• Number of products with CEPA origin rules expanded by 17 to 1,465
• 40 liberalisation measures spanning 28 services sectors
• Six new business areas opened to Hong Kong residents' individually-owned stores
• Cooperation in the areas of finance, conventions and exhibitions

Shortly before the Hong Kong Special Administrative Region (HKSAR) marked its 10th anniversary of establishment, the Central and Hong Kong governments agreed on 29 June of 2007 on the latest round of liberalisation measures under CEPA (thereafter, CEPA V) which are to be effective from January 2008.

On the heels of the implementation of CEPA IV measures from January 2007,¹ the agreed CEPA V liberalisation measures cover trade in goods, trade in services, trade and investment facilitation, financial cooperation as well as in mutual recognition of professional qualifications. Under CEPA III, all Hong Kong-made products are eligible for zero-duty access to the Chinese mainland if they comply with the agreed CEPA rules of origin from January 2006. Through the implementation of CEPA from January 2004 to June 2007, the number of goods eligible for tariff-free treatment rose from 273 to 1,448. CEPA V has added 17 new products to the list, to bring the number to 1,465. For these items, the applicable tariff rates which would otherwise apply range from 4% to 30%.

Compared with CEPA IV, which added 15 liberalisation measures in 10 services sectors, the scope of service liberalisation under CEPA V is even wider. A total of 40 liberalisation measures spanning 28 services sectors are added, with 11 new services sectors. Apart from WTO-plus access, Hong Kong services suppliers can also expect to enjoy CAFTA-plus access to the mainland market, as CEPA V provides them with even better market access to the Chinese mainland than their counterparts in ASEAN.²

Hong Kong permanent residents with Chinese citizenship are allowed under CEPA to set up individually owned stores throughout the country. CEPA V broadens their services scope to provide six more kinds of services, namely: computer services, software services, road transport goods handling services, other transport services except international freight forwarding and courier services, storage and warehousing services, and translation and interpretation services to business activities. These new measures will further stimulate the entrepreneurship of Hong Kong residents.

Consistent with the mainland's commitment in its 11^th Five-Year Plan to supporting the development of financial services in Hong Kong and maintaining Hong Kong's status as an international financial centre, the two sides have agreed to strengthen cooperation in the areas of finance. For example, measures will be undertaken to actively support mainland banks to set up subsidiaries for business operations in Hong Kong and to establish a fast track for applications by Hong Kong banks to set up branches in Guangdong. Apart from this, the mainland has also agreed to offer support and cooperation to Hong Kong for organising large-scale international conventions and exhibitions.

Trade in Goods

Recent Developments

The Chinese mainland has granted all products of Hong Kong origin tariff-free treatment under CEPA III, which took effect from 1 January 2006, except for prohibited items such as used electrical machinery and medical products, chemical residual, municipal waste, tiger bone and rhinoceros horn. However, eligible products must fulfill the CEPA rules of origin to enjoy tariff-free treatment. For products which have no agreed CEPA rules of origin, Hong Kong will initiate discussions with the mainland twice a year upon request by local manufacturers.

From the implementation of CEPA in 2004 until the first half of 2007, the mainland and Hong Kong had reached agreement on the rules of origin for a total of 1,448 products. Effective from 1 July 2007, 17 new products have been included in the list of goods eligible for tariff-free treatment under CEPA. As a result, the number of products with agreed CEPA rules of origin, and hence which are eligible for zero-duty access to the mainland market, increased from 1,448 to 1,465.

These newly-added products cover cut flowers; branches, foliage and grasses; chewing gum; medicaments containing sulfa dugs; black printing ink; tools for milling; knives and cutting blades; piston engines; cranes; video recording or reproducing apparatus; colour projectors; and mechanical wrist-watches. In 2006, Hong Kong's domestic exports of these 17 products to the mainland only amounted to HK$8 million. But now with zero-duty access, Hong Kong's domestic exports of these products to the Chinese mainland are expected to go from strength to strength in the way ahead. Without tariff-free treatment, the applicable tariff rates for these 17 products range from 4% to 30%.

