[pic] | COMMISSION OF THE EUROPEAN COMMUNITIES |

Brussels, 8.7.2005

SEC(2005) 922

COMMISSION STAFF WORKING DOCUMENT

Annex to the REPORT FROM THE COMMISSION TO THE COUNCIL AND THE EUROPEAN PARLIAMENT ”Hong Kong Special Administrative Region: Annual Report 2004” {COM(2005)308 final}

TABLE OF CONTENTS

1. ONGOING CONSULTATIONS ON THE REFORM OF THE HONG KONG POLITICAL SYSTEM 3

2. LEGISLATIVE COUNCIL ELECTIONS 7

3. OTHER POLITICAL EVENTS DURING THE YEAR 8

4. CIVIL SOCIETY AND THE PRESS 9

5. THE ECONOMY 10

6. TRADE ISSUES 11

7. APPLICATION OF THE “ONE COUNTRY, TWO SYSTEMS” PRINCIPLE 13

8. EU-HONG KONG RELATIONS 14

ANNEX - TABLES 16

ONGOING CONSULTATIONS ON THE REFORM OF THE HONG KONG POLITICAL SYSTEM

The year 2004 began with high expectations among Hong Kong’s pro-democracy groups. Following successful public lobbying in 2003 against the Article 23 legislation, pro-democracy elements were hopeful of carrying forward that momentum to achieve wider political reform and an estimated 100,000 Hong Kong citizens marched peacefully through the streets on 1st January expressing their will to participate more in Hong Kong’s politics and government. Articles 45 and 68 of the Basic Law of Hong Kong explicitly foresee the “ultimate aim” of the election of the Chief Executive and all members of the Legislative Council by “universal suffrage.” Debate in public, the Legislative Council and the press during 2004 has focused on how and when universal suffrage might be achieved. However, the formal Constitutional Development Consultation process in the event produced mixed results for progress towards universal suffrage.

On 7th January 2004, Chief Executive Tung Chee Hwa announced the establishment of a Constitutional Development Task Force led by members of the HK SAR administration. The Task Force’s mandate was to consult, report and propose on Hong Kong constitutional development. The Secretary for Constitutional Affairs confirmed that the SAR Government had set up the Task Force specifically to take account of the Central Government’s wishes. He said on 7th January that the HK SAR Government itself “originally proposed conducting an internal study to consider whether to create a timetable” (…but…) “Following contacts between the HK Chief Executive and the Central Government, the Chief Executive therefore established this Task Force to enhance communication with the Central Government.”

The Task Force’s public consultations began in February. The public rhetoric and debate on political reform became heated in March when Hong Kong pro-democracy campaigners discussed Hong Kong’s need for political reform while testifying before the US Senate’s Foreign Relations Committee on 4th March. They were criticised as “unpatriotic” by both the HK and the Central Government for discussing the Hong Kong’s political development with “foreigners”. On 4th March the Chief Executive said “Hong Kong’s political development is a family affair. We cannot tolerate foreign intervention.”

Mainland legal experts visiting Hong Kong on 16th January had already argued that the central Beijing authorities were vested with the final power to decide on electoral reform and constitutional development in Hong Kong. On the other hand pro-democracy lawyers in Hong Kong asserted that the Hong Kong courts have the final say in interpreting the Basic Law. But on 13th March the Secretary-General of the National People’s Congress (NPC) using a political, rather than a legal argument averred that “the Central Government has the decision power from the beginning to the end.”

The consultations and reports during 2004 of this Constitutional Development Task Force have continued under the influence of the Central Government of the People’s Republic of China ensuring that the proposals for development of democracy in Hong Kong will be “gradual”. The position of the Hong Kong Government has followed that of the Central Government.

As regards Selection of the Chief Executive, Annex I para 7 of the Basic Law provides that it “shall be reported to the National People’s Congress for approval .” But as regards the formation of the Legislative Council Article III of Annex II of the Basic Law on the “Method for the formation of the Legislative Council and its voting procedures subsequent to the year 2007” reads “ (this) shall be reported to the Standing Committee of the National People’s Congress for the record. The Central Government Xinhua News Agency announced on 26th March that between 2nd and 6th April the NPC Standing Committee “would interpret” these two articles of the Basic Law dealing with the procedures for changing the election methods of the Chief Executive and of the Legislative Council.

It was in this uncertain context that on 30th March the Hong Kong Government’s Task Force’s First Report on Constitutional Development was published. It concluded that changes were in principle possible to the selection method of the Chief Executive and the formation of the Legislative Council after 2007 but did not go into details of possible changes.

On 6th April the NPC Standing Committee provided its interpretation of the relevant Annexes to the Basic Law asserting that any changes to the selection method of the Chief Executive and the formation of the Legislative Council in Hong Kong after 2007 should be subject to NPC Standing Committee’s decision and approval . During 2004 this position has been consistently argued in public by both mainland legal experts and supported by the Hong Kong SAR Government.

