants and a further 1,570 private individuals who had sought to bribe public servants. The ICAC estimated in 1991 that the cash and gifts paid to mainland Chinese firms to do business in China added between 3% and 5% to business operating costs.

There is no reason to be believe the culture of Hong Kong is immune to corruption should it fail to be policed properly. The principal fear is that princeling sons and daughters of the Beijing elite, the People's Liberation Army and mayors from China, will muscle their way into Hong Kong franchises. This would quickly destroy the image of the level playing-field, which Hong Kong financial secretary (the territory's equivalent of a finance minister) Donald Tsang refers to as one of the pillars of the territory's success.

Irregularities already emerge from time to time. A famous example led to the resignation in May 1991 of the deputy chairman of the stock exchange, Philip Wong Yu Hong. He had attempted to get the exchange's governing council to return to the old practice of giving members preferential share allotments when new issues were listed. His proposal was pushed through when exchange chairman Lee Quo Wei was away. It was overturned as soon as he returned. Afterwards it emerged that Piers Jacob, then financial secretary, had sought Wong's resignation not just because of the share-allotment affair but because other transgressions had emerged from an investigation of Ronald Li, the flamboyant former exchange chairman, who was jailed for corruption.

This has not prevented Wong, 42, from representing the business chamber in the legislative council. The legislative council (Legco) is Hong Kong's lawmaking body and membership is equivalent to being a UK MP or US congressman. Another businessman, Chim Pui Chung, 49, represents the financial services constituency in the legislature. He is on HK$40 million (US$5.1 million) bail on charges of share irregularities in a property company.

Nor are investors or tycoons averse to ingratiating themselves with their new masters in Beijing. In 1993, for example, a Hong Kong fund was set up by TT Tsui to invest US$25 million in China. There were to be 20 Hong Kong shareholders and 10 from the mainland. When word got out that premier Li Peng had sanctioned the fund personally, it rapidly grew in size to US$65 million and 54 shareholders.

The situation is not helped by the fact that a worrying number of public servants are leaving. More than a third of the inspectorate level of the police have indicated an intention to go. Between April 1995 and March 1996, 237 expatriates left the civil service. The director of public prosecutions, Peter Nguyen, admits to losing 65 public prosecutors ­ 59% of his staff ­ between 1993 and 1995. They had an average 12 years' experience. By law, the top layer of the civil service now has to be ethnic Chinese.

Some businessmen are already complaining of a fall in efficiency. Nick Brooke, senior partner at property consultants Brooke Hillier Parker, says: "To get a planning application approved to get a lease modified for an alternative use can now take up to two years. It used to take a third of that time." About 70% of the companies listed on the stock exchange are real-estate related, so if bureaucracy slows down the real estate sector it slows down the economy as a whole. "I'm more concerned about bureaucracy than corruption," Brooke adds. "Bureaucracy is a creeping malaise."

Another practical issue concerns visas and work permits, the details of which have not yet been explained and about which most investment bankers admit to confusion. Frank Martin, a former banker now in charge of the American Chamber of Commerce, says the present system has become more flexible in recent years. Although regulations state expatriates should arrive in Hong Kong with their work permits finalized, in practice most arrive first and sort out permits later. He notes that if the authorities simply enforce the rules more strictly and are less flexible, the numbers of quai lohs (politely translated as "foreigners") coming to the territory would naturally decrease. This, however, would not affect investment bankers and key staff so much as the transient young population that reinforces Hong Kong's cosmopolitan image.

In the run-up to the handover in July the Chinese political scene could get messy. In September and October a National People's Congress is to be held at which a new central committee is to be chosen, and premier Li Peng is to retire. The resulting power struggle will coincide with the handover, and may make Hong Kong something of a political pawn.

Perhaps this sort of fear is why over half the companies listed on the stock exchange now have their domicile outside Hong Kong.

The most bearish on Hong Kong ­ and on most matters ­ is Hong Kong-based Marc Faber, who owns Marc Faber Limited and is author of the widely respected Gloom, Boom and Doom Report. He acknowledges that although the Chinese authorities are fully aware of the territory's importance to its interests, they will inevitably screw up: "You give your Porsche to your 18-year-old son. He doesn't want to run it into a wall. But the chances are he will." Faber, who has the largest collection of Mao badges in the world, figuring that if Americans collect baseball cards some of the 1.2 billion people of China will collect Maoist memorabilia (recent price rises confirm he is right), adds: "Hong Kong is a dark spot in the history of China. In 100 years' time Hong Kong will be erased from Chinese history."

He observes that while the US stock market is up 40% since January 1994, Hong Kong is down from its high and all the Asian funds are overweight the Hang Seng index. He says it is obvious that locals have been selling. His key doom scenario involves the Hong Kong dollar. "Some time in the next five or 10 years the Dow Jones will drop 40% from its high and capital flow to emerging markets will slow down," he says. "China will need money and will get it from where it can. Hong Kong is China's main trading partner and so it is illogical that the exchange fund has no renminbi in its reserves. Hong Kong will be flooded with China stocks and bonds, and at least 50% of the exchange fund will be invested in renminbi. The next step will be to have just one currency."

He further prophesies that Hong Kong will go the way of Venice, Tangier, Salzburg and Goa. "They all became parts of empires," he says. "All the privileges they were initially given were gradually abolished. In big societies the easiest thing is to abolish the privileges of the few in favour of the many."

Reading the tea leaves

Perhaps the strongest warning comes from China itself. Li Ruihuan, a member of the seven-man standing committee of the politburo, and tipped by some to be the next premier, gave an address in March 1995 in which he likened the takeover to the case of an old lady who had agreed to sell a 100-year-old Yi Xiang teapot that was famous for the quality of the tea it poured. Unbeknown to her its quality derived from the residue that had accumulated inside the pot. In her eagerness to prepare the pot for the purchaser she polished it, removing the residue. When the purchaser came to redeem the pot he pronounced it valueless. The point is that Hong Kong's value lies mostly in qualities that Chinese politicians and administrators do not understand. Too many small changes will clean the pot and spoil the tea ­ Hong Kong's prosperity and usefulness.

In spite of such analogies, there is no doubt that there are far more optimists in Hong Kong than pessimists.

Henry Tang, whose business federation has 2,600 members, says: "The Chinese authorities are exceptionally understanding of the Hong Kong situation. They understand they must leave us alone as a free-enterprise capitalist society. Without these things we'll merely become a coastal city of China." An American Chamber of Commerce survey recently found that 91% of its membership said that the business environment over the next five years would be favourable or very favourable. The British Chamber of Commerce, whose members employ 250,000 Hong Kongers, found in a recent survey that 98% of its members would stay until 2000. "The media like bad news," says Patrick Paul, Britcham's chairman. "Everyone wants it to go wrong. I think it might be all rather dull and anti-climactic."

Alan Smith, chairman of Jardine Fleming, agrees: "It would be easy if you live abroad to think there's a lot of danger ahead. But here, it's not a panicky city." Andrew Lo, head of fund manager Invesco, takes a similar line of argument: "I become more optimistic the more often I go to China." These opinions are
typical.

"Both in terms of evidence and indications from the private sector, I don't think that 1997 is a negative confidence factor," notes chief government economist KY Tang. "Rather it is the reverse ­ greater opportunities will open to the Hong Kong business sector." He forecasts 5% annual growth over the next four years.

The principal reason for confidence is that Hong Kong is so important to China. Between 1978 and 1994 an estimated US$100 billion has been invested in China, 75% of it from Hong Kong. Almost 90% of syndicated loans for use in mainland China are arranged in the territory. And Hong Kong companies have stakes in 42,000 enterprises just across the border in Guangdong (Canton).

"I've been to see Zhu Rongji [China's economic tsar] five times since I took up this job," says Anthony Neoh, chairman of the Securities and Futures Commission, sitting in front of a photograph of Queen Elizabeth II, "and each time he reminds me of the practical importance of Hong Kong to China. There are over 300,000 state-owned enterprises in China. Hong Kong can play an important capital-formation role for China." At present there are 17 state-owned enterprises listed on the Hong Kong stock exchange with a total market capitalization of HK$100 billion.

China also has a lot of money invested in Hong Kong. For example, China International Trust and Investment Corporation (CITIC) has a 20% stake in Hong Kong Telecom, 25% in the second cross-harbour tunnel, 33% in Asia Satellite and 33% in Hong Kong Petrochemical. It has just substantially increased its stake in Cathay Pacific airline. An estimated US$10 billion has been put into the property market by Chinese trading companies. About half these funds belong to quasi-national institutions such as China Resources, China Merchants and China Construction. The rest belongs to regional enterprises like Guangdong Enterprises and Catic (City of Canton). Mainland companies have invested an estimated US$30 billion in Hong Kong.