On 11th April an estimated 20,000 people attended a rally in Hong Kong to express their concern at this interpretation. International comment also expressed concern that this would undermine the principle of “Hong Kong people ruling Hong Kong people.”

On 15th April the Hong Kong Constitutional Development Task Force released its Second Report which became the basis of the Chief Executive’s Report made in the same day to the NPC Standing Committee. The Report concluded that the methods for selecting the Chief Executive in 2007 and for the forming of the Legislative Council in 2008 should be amended but that constitutional development “should not be too fast.”

On 26th April, in the light of the Chief Executive’s Report, the NPC Standing Committee announced its decision that “the election of the Chief Executive of the Hong Kong Special Administrative region to be held in the year 2007 shall not be by means of universal suffrage. The election of the Legislative Council of the Hong Kong Special Administrative Region in the fourth term in the year 2008 shall not be by means of an election of all the members by universal suffrage. The ratio between members returned by functional constituencies and members returned by geographical constituencies through direct elections, who shall respectively occupy half of the seats, is to remain unchanged. The procedures for voting on bills and motions in the legislative Council are to remain unchanged.”

Essentially the NPC Standing Committee’s interpretation of 6th April, combined with its decision of 26th April, asserts that Chinese sovereignty over Hong Kong allows China to interpret the Basic Law when essential Chinese sovereign interests are at stake. The NPC decision of 26th April precludes significant progress towards universal suffrage in Hong Kong in 2007 and 2008. However, the NPC decision does not rule out constitutional and political reform in the long term and mentions the “principle of gradual and orderly progress, and that the ultimate aims are the selection of the Chief Executive by universal suffrage upon nomination by a broadly representative nominating committee in accordance with democratic procedures and the election of all the members of the Legislative Council by universal suffrage.” Nevertheless, no timeline is given for these possibilities.

While the Hong Kong Chief Executive and Government welcomed the NPC decision many in Hong Kong society objected to it. A motion was tabled in LegCo to “strongly condemn” the NPC Standing Committee for abusing its powers, violating the Basic Law and seriously damaging the “One Country, Two Systems” principle and Hong Kong’s high degree of autonomy. This was blocked by the LegCo President after receiving a letter from the Secretary for Justice saying it was “out of order” to debate a motion criticising the NPC. LegCo members commented that this decision had serious implications for legislators’ ability and free speech rights to criticise the Central Government.

The HK Government’s Constitutional Development Task Force released its Third Report on 11th May setting out the possible scope for amending the methods for selecting the Chief Executive in 2007 and the Legislative Council in 2008. The ideas therein were limited within the tight constraints set by the NPC Standing Committee’s decision on 26th April. Public consultations on these ideas were opened until 31st August.

An EU diplomatic demarche expressing concern about the NPCSC referral’s inconsistency with the high degree of autonomy guaranteed under the Basic Law was made in Beijing and in Hong Kong on 28 May.

On 4th June (the anniversary of the 1989 Tiananmen events) approximately 80,000 people attended a candlelit vigil and then on 1st July an estimated 500,000 marched peacefully through Hong Kong in what was an expression of discontent at the Central Authorities’ decision and the Hong Kong Government’s recent policies.

Public attention then became focused on the campaigning for the Legislative Council elections to take place on 12th September wherein universal suffrage and Constitutional Development were the central issues discussed. Despite the Decision of the NPC, the Democratic Party continued to campaign for universal suffrage in 2007/2008 while the Liberal Party and the DAB Party adapted their programme to campaigning for universal suffrage in 2012. Calls from the pro-democracy camp to propose measures for 2012, and to elucidate a timetable for reforms after 2008 did not receive a positive reaction from the Hong Kong Government. (The LegCo elections are discussed in section 2).

In October a pro-democracy legislator put forward a motion in LegCo proposing to hold a “non-binding” referendum on universal suffrage on the 2007/2008 electoral system. There were reports that he had tabled the motion without any prior consultations, but still all the pro-democracy legislators in LegCo voiced support. Beijing immediately dismissed this as a direct challenge to the authority of the Central Government. The move was criticised by pro-Government legislators, and received a categorical refusal from the Hong Kong Chief Executive. On 15th November the motion was voted down by LegCo when a majority of the directly elected geographical constituency legislators voted for it, but the majority of functional constituency legislators against.[1]

On 15th December the Constitutional Development Task Force published its Fourth Report subtitled the “Views of Members of the Community for Selecting the Chief Executive in 2007 and Forming the Legislative Council in 2008.” The suggestions for change emerging from this report represent only minimal changes in the existing elections systems, i.e. increase the number of Election Committee members from 800 to 1200 or maybe 1600; minor changes in the composition of the Election Committee; and to abolish the requirement for the Chief Executive not to be affiliated to a political party. These changes are defined within the parameters of the NPC Standing Committee decision of 26th April 2004.