The People's Liberation Army (PLA), which is estimated to have interests in 20,000 businesses inside China, is also in Hong Kong, with stakes in such firms as Hong Kong Polytechnologies. In addition the PLA will inherit an estimated $70 billion of real estate, including Tamar, the British naval base that adjoins the Central district. According to William Overholt, author of The Rise of China and head of research at Bankers Trust: "There are dozens of PLA firms in Hong Kong. They play by the rules and compete. They like the rules here because they get much more autonomy to behave like businesses. Decisions aren't politicized. They don't want to wreck this."

Overholt, a renowned China-watcher, adds that the rumours that soldiers in the PLA garrison will earn HK$1,000 per month and will get involved in checking visas are misguided. "The PLA garrison is an elite unit and will be confined to barracks. You'll see more American sailors in Wan Chai [a red-light district] than Chinese soldiers."

Countering negative thought

What worries businesspeople is the negative image of the handover that is constantly being portrayed by the media. One of those who is trying to restore the balance is Paul Cheng, chairman of Inchcape Pacific, one of the great hongs (foreign trading houses established in the 19th century). He is a member of the preparatory committee China picked to deal with the transition. He is also a legislative councillor. "A lot of people don't realize how flexible China is," says Cheng, who next to his armchair has a photograph of himself shaking hands with Chinese president Jiang Zemin. "I was recently giving a speech in Australia. The audience was surprised when I said that 12 members of the legislative council [out of a total of 60] can be foreign passport-holders. What other country in the world would
do that?"

Cheng, in common with many Hong Kong businessmen, has done his best to cultivate relations in Beijing. Aside from his duties on the preparatory committee, which at one stage meant spending five days every month in Beijing, he was part of a delegation in March which was told by Chinese foreign minister Qian Qichen: "The fewer changes there are in Hong Kong, the better."

Perhaps the organization with most to lose is Hongkong Bank, which makes 52% of its group profits in the city, and holds about 30% of the city's deposits ­ a similar figure to that held by the Bank of China. "We are bound to talk a good story because of that," chief executive David Eldon candidly admits. "But just look at that outcrop of land where the buses are," says the Scotsman, pointing out of his wall-sized window. "Twenty-four months ago that was water. That's why I'm confident. It's the people and the energy here that make Hong Kong."

Similarly confident is Citibank's Asia tai-pan, Stephen Long. "When I sit down with customers we talk about business. We don't dwell over the handover," he says. Indeed his main concern seems not to be July 1997 but the date when property tycoon Li Ka-shing puts a 60-storey skyscraper on the site of the old Hilton Hotel and ruins his view of the harbour.

Hong Kong is the place to cover China ­ so say the optimists. It is likewise the most central location in Asia ­ being Asian regional headquarters for 51% of major companies. It is three hours' flying time from Beijing, two hours from Bangkok, four hours from Tokyo, and three-and-a-half hours from Singapore. Chek Lap Kok airport is due to be completed in 1998 and the Airports Council International expects Hong Kong to have the world's busiest airports by 2005, serving 82 million passengers a year.

"They are communists, but they are changing," says Philip Wong (no relation of the former stock exchange deputy chairman), the entrepreneur who established and is head of Internet service Asia On-line. He has worked with China for 14 years. "Is China worse than Singapore in terms of censorship? No." The South China Morning Post and the Asian Wall Street Journal can both be read in international hotels in China ­ without sections cut out. He ruefully recalls it was the Crown Colony government that shut down his Internet service for a day last year because it didn't understand it. "I had a press conference and held up the Idiot's Guide to the Internet for the police commissioner to read."

Businesspeople are keen to stress how understanding the Chinese leadership is. Overholt, who is as bullish as Faber is bearish, stresses several incidents where he and Hong Kong businesspeople have taken their problems to Beijing and got their way. He also recalls a lunch with one of those who will contend for the premiership next autumn, Wu Bangguo. "The president of Duty Free Shops was sitting beside me at lunch and mentioned to Wu Bangguo that he had just opened a shop in Beijing. He replied that he knew of it and described the shop in great detail, speaking of its strategy."

Overholt continues: "The best indicator is not necessarily what Chinese leaders say, but how they spend their time. Wu spent his getting briefed about the economy and foreign investment. He's the kind of guy that if he took over IBM in trouble he would instil confidence."