This Fourth Report provides two clear overall conclusions as regards universal suffrage. Firstly, it concludes “it is premature and impractical to set out a timetable for the selection of the Chief Executive by universal suffrage.” And secondly, it says that as regards “views that the Chief Executive should be returned by universal suffrage in 2007 as this proposal is inconsistent with the decision of the Standing Committee of the National People’s Congress, the Task Force will not process it further.”

In a brief press session on 15th December, the Head of the Task Force, Hong Kong’s Chief Secretary for Administration repeated that “Hong Kong is a Special Administrative Region of China and any constitutional development changes must require the tripartite agreement which has been enshrined in the Basic Law from day one. So if one of the three parties, in this case the National People's Congress Standing Committee have very clearly indicated that for the elections in 2007, 2008 universal suffrage elections will not be acceptable.”

With such concordance between the Beijing Central Government, the Hong Kong SAR Government and a majority in LegCo the prospects for Constitutional Development before 2007 and 2008 are limited. The universal suffrage question is no longer on the immediate agenda for constitutional reform.

The next formal step in the political reform process was to continue consultations until 31st March 2005 and then for the HK Government Task Force to provide a Fifth Report of the Constitutional Development Task Force in mid-2005. This Fifth Report is expected to make specific formal proposals based on the suggestions and conclusions of the Fourth Report. Thereafter, towards the end of 2005 it is expected that a Sixth (and final) Report of the Constitutional Development Task Force would provide the specific text of proposed legislation to enact the reform proposals which have emerged from the previous reports.

LEGISLATIVE COUNCIL ELECTIONS

On Sunday 12th September 2004, a record 1.784 million people, or 55.6% of the 3.2 million registered voters, cast their ballots for the third Legislative Council (LegCo) election in Hong Kong since the handover. This compares with 43.5% in the 2000 polls and 53% in 1998. The pro-democracy camp secured 18 of the 30 available seats in the Geographical Constituencies (GC) which, together with the 7 gained in the Functional Constituencies (FC), gave them a total of 25 of the 60 seats in the legislature. On the other hand, the pro-government parties, including the Democratic Alliance for the Betterment of Hong Kong (DAB) and the Liberal Party (LP), obtained 12 seats in the GC and 23 in the FC, thereby securing an absolute majority in LegCo. The leaders of the three major parties, DAB, LP, and the Democratic Party (DP), were re-elected through direct vote. Two outspoken independent figures received the highest number of votes among the geographical constituencies. All four barristers from the moderate pro-democracy Article 45 Group were also directly elected. (See the full breakdown of the LegCo election results in Annex).

The LegCo elections took place in an enthusiastic and orderly manner. Whilst the election process itself was marked by delays in several polling stations as a result of a shortage of ballot boxes, and some other problems of an administrative nature were also noted, these incidents did not compromise the integrity of the poll.

Contrary to some earlier predictions, the higher voter turnout did not fully benefit the candidates of the pro-democracy camp, who failed to obtain the majority in LegCo. This can be attributed to several factors, including: the complex proportional electoral system which strongly benefits the pro-government parties, especially with half of the legislature returned from the functional constituencies, whose voters tend to favor pro-government candidates; the spate of “scandals” involving members of the pro-democracy camp during the election campaign (see section 3 of this report); the wishes of the electorate for more dialogue with Beijing rather than confrontation; the lackluster election campaign and tactics employed by the Democratic Party which were admitted by its leadership after the elections to have been mistaken. Nevertheless, the pro-democracy camp parties achieved 61.83% of the popular vote in the geographical constituencies.

Prior to the elections, the political parties had put constitutional development and relations with the Mainland at the forefront of their election campaigns. On the economic front, all the three major parties - DP, DAB and LP – called for the strengthening of economic integration with the Mainland, in particular the Pearl River Delta, with the aim of creating a “super economic zone”. However, on other important policy issues such as education, health, or the environment, few clear positions were tabled.

The record high turnout at the polls combined with the manner in which they were conducted, are positive indicators of Hong Kong’s political development and a sign of Hong Kong peoples’ commitment to democracy. The European Commission welcomes this fact and believes that the demonstrated political maturity of the people of Hong Kong provides a good foundation for progressing toward the Basic Law’s ultimate aim of universal suffrage.

OTHER POLITICAL EVENTS DURING THE YEAR

A variety of political incidents during 2004 showed an increased level of political activity and that the interactions between interest groups within Hong Kong Society were becoming more tense. The style and tone of debate became more pointed and adversarial.

One year after the end of the SARS crisis, Hong Kong’s Secretary for Health resigned on 7th July. His resignation came two days after the publication of the Legislative Council’s report on the handling of the crisis. The report highlighted a series of criticisms and lack of communication with the public. Hong Kong’s Chief Executive accepted the Health Secretary’s resignation “in accordance with the spirit of the Accountability System”.