There are three key reasons why the Beijing authorities cannot afford for Hong Kong not to work ­ in the medium term at least. The first is simply China's economic need for growth and the city's ability to generate it. The second is Taiwan. Deng's one-country, two-systems philosophy was originally developed with Taiwan in mind ­ if the People's Republic can show the system works in Hong Kong, then the much bigger prize of Taiwan may follow, finally uniting China. Finally, there is enormous face at stake. If China screws up what Britain ran so well, it will prove the foreign devils are better rulers than the people of the Middle Kingdom, and China will be embarrassed in front of the whole world. So goes the received logic.

Little wonder, then, that men like David Li Kwok-po, deputy chairman and chief executive of the Bank of East Asia, have become positive. "I feel more and more confident as time goes by," says the Cambridge-educated Li. "To be perfectly honest, I think it will be much better than colonial government because that encouraged certain interests."

Hong Kong businesspeople like to talk about this as a takeover, using the analogy that the territory is really like a very well run conglomerate. The analogy fits all the better for the fact that China will replace the British governor with a chief executive. The chief executive has an executive council, which acts in almost the same way as a board of directors, approving major policy decisions. The company analogy only starts to become a little contrived when you try to fit the 60-person legislative council (Legco) into the scheme of things. This is the lawmaking body for Hong Kong and has traditionally acted as a check on the governor. For most of British rule, it was about as democratic as 18th-century Britain, with government appointees supplemented by councillors elected by monied interests and compliant to those interests. This all changed when the British decided to hand Hong Kong back to China, and current governor Chris Patten made it more answerable to the mass of the populace.

In the short term, Legco is the most explosive and potentially disruptive single issue facing the people of Hong Kong. Both Britain and China deny responsibility for this, but the process of making Legco more democratic has thrown up a good few problems.

Briefly, the present Legco, elected in 1995, was supposed to run till 1999. This was called the through-train principle, and was supposed to guarantee some continuity and stability for Hong Kong. A gradual process of democratization was laid out by China for the following two elections. However ­ rightly or wrongly ­ Patten made use of China's deliberately vague wording on the process for electing Legco in 1995 to speed up reforms. Patten extended the so-called functional constituencies ­ which traditionally were hardly democratic at all ­ to make them very democratic. For example, the electorate for accountancy came to include everyone who worked at an accountancy firm, down to the doorman, where previously it would just have consisted of partners. In 1981 the electorate numbered 34,381. After Patten's reforms 2.7 million were enfranchised.

The Beijing authorities were livid. Patten was condemned and called a "strutting prostitute" and a "two-headed snake". More important, the Chinese declared the through train derailed and the elections invalid.

As matters stand, a pro-Beijing selection committee of 400 people is being formed that will "elect" a temporary Legco until "proper" elections can be held in 1998, thus putting an unceremonious halt to the idea of a democratically-elected through train to 1999. Only 16 members of the existing Legco will probably sit on the 400-strong selection committee.

The winners of the 1995 elections, for which there was a turnout of about one million, were the Democrats, a party run by Martin Lee (see interview on page 82). His party received 52% of the popular vote, but since only one-sixth of the population voted it has been argued that this does not constitute a conclusive mandate to speak for the people of Hong Kong.

Martyrs and moneymakers

The danger is clearly that Hong Kong, a business city, has done very well exactly because it has never been a political city. However, it is fast becoming one. The Chinese, rightly or wrongly, feel cheated that Britain introduced political intrigue into the system only as they were getting ready to pull down the flag and leave. What is resulting is an increasing schism between the tycoons who generate the wealth and the Democrats who win the votes. The tycoons are especially suspicious of Lee. They have the feeling that he wants to antagonize Beijing with the ultimate goal of being arrested on July 1 1997 and becoming a martyr.

Ronnie Chan, chairman of top property company Hang Lung Development and a board member of Standard Chartered Bank, has been inviting members of his 2,000 staff to lunch to "take their temperatures". Do they care about Legco? "They don't give a damn," says Chan. "The issue didn't come up, although I danced around it. I invited eight secretaries. But all they were really bothered about was their children's education." Chan also says he had lunch with the Democrat Party's economic spokesman. "He didn't know a thing about economics. It scared me." It turns out the economic spokesman of the Democrat Party is a neurologist by profession.