During the lengthy run-up to the election campaign, several irregularities were alleged in voter registration, especially with regard to forged signatures of citizens who had not registered to vote. There were also concerns about intimidation of voters when the media reported allegations that Mainland officials were putting pressure on relatives of Hong Kong citizens to vote for pro-government candidates. In the same period, there were also the incidents involving three radio talk show hosts, two of whom resigned their posts. (See section 4 of this report).

Election campaigning became more personalised and heated in August following several incidents involving members of the democratic camp. Firstly, a Democratic Party candidate was arrested on the Mainland on August 13th, on charges of “soliciting a prostitute” and without a trial was sentenced to 6 months “re-education” confinement. Ten days later, a pro-government newspaper revealed that a Democratic Party legislator allegedly had misused public funds by failing to declare ownership of a flat which was being rented to the party for use as an office, at a rent above market price.

Members of the pro-democracy camp denied any wrongdoing and claimed that they had been the victims of an orchestrated smear campaign to tarnish the democratic camp’s chances of a clear victory in the elections. Without ever naming it, several members of the pro-democracy camp implied that the Central Government of the PRC was behind the smear campaign. The conspiracy theory was firmly dismissed as groundless by the Central Government’s Liaison Office in Hong Kong. On 9th September, a Human Rights Watch Report severely criticised the human rights situation in Hong Kong. The Hong Kong SAR Government rejected the comments of this report as “groundless and uncalled for”.

In an incident of a different nature, the spokesman of the Democratic Party was denied entry to the Mainland despite the fact that, prior to his departure, he had obtained authorisation from the Liaison Office in Hong Kong to visit Shanghai for academic purposes.

During the same period the Central Government undertook several actions to foster national sentiment. Such actions included visits to Hong Kong of a Chinese naval fleet, the first Chinese astronaut and the Mainland’s Olympic Games gold medalists. There was also the first ever military parade in the territory (inside the PLA barracks) by the People’s Liberation Army.

Three days after the LegCo elections of 12th September 2004, the leaders of the pro-government Liberal and DAB Parties suggested that it was timely to re-introduce the shelved Article 23 legislation, despite the fact that neither party had made any reference to the controversial bill during their election campaigns. Hong Kong’s Chief Executive Tung Chee Hwa quickly dismissed the call and underlined that his Government’s prime concern was “reviving the economy”, before any further discussion on Article 23. He gave no indication as to when the SAR Government plans to re-introduce the bill.

In its report on Hong Kong for the year 2003, the European Commission encouraged the HKSAR Government in its intention to introduce legislation against racial discrimination. In September 2004, the HKSAR Government published for public consultation a draft legislative proposal on the matter. The European Commission welcomes this. It notes that concerns have been aired by the community in the consultation process, on issues such as; discrimination against immigrants from Mainland China, and the lack of mention of the situation of foreign domestic helpers. It hopes that the SAR Government will take all these concerns into consideration in a comprehensive text which will ensure that future legislation is in accordance with the International Covenant on the Elimination of Racial Discrimination. The European Commission also suggests that the introduction, as appropriate, of clear enforcement measures would enhance the future effectiveness of the legislation. The law is expected to come into force in late 2005.

CIVIL SOCIETY AND THE PRESS

Civil society and press influence in Hong Kong continued to rise and went hand in hand with deterioration in the relations of the Hong Kong SAR Government with the press and civil society. Some accusations were voiced of attempts to limit press freedoms. Several major incidents involving strong civil society and press pressure were a sign of growing distrust of government and business. Concerns have been raised that anti-business sentiments, if prolonged, might damage the business-friendly environment and dampen investors’ and international confidence in Hong Kong.

In the face of public pressure and staunch opposition from environmentalists, private property developers gave up their original plan to demolish seven newly built former public HOS (home ownership scheme) residential blocks, known as Hunghom Peninsula, which were being sold back to them by the Government. In the face of mounting public pressure, the developers suddenly declared that in order to avoid political dispute they would not demolish the buildings.

The West Kowloon Cultural District development has also stirred up strident debate and strong criticisms from politicians, businesses and cultural interests. The Hong Kong Government continued to insist upon a single-developer approach that would allow just one developer to coordinate the project and develop the high-value 40-hectare waterfront site. Three finalists out of five groups of applicants were selected. However, smaller property developers expressed dissatisfaction that only very large developers with enough resources were being allowed to tender.

Another major property-financing deal exposed the HK SAR Government to further criticism when the divestment plan of the Hong Kong Housing Authority (HKHA) through an initial public offering of units in a real estate investment trust (namely the Link REIT) was unexpectedly suspended at the last moment before flotation by a public housing tenant’s lawsuit. (See section 5 below for further details).

Thus, during 2004 the Hong Kong press has become more and more critical of the HK SAR Government and its leadership. There is an impression that the gap seems to be widening between civil society and the press on one side and the Hong Kong SAR Government on the other. It is thus to be welcomed that the Hong Kong SAR Government has been intensifying its public consultations during 2004 on a variety of issues.