George Chao, head of Wah Kwong Shipping and chairman of the Hong Kong Shipowners Association, strikes a similar note. "Hong Kong at the moment has overdemocracy and too much social welfare," he says. "It will lose some of its competitiveness. Hong Kong is not cheap." Chao, who employs 5,000 continues: "The reason we have no manufacturing industry is you cannot afford to employ too many people because it is too expensive to sack them. Democrats are to blame for this. In Hong Kong only the system works. We have nothing other than people." Funding the welfare system took up 35% of government expenditure in 1985. By 1995 the figure had risen to nearly 50%.

A more statistically accurate barometer of Hong Kong public opinion exists than Chan's lunches. It is the Hong Kong Transition Report, which has been running since 1992. Its latest survey in February 1996 threw up some interesting results. An encouraging 46% responded that they would freely join China, 54% said they saw no problem with the People's Liberation Army being on their streets and 85% said they were currently satisfied with life. However, 50% of respondents expected corruption to have serious effects on the economy after 1997, and only 7% expected it to have no effect.

Who should be nominated chief executive? The poll was overwhelmingly in favour of the current chief secretary ­ Hong Kong's highest civil service appointment ­ Anson Chan. She obtained 45% of the vote. However, her chances of being appointed by the authorities in Beijing look slim, above all because she is tainted with serving under Patten and the British.

Choosing the chief executive is likely to be difficult. The London School of Economics' Michael Yahuda refers to the process in his book Hong Kong: China's Challenge: "In early 1995 some scholars in Beijing claimed that the central leaders wanted someone whom they could trust; someone who at the same time would enjoy the confidence of the business community; someone who would be a high-profile figure, respected internationally, who would enjoy the confidence of the international financial community. When asked as to whether any such person existed, they freely confessed they did not know of one."

Contenders include Peter Woo, 49, who used to head the Wharf and Wheelock groups, but recently took over the territory's hospital supervisory board and applied McKinsey-style management techniques to improve its efficiency. A good candidate, he unfortunately supported Patten's electoral reforms, a political gaffe that may work against him. Leung Chun-ying is another property magnate, who has made some brilliant connections in Beijing and was made vice-chairman of the 150-person preparatory committee. However, at 41 he may be too young.

TS Lo has said he wants the job, although his public approval rating is below 1%. His connections are good, as is his game of mahjong. His magazine, Window, is suitably pro-China, even though his family is steeped in colonial history with connections to the first compradores of the British trading houses. But he started to deny this legacy almost a decade ago when he resigned from the executive council, a central plank of the colonial establishment, then he dropped his CBE (Commander of the British Empire) and took a Chinese passport. The contrarian and bearish Faber thinks Lo is the only candidate with a personality strong enough to stand up to Beijing.

The only other person to have gone public with his ambitions is the chief justice, Sir Ti Liang Yang. He is viewed as a compromise candidate because he has few business connections. He is originally from Shanghai. But critics suggest his very lack of business experience may count against him.

The favourite ­ barring surprises ­ continues to be shipping tycoon Tung Chee-hwa, who, like Leung, is a vice-chairman of the preparatory committee. In an impressive and maybe significant gesture, president Jiang Zemin chose to shake his hand ostentatiously at a recent gathering of the preparatory committee in Beijing. His chances are further enhanced by the fact that he never seems to have gone on record saying anything, and does a grand job of keeping a low profile.

The result of the "election" will probably become public in late November or early December.

The chief executive's responsibilities will include liaising with Beijing to make certain the Basic Law ­ which could be described as Hong Kong's constitution ­ is upheld, thus maintaining business confidence. The law contains some impressive guarantees, such as Article 22: "No department of the Central People's Government and no province, autonomous region, or municipality directly under the Central Government may interfere in the affairs which the Hong Kong Special Administrative Region administers on its own in accordance with this law."

Towards the end, though, there are a couple of sobering passages. Article 158 reads: "The power of interpretation of this law shall be vested in the Standing Committee of the National People's Congress" ­ meaning China. And Article 159 goes further: "The power of amendment of this law shall be vested in the National People's Congress" ­ China again. So putting your faith in the Basic Law's promises is simply a matter of how much you trust the leaders sitting in Beijing ­ they can change anything whenever they wish.

"China can always change the Basic Law," notes Shiu Sin Por, head of the pro-China economic think-tank, the One Country Two Systems Economic Research Institute. "China can improve it in ways that allow the courts to make the kind of decisions that were intended when China drafted the Basic Law," he adds.

Cynics look to China National Aviation Corporation (CNAC) when they want to prove China-watching is not always logical or fruitful. In a recent deal CNAC and China-controlled Citic Pacific bought into British hong Swire Pacific's stakes in the territory's flagship airlines. CNAC bought 36% of Dragonair at a mere seven times estimated earnings per share, and Citic raised its stake in Cathay Pacific to 25% at a 15% discount to Cathay's share price. The deal got mixed reactions, but informed observers agreed that at least it would prevent CNAC continuing to apply for a licence to operate out of Hong Kong, thereby disturbing the status quo. A joint press statement read: "CNAC Group will use Dragonair as a vehicle for the development of its airline interests in Hong Kong."

Competing against oneself

At the time of writing this assumption appeared to have been turned on its head. CNAC had not withdrawn its application for a licence. It still wished to get one to operate its own flights under the name China Hong Kong Airlines, and Wang Guixiang, chairman of CNAC Hong Kong, recently said the airline certificate and Dragonair were not related matters. "You cannot relate these two matters," he said rather mystically. The situation is thus a bizarre example of a top Hong Kong company exercising a sensible forward strategy with China in good faith, while the Chinese corporation pursues a contrary strategy of its own. Moreover, if the reports are to be believed, CNAC has rather illogically invested in an airline, only to set up a rival that may put it out of business.

In the midst of such operational uncertainty, it's no wonder that one investment bank has set up a trading floor in Singapore ­ with only six people on it. "It will get used more in the future," says a source. "But basically it's a contingency plan."

Perhaps a bigger danger than even the takeover for the city's role as a financial centre is the appalling standard of spoken English. (Not least a problem with taxi-drivers, who on the whole don't speak it at all.) Financial secretary Donald Tsang says he's budgeting to employ 2,000 teachers who speak English as a mother tongue. "With the status of English likely to be scaled back after 1997, this is an area which needs to be kept under constant review," says the Hong Kong Monetary Authority's strategy report.

There is already evidence of a shortage of English speakers. Hong Kong Telecom's directory assistance calls are answered in Guangdong province in China. And the Hong Kong General Chamber of Commerce has sought permission to import as many as 100,000 English-speakers from the mainland to fill positions.

Localization also continues in the upper echelons of Hong Kong business and society. Vincent Cheng is the first Chinese to be appointed to Hongkong Bank's board and is tipped as David Eldon's heir apparent. And those quai lohs who still retain power know it won't be for long. "Five years from now there'll be a Hong Kong Chinese sitting in this chair," says Rod Eddington, chief executive of Cathay Pacific, without malice.

Meanwhile the most important man in Hong Kong is no longer the taipan of the noble trading house Jardine Matheson, but Larry Yung, head of Citic Pacific. Son of Chinese vice-president Rong Yiren, he has been made chairman of the (Royal) Hong Kong Golf Club, which leases its land from the government at very favourable rates. And while Jardines no longer has one of the 12 stewards' seats at the Jockey Club, Yung now does, along with a champion racehorse called Mr Vitality.

After the sun finally sets on Britain's colonial ambitions at midnight on June 30 1997, journalists will probably find their first story before lunch at the (previously Royal) Yacht Club. There the noon-day gun ­ the one referred to in Noel Coward's song Mad Dogs and Englishmen ­ was first fired early last century as a punishment imposed on its owner, Jardines. The local British naval commander was upset that the hong's gun was bigger than his own and ordered it fired every day at noon. It has been ever since. But will this gun, so steeped in colonial history ­ and belonging to Jardines, the noble house of the James Clavell novel ­ be fired in the new Hong Kong, a Special Administrative Region of the People's Republic of China?

A source close to the gun hopes it will be: "We have been promised a high degree of autonomy and we have been guaranteed that Hong Kong's way of life will remain unchanged. The gun will be the first test." *

The future according to Martin Lee

Martin Lee is chairman of the Democratic Party, Hong Kong's largest political party. The Democrats received 52% of the popular vote in the 1995 legislative council elections. He spoke to Steven Irvine about his hopes and fears for the territory's future

If you were an international business would you feel comfortable being in Hong Kong in 1997?