Some commentators have insinuated that the press has also come under increased commercial and political pressures to moderate their criticism of Government policies during 2004. For example, the three radio hosts resigned during 2004, claiming that they had been intimidated to become less strident in their criticisms. These events prompted 400 academics to address a letter to the Apple Daily newspaper expressing their concern that “there is growing alarm at the threat to ‘freedom of speech’”.

Nevertheless, the Hong Kong press remains dynamically critical and diverse, including many major foreign journalists and organisations that use Hong Kong as their editorial hub for the East Asia region, and deliver their global reporting for the Asia time zone from Hong Kong.

THE ECONOMY

Economic optimism in the beginning of 2004 proved to be sustainable throughout the year. Hong Kong’s economy achieved a remarkable recovery, following the depression caused by SARS in 2003. GDP growth is forecast to reach 8.1% in real terms for 2004. The growth was broadly based, driven by strong exports of goods and services, private consumption and investment spending. There was a major turnaround of asset prices in Hong Kong amid a strong inflow of funds. The property market heated up again. Consumer spending progressively recovered. The 68-month long deflation finally came to an end in July 2004 and was followed by a trend of mild consumer price inflation. The unemployment rate eased steadily from the peak of 8.7% in mid-2003 to 6.5% in the last quarter of 2004.

Hong Kong’s merchandise exports fared well on the back of a buoyant global environment, and also benefited from the sustained weakening of the US dollar (to which the HK$ is linked at a rate of HK$7.80=US$1). According to Hong Kong statistics, total exports rose by 15.9% in 2004 to HK$2,019 billion. Within this total, re-exports increased by 16.8% to HK$1,893 billion, and domestic exports went up by 3.5% to HK$126 billion. Imports increased by 16.9% to HK$2,111 billion, resulting in a visible trade deficit of HK$92 billion.

The influx of Mainland Chinese visitors to Hong Kong provided a strong impetus to the tourism sector, and hence boosted consumer spending. The progressive extension of the Individual Visitor Scheme has made it easier for Mainland residents to make frequent trips to Hong Kong. About 35% of the Mainland visitors were recorded under this scheme during 2004. As a result, total visitor arrivals grew sharply by 40% in 2004, hitting a record level of 21 million, of which 56% were Mainland Chinese visitors.

The financial sector recorded robust growth as well. With strong capital inflows and active trading, the market capitalisation and market turnover of the Hong Kong Stock Exchange hit an all-time high and a post-1997 record. Hong Kong became the world’s third largest equity fund-raising centre in 2004, mobilising HK$266 billion with Mainland enterprises playing a primary role in the Hong Kong securities market. Operations with underlying assets on the Mainland accounted for over two thirds of the volume of the Initial Public Offering (IPO) in Hong Kong.

The property market has rebounded strongly in terms of prices and transaction volume. Residential prices have picked up sharply since mid-2003 especially in the luxury sector. The first land auction since the Government suspended all land sales to control supply in September 2002, was conducted in May, with two more following during the year. All three auctions recorded high closing prices, boosting market confidence. As market conditions improved, the number of homeowners in negative equity fell steadily to below 20,000 or 4% of all mortgage borrowers in the last quarter of 2004 from the peak of over 100,000 in mid 2003.

The fiscal deficit has been a major concern for some years. The Hong Kong SAR Government launched its first asset sale and debt financing programmes in 2004 to ease the deficit. A total of HK$26 billion was generated during the year with the issuance of HK$20 billion Government bonds and the sale of five tunnels and one bridge. Together with increased fiscal revenues, particularly from land-related premiums resulting from a full-fledged property market recovery, the fiscal position has turned around from deficit to surplus after bon issuance. A consolidated surplus of HK$21.4 billion was recorded for 2004-2005. After discounting proceeds from bond issuance, a deficit of HK$4 billion remained. This is a positive development compared to the 3.3% of GDP deficit recorded in 2003-2004. The introduction of a general sales tax, as a means to improve the structural aspect of the tax system, remains an issue to be considered by the Government at a later date. However, it has ruled out the possibility of introducing such a tax prior to 2008-2009. Meanwhile, on spending cut efforts, the legislation passed in 2002 to cut civil service salaries was successfully challenged in court by Hong Kong’s Civil Service Unions. The Court of Appeal ruled that the law was in breach of Article 100 of the Basic Law. The Government stated that it would take the case to the Court of Final Appeal. If the Court of Final Appeal upheld this judgement, it would make it harder for the Government to meet the target of balancing the budget by the 2008-2009 financial year.

A different Government attempt to raise public funds was not as successful. The divestment plan of the Hong Kong Housing Authority (HKHA) through an initial public offering of units in a real estate investment trust (namely the Link REIT) was suspended by a public housing tenant’s lawsuit. The global offering had been heavily subscribed. In Hong Kong alone, over half a million people subscribed to the Link REIT. The listing would have been the world’s largest property trust raising HK$32 billion (€3.1 billion) for the HKHA to carry on its mandate of providing low cost public housing. The debate surrounding the incident revealed sharp societal differences over the privatisation of public assets. Polarisation of the interests of the lower income groups from the middle income groups in Hong Kong became more apparent.

While overall economic performance was impressive, it is to be noted that the wealth gap between the rich and the poor continued to widen, and the structural unemployment situation remained unresolved, with a large pool of unskilled workers in difficulty. This problem is exacerbated by the continued relocation of production and services into Mainland China as cost levels in Hong Kong increase and the economy increasingly integrates with its hinterland.

TRADE ISSUES

In accordance with the Basic Law, the Hong Kong SAR conducts its own trade policy for which it has full competence as a separate customs territory. Hong Kong is a founding member of the World Trade Organisation (WTO). The European Commission welcomes the fact that Hong Kong will host the sixth Ministerial Conference of the WTO from December 13th – 18th 2005. The Commission will continue to work constructively with Hong Kong for the successful conclusion of the Doha Development Agenda, with a view to further liberalising trade and developing and strengthening the multilateral rules-based system under the WTO.

The first phase of the Closer Economic Partnership Arrangement (CEPA) between Mainland China and Hong Kong came into effect on 1st January 2004. CEPA I cover tariff free treatment of goods of Hong Kong origin in 374 Chinese 2004 codes and liberalised market access to 18 services sectors in Mainland China. The second phase of the free trade arrangement (CEPA II) was signed on 27th August 2004, and became effective on 1st January 2005. CEPA II covers tariff free treatment of 713 additional products in the Chinese 2004 tariff codes, and 8 additional service sectors. A total of 1,087 Hong Kong origin products and 26 service sectors enjoy liberalised market access to the Chinese market.

The trade creation effect of CEPA was barely noticeable in the first year of its implementation. Although certain products that benefit from the tariff free treatment recorded marked export growth to China the expansionary effect on overall domestic exports to China remained minimal. In the first year of CEPA implementation, Hong Kong’s domestic exports to China increased only modestly by 3.1%. For trade in services, more than 700 applications for certificate of Hong Kong service providers were submitted in the first year of implementation. Distribution services and logistics services made up the bulk of the applicants. In terms of the number of applications, businesses have not been very active in utilising the free trade opportunities offered by CEPA. The European Commission will continue to monitor CEPA’s implementation, especially with regard to its compliance with WTO rules.

The European Commission continues to be very concerned by the fact that a general competition law has not been introduced in Hong Kong, where anti-competitive behaviour in some areas remains. The case-by-case, sector-specific approach to competition is inadequate to deal with anti-competitive practices that may arise across different sectors, as products and services increasingly overlap and inter-depend . It is noted that the Office of the Telecommunications Authority of Hong Kong acknowledges the inadequacy of the present system[2]. The European Commission believes that a general competition law would help ensure a more level playing field for businesses and be beneficial to the overall economy of Hong Kong by further increasing competition, integration, transparency and trust.

The European Commission fully recognises Hong Kong’s diligent efforts towards increased intellectual property rights (IPR) protection. A Hong Kong SAR Government review of Copyright Ordinance was conducted at the end of 2004, seeking to strengthen and update the legislative framework. Large-scale educational campaigns were launched to promote the importance of IPR. Thanks to the vigorous enforcement actions of the Hong Kong Customs, the local piracy situation has largely been under control. However, the European Commission is still concerned by significant quantities of pirated and counterfeit goods that are transhipped and/or re-exported through Hong Kong to the EU. According to the latest available statistics, Hong Kong was the third largest provenance of counterfeit goods seized at EU borders in 2003, accounting for 6.5% of the total number of cases after Thailand and Mainland China.

he European Commission is concerned that patent rights owners of pharmaceutical products are not adequately protected under the current system of registration of pharmaceuticals. The system allows generic copies of patented drugs to be registered legally, hence approving potential infringing pharmaceutical products giving them legal marketing status to be sold to the public. The European and Hong Kong pharmaceutical industry has been pushing for a legislative change without much progress. The European Commission urges Hong Kong to improve its pharmaceutical registration system to avoid potential infringement of patent rights.

The European Commission welcomes that a review on the existing duty system on alcoholic beverages was being conducted by the HK SAR Government to see if any changes should be introduced. The exceptionally high duty on wine has caused concern among wine-producing states in particular as regards its detrimental effects on the trade between Hong Kong and the EU.

APPLICATION OF THE “ONE COUNTRY, TWO SYSTEMS” PRINCIPLE

The year 2004 was a turning point for the both the economy and the politics of Hong Kong and saw significant changes in the application of the “One Country, Two Systems” principle.