If I were putting money into Hong Kong I would look at the rule of law. Today if something goes wrong, it goes to the courts and you know you get a fair hearing. After 1997 we will have a Court of Final Appeal in Hong Kong, but the problem is that when the Court of Final Appeal has to decide a case which involves an interpretation of the Basic Law ­ our constitution ­ the court must reserve judgement and remit that point of law to Beijing. Here it will be looked at by a political body, the Standing Committee of the National People's Congress. They're not even a group of lawyers. They're politicians.

To give you an example. Suppose the Bank of America were to sue the Bank of China for $20 billion of unrepaid debt. The leaders of China might say, we can't afford to pay this, because it would mean bankrupting the Bank of China. A lawyer may well advise them, despite the contract, to call it an act of state. [Hong Kong has no jurisdiction over these.]

How can you say this is an act of state? Well, they will say, clearly this Bank of America is now trying to bankrupt the Bank of China, and how can they allow that? Anyway it's the Standing Committee of the National People's Congress that determines whether it's an act of state or not. So the Bank of America loses. "It is an act of state, so we have no jurisdiction any more," the Hong Kong court tells it. "Sorry."

What would be your other concerns?

Individual freedoms. When foreign companies send their top executives to Hong Kong, how safe are they? Suppose they have a dispute with a China-funded company. I should give you the example of James Peng. He worked in Hong Kong and subsquently obtained an Australian passport. He then went to China to do business. He found a partner, a niece of Deng Xiaoping, and the business, called Champagne, prospered. But then he had a legal battle with his erstwhile partner. She won in a Chinese court, but on appeal he won back, and in China there is only one appeal. So legally he was in a very strong position. One morning he was in Macau, and was abducted and spirited away into China where he was kept in custody because his erstwhile partner had a lot of clout.

He was kept there without being charged for two years. Ultimately the Chinese government made a new law. He was convicted retrospectively and was given 15 years in jail. The Australian government has made over 100 protests. Of course, I'm painting a very negative scenario, but it could happen.

But there does seem to be a lot of optimism among business people.

Of course: it's in their interests to preach optimism, because it is hoped that more people will invest in Hong Kong. The stock market is relatively small and can be manipulated by money from China. I'm sure they will have already told tycoons, okay let's all make money. You put the money in now, buy shares, then we put the money in and buy shares, we all make money. Why not?

Many of the Chinese leaders, especially the foreign minister, have been making positive noises.

My experience with the communists is that individually they are nice guys, but when it is the Communist Party they all speak with one voice.

What are you going to be doing June 30 at midnight?

We don't know, but we'll do something.

Do you think you'll be a martyr?

I don't intend to die yet. I also don't believe there will be political assassination.

Long live the Shanghai mafia

The "election" of the new Central Committee and prime minister in Beijing next September will create some uncertainty for Hong Kong but throws up interesting possibilities.

Notably, all the candidates to succeed Li Peng as prime minister of the State Council are considered less hard-line and more moderate than the incumbent. Wu Bangguo is thought to be president Jiang Zemin's candidate. Li Ruihuan, chairman of the Chinese People's Consultative Conference, has a mandate to deal with Chinese peoples outside China and is considered a reformer. He was the originator of the perceptive teapot analogy which refers to the Hong Kong problem. Qiao Shi, in his role as chairman of the Standing Committee of the National People's Congress, has come out in favour of the rule of law in China ­ partly because that shifts more power to the National People's Congress, which he runs. And Zhu Rongji, the economic tsar of China, has consistently made the right noises about Hong Kong ­ he even modiWed an investment tax designed to curb speculation after Hong Kong businesspeople explained it would be detrimental to their investment plans in China.

Of those listed, only Li Peng, the current premier, does not speak English. Zhu Rongji's English is so good that he often corrects the nuances of his translator. Jiang Zemin is famous for quoting whole sections of the us constitution to Bill Clinton. Both Zhu Rongi and Jiang Zemin are former mayors of Shanghai. Qiao Shi was educated at Shanghai Tongji University, while foreign minister Qian Qichen was born in Shanghai, and Wu Bangguo spent his entire career in Shanghai, eventually becoming secretary of the Shanghai Municipal Committee.

The optimists in Hong Kong say that as long as the Shanghai maWa hold sway, Hong Kong's future will be relatively secure. It's comforting that the newly published oYcial Chinese dictionary no longer contains ultra-leftist terms. It does include new entries such as "karaoke" and "special economic zone". ­ SI

"We just cannot go back"

Donald Tsang is Hong Kong's financial secretary. He is the second most important civil servant in Hong Kong, and although unelected his role is similar to that of a finance minister. This is an edited version of an interview he gave to Steven Irvine

Is it possible to separate politics from business?