Developments through this year were not encouraging for the maintenance of the political dimension of the principle of “One Country, Two Systems” in particular as regards the principle of “Hong Kong people ruling Hong Kong people”.

Hong Kong’s political system became more integrated with, and was more influenced by, the Mainland. It was also the case that increased interaction and communication between Mainland and Hong Kong individuals and between the Hong Kong and the Central Governments allowed all parties to clarify and understand better their differing expectations as regards extending, or not, political reform and democracy in Hong Kong as provided for in the Basic Law.

The main threat to progress of the Hong Kong political system towards democracy was the decision by the Standing Committee of the NPC in coordination with the Hong Kong SAR Government’s lack of significant reform of the territory’s political system, as elucidated in previous section 1 this report above.

While the rule of law and free speech were essentially maintained in Hong Kong, there were minor incidents of pressure on the system that are elucidated in section 4 of this report entitled “Civil society and the press”.

Hong Kong’s economy returned to high growth and continued to be characterised by market forces, the rule of law, and private contract and property rights (see section 5 of this report). While still retaining an essentially capitalist economic system, Hong Kong’s economy became less separate than before from China’s economy and Hong Kong significantly deepened its economic integration with, and dependence on, the booming economy of Mainland China.

In many ways, Mainland China’s economic system opened up more to Hong Kong and began to converge with it. Chinese government policy allowed its economic operators to work more closely with those of Hong Kong through finance and trade. A large proportion (43 %) of Hong Kong’s external trade was with Mainland China. Mainland China allowed Hong Kong banks to begin dealing (in small amounts) of renminbi (yuan). The Hong Kong Monetary Authority continued to operate the renminbi clearing system established in 2003 in Hong Kong. Over two thirds of the large volume of initial public offering equity flotation in Hong Kong in 2004 actually concerned assets located in Mainland China. Cross-shareholdings and joint ventures between major banks, telecommunications, and airline companies in Hong Kong and China were authorised allowing their organisational integration to deepen across the border. Hong Kong’s Closer Economic Partnership Agreement (CEPA) arrangements with the Mainland were deepened. Hong Kong companies and investors continued to be extremely active in the Mainland, and a new trend was for Mainland companies increasingly to invest and operate in and through Hong Kong.

The Pan Pearl River Delta Regional Cooperation Development Forum, also known as “9 + 2”, provided a framework for discussions and planning as regards major transport infrastructure and interconnectivity projects integrating Hong Kong even more into a South China regional network. This regional integration includes; the proposed Hong Kong-Macao-Zhuhai bridge, increased ferry routes from Hong Kong to other locations around South China, interconnectivity arrangements as regards the five major international airports in the Pearl River Delta area including Chep Lak Kok International Airport of Hong Kong, Hong Kong investment in and operation of ports and container facilities in other parts of the Pearl River Delta reinforcing their systemic integration, and - last but not least - the Mainland’s Individual Visitor Scheme enabled a sharp increase in the number of visitors coming to spend and consume in Hong Kong as well as facilitating work practices and journeys across the border with China.

Thus during 2004 the two economic systems – in China and in Hong Kong – constructively coexisted and further integrated to their mutual advantage, converging significantly.

EU-HONG KONG RELATIONS

The EU is well represented in many sectors of the Hong Kong economy. In terms of foreign investment, the EU was the third largest source of direct investment for Hong Kong in 2003 after the British Virgin Islands and Mainland China. The cumulative value of direct investment from the EU in that year amounted to HK$345.2 billion (35.6 billion euro), accounting for 11.7% of the total, well ahead of the US (6.3%) and Japan (4.8%).

The EU was Hong Kong’s third largest supplier of goods in 2004 after China and Japan, and was the third biggest market for Hong Kong‘s exports, after the US and Mainland China. According to Eurostat, total bilateral trade between the EU and Hong Kong grew by 3% in 2004, reaching 29 billion.

EU companies are leading market players in financial services in Hong Kong. There were 133 foreign licensed banks in Hong Kong of which 34 were incorporated in the EU in 2004. In addition, a total of 68 EU companies engaged in securities and commodities trading business in 2004. In the insurance sector, EU companies ranked first in the number of overseas insurers operating in Hong Kong. Of the 181 insurance companies authorised in Hong Kong, 30 were incorporated in the EU in 2004.

EU companies that based their regional headquarters and regional offices in Hong Kong amounted to 339 and 694 respectively in 2004. There were 37,410 EU nationals residing in Hong Kong at the end of 2004.

European Commissioner for Trade, Pascal Lamy, paid an official visit to Hong Kong between 11th and 14th March 2004. This was Mr Lamy’s second visit to Hong Kong since his appointment to the Commission in 1999. He held talks with Chief Executive Mr Tung Chee Hwa, Financial Secretary, Mr Henry Tang and Secretary for Commerce, Industry and Technology, Mr John Tsang, as well as with a number of prominent European and local business leaders. He also addressed students at the City University on “The EU, Hong Kong and the WTO”, participated in a Town Hall Forum organised by the European Committee of the Hong Kong General Chamber of Commerce and delivered a speech entitled “EU-HK Trade Crossroads” to the European Chamber of Commerce in Hong Kong.

On 20th September 2004, EU Commissioner for Justice and Home Affairs, Mr Antonio Vitorino, and the Hong Kong Secretary for Security, Mr Ambrose S K Lee, opened the first meeting of the Joint EC-Hong Kong Readmission Committee in Brussels. The meeting was convened to discuss the implementation of the Agreement between the European Community and the Government of the Hong Kong Special Administrative Region (HKSAR) of the People’s Republic of China, on the readmission of persons residing without authorisation. The Readmission Agreement was signed in November 2002 and came into effect on 1st March 2004. It is the first agreement of its kind entered into force concluded by the EU. Both Mr Lee and Mr Vitorino agreed that the agreement demonstrates the determination of both sides in tackling illegal immigration, and opens the door to greater co-operation between Hong Kong and the EU in immigration matters. Hong Kong hosted a major conference on electronic identity documents later in the year in December in which the Commission was pleased to participate fully.

The 5th EC-HK Joint Customs Co-operation Committee was held in Brussels on 26th September 2004. Various issued were discussed, such as protection of intellectual property rights, anti-cigarette smuggling measures, implementation of new customs legislation, use of electronic customs procedures and new developments on international agreements.

The 5th plenary session of the EU/HK Business Co-operation Committees took place in Hong Kong on 21st March 2004. The Committees, which comprise the leaders of major companies in the EU and Hong Kong, reaffirmed their aim of promoting and expanding trade, investment, tourism and understanding between the two business communities. Among the topics discussed were the business opportunities arising from CEPA, implications of the Euro exchange rate, EU enlargement and the competitive advantages of the HK-Pearl River Delta region.

The Directorate-General Transports and Energy (DG TREN) of the European Commission has had several meetings with Hong Kong government representatives on the need to amend bilateral air services agreements between Hong Kong and Member States in order to bring such agreements into conformity with Community law following the 5 November 2002 “open skies” judgments of the European Court of Justice. Priority must be given to this, as otherwise existing bilateral agreements will remain vulnerable to legal Challenge.

ANNEX - TABLES

LEGCO Election Results 2000 and 2004

Pan-democratic camp |

Geographical Constituencies | Functional Constituencies |

2000 | 2004 | 2000 | 2004 |

DP | 8 | 7 | 3 | 2 |

Frontier | 2 | 1 |

CTU[3] | 2 | 2 |

NWSC[4] | 1 | 1 |

ADPL[5] | 1 | 1 |

Article 45 Group | 1 | 3 | 1 | 1 |

Others | 2 | 3 | 1 | 4 |

Total | 17 | 18 | 5 | 7 |

Pro-Government Camp |

Geographical Constituencies | Functional Constituencies |

2000 | 2004 | 2000 | 2004 |

DAB/FTU | 6 | 9 | 4 | 4 |

Liberal Party | 0 | 2 | 8 |

HKPA | 1 | 0 | 1 | 0 |

Breakfast Group | 6 | 4 |

Others | 0 | 1 | 6 | 7 |

Total | 7 | 12 | 17 | 23 |

Total No of seats | 2000* | 2004 |

Pan-democratic camp | 22 | 25 |

Pro-government camp | 38 | 35 |

*including geographical constituencies, functional constituencies and Election Committee.

Number & percentage of direct votes received by different parties 2004, 2000 |

2004 | Pan democratic camp 1,094,326 (61.83%) Democratic Party 457,994 (25.7%) | Liberal Party 118,997 (6.72%) Independent Rita Fan 65,661(3.71%) | DAB 454,827 (25.7%) |

2000 | Pan democratic camp 799,249 (60.57%) Democratic Party 464,423 (34.7%) | Both Liberal Party and Rita Fan were elected through functional constituencies in 2000 | DAB 391,718 (29.42%) |

[1] According to the Basic Law (Annex II Article II) “motions, bills or amendments introduced by individual members of the Legislative Council shall require a simple majority of each of the two groups of members present: members returned by functional constituencies and those returned by geographical constituencies”.

[2] In the absence of a general competition law in Hong Kong, the application of sector specific telecommunications laws outside their designated area would be cause for concern. Accordingly, potential competition issues that may be identified outside the scope of present regulations may suggest that a broader regulatory framework would be beneficial to the economy." (paragraph 70, Report on Complaints about Arrangements for the Provision of Telephone and Internet Access Services at Banyan Garden Estate, August 2004).

[3] CTU- Confederation of Trade Unions

[4] NWSC – Neighbourhood and Workers’ Service Centre

[5] ADPL – Association for Democracy and People’s Livelihood