Only to a certain extent. In Hong Kong our political stability rests entirely on our economic performance. Our value to China rests largely on our economic prosperity.

Do you think investors should be concerned that because the Chinese have already broken the Basic Law by abolishing the elected legislature it sets a bad precedent?

China has never accepted that it has broken the Basic Law by reconstituting the legislature, because the Basic Law starts to run on July 1 1997.

What I am more concerned about is how the legislature is actually constituted, and whether it will have the support of the community here, and what credibility it will have.

But intelligent investors might then think, well, is the rule of law going to be that important?

The rule of law is absolutely important, and underlines Hong Kong's success. It is one of the four pillars: freedom of the press, freedom from corruption in public service, the rule of law and a level playing-field. These are the four pillars underpinning Hong Kong's success, and the nature of what I call Hong Kong-style capitalism.

Of your four pillars, freedom of the press is vulnerable. One article said China has indicated through its ministry of information that it might manage the press.

I think that's probably an erroneous report. We are going to practise the Basic Law here. The freedom of the press is enshrined in the Basic Law. Of course you cannot slander, or get involved in subversive activities. I think that's probably what the Chinese authorities referred to ­ exaggerated, I'm afraid, by some reporters.

And corruption?

China's China, Hong Kong's Hong Kong. We will no longer stomach corruption in Hong Kong. We rose from that level in the 1970s when we established the Independent Commission Against Corruption. We just cannot go back.

If for example you were being pressured by an official in China on a government tender, would you resign?

First, how would he pressure me? There is no way he can do it. Our procurement procedures are transparent. If anybody tried to ring me up and threaten me, that Chinese official would end up in jail ­ if he's in Hong Kong.

If the chief executive asked me to show favouritism, again that's against the law. I might resign or the chief executive might end up in jail. I just don't see it.

But I do understand the question. During [investment] roadshows, people always ask me similar questions. But I come back again to the Basic Law. What is important is for us to defend those rights. I'm not saying that there will not be pressure, but it is for us Hong Kong people to stand up to it. And because of the transparent way we do things in Hong Kong, such shenanigans will be apparent to all and sundry.

If you saw signs of corruption would you resign?

Why should I resign? I would stamp it out.

But if you felt that it was impossible to do anything about it?

How could that happen? But of course, if it was something I felt I could not do anything about I would resign.

In the midnight hour

At the stroke of midnight a bevy of international handshakers will be in Hong Kong for what promises to be the biggest party of 1997. Over 2,400 journalists will also be there, including a posse from cnn that has booked 60 rooms in the territory's most central hotel, the Mandarin Oriental ­ for three whole weeks.

Nothing is certain about the handover celebration except that it will happen on June 30 1997. The Chinese authorities have a "celebration committee" working on it but have released very few details. Planning would appear to revolve around whether the long-standing leader, Deng Xiaoping, is still alive and able to go.

Another piece of protocol is not a matter of life or death, but gossip has it that the Queen will send either Prince Charles or Princess Anne to represent her, depending on how much face the British government wants to give the Chinese. The governor, Chris Patten, known locally as Fei Pang or Fat Patten, may possibly sail away on the Royal Yacht Britannia in a dramatic exit from the Fragrant Harbour the gunboats Wrst sailed into over 150 years before.

China will inherit the 89th largest population in the world and a territory with a gdp a Wfth the size of its own; the eighth largest trading "nation" in the world, and an economy recently reckoned by the Heritage Foundation's index of economic freedom to be the world's freest. In just a small central part of its 1,036 square kilometres it houses 80 of the world's top 100 banks and a Wnancial services labour force of 350,000 ­ just 50,000 short of New York's.

Hong Kong has been British since the victories over China in two separate drugs wars ­ or opium wars, as history chooses to call Britain's enforcement of freedom to trade narcotics. Both the treaty of Nanking and the Convention of Peking guaranteed that the uk would govern both Hong Kong island and the Kowloon peninsula until the end of the world. However, a third treaty was signed in 1898 by British minister Sir Claude MacDonald to lease the New Territories beyond Kowloon for 99 years. This makes up 92% of the territory's land mass and it is its lease that runs out on June 30 1997, making retention of Hong Kong untenable, militarily and politically. ­ SI