Particulars of 17 Newly-added Tariff-free Hong Kong-origin Products

Cost Savings for Hong Kong Products

The immediate benefit of tariff-free access is cost savings for Hong Kong's domestic export items being sold to the Chinese mainland. From January 2004 to June 2007, a total of 24,174 Certificates of Hong Kong-origin (CEPA) were approved under different phases of CEPA, incurring a total value of HK$8,660 million. Textiles and clothing products were the largest beneficiary, followed by food and beverages, pharmaceutical products, plastics and plastic articles, chemical products, paper and printed articles, and colouring matters.

Distribution of Products Approved with Hong Kong Origin
(as of 30 June 2007)

Note: The total figure is smaller than the sum of all product types as one Certificate of Origin can cover products of more than one type.

Indeed, spurred by the growing number of products eligible for tariff-free treatment, which have surged from 374 in 2004 to 1,465 at present, the share of Hong Kong exports benefiting from CEPA in Hong Kong's domestic exports to the mainland has increased from 3% to around 10% accordingly.

Export Value of Goods Benefiting from CEPA
and Their Shares in Hong Kong's Domestic Exports

With the origin rules of an increasing number of items to be worked out over time, it is expected that zero-tariff access to the mainland market will stimulate some manufacturing activities in Hong Kong, and provide an impetus for Hong Kong's domestic exports to the mainland. While the CEPA rules of origin have now been agreed for 1,465 products only, all other products will subsequently be eligible for tariff-free access, amid applications by Hong Kong manufacturers and the rules of origin being agreed and met. Existing production can also be expanded to take advantage of the zero-tariff benefits.

Apparently, most manufacturers in Hong Kong will continue to use the mainland as their main production base. Yet, some may consider revitalising their existing facilities or setting up new production lines in Hong Kong to take advantage of CEPA. Meanwhile, given the zero-tariff advantage of Hong Kong's domestic exports to the mainland, it is hoped that some foreign manufacturers that plan to set up production lines in the region will be attracted instead to Hong Kong.

Given that the ultimate or target market of these companies is the Chinese mainland, tariff savings in Hong Kong must be substantial enough to offset the higher Hong Kong production costs. Alternatively, for products with high value-added content (in terms of brand, design, quality, technology, etc.) or intellectual property (IP) input being the major component in their total cost structure, production in Hong Kong would be more feasible if Hong Kong could generate a higher IP value, or provide better IP protection.

In these circumstances, it is expected that some high value-added or IP input industries that do not require a mass scale of production would probably be set up in Hong Kong. These industries are likely to be high-end lifestyle products that have a strong design element. A case in point is clothing, of which Hong Kong still maintains quite substantial production locally. Prior to 2005, existence of a clothing quota encouraged Hong Kong companies to retain domestic manufacturing in light of the quota availability in Hong Kong. Currently, local production continues to bypass the quota re-imposed by the US and EU on mainland-origin clothing products.

Given widespread food safety concerns on the mainland, food processed in Hong Kong may also instil better confidence in product quality among mainland consumers. A "Made in Hong Kong" label for these products is expected to be a sought-after item by mainland consumers, and their production in Hong Kong seems feasible. In the meantime, production that requires strong protection of the investor's proprietary technology or R&D results, such as medicines, may further find Hong Kong a better investment location, although sales across the border are subject to a set of rules governing drug importation into the mainland.

Effect on Manufacturing Investment

While increased opportunities in exporting Hong Kong-originated products to the mainland market may encourage existing local industries to expand their output and production capacity, it is also expected that some Hong Kong and foreign companies may be attracted by CEPA into setting up new production lines in Hong Kong. Under CEPA, the rules of origin have now been agreed for 1,465 products only. But all Hong Kong-origin products will subsequently be eligible for tariff-free access amid applications by Hong Kong manufacturers, with the rules of origin being agreed and met, including those without existing production in Hong Kong. This demonstrates the positive effect of CEPA in attracting new industrial investment and new manufacturing activities to be located in Hong Kong.

According to a recent HKSARG study for the first three phrases of CEPA³, CEPA had led to HK$305 million worth of extra capital investment in Hong Kong's manufacturing industry in 2005 and 2006, and a planned investment of HK$239 million in 2007 and beyond was envisaged. As regards employment, the study estimated that 3,319 jobs were created in Hong Kong due to CEPA in trade/manufacturing between 2004 and 2006. It was expected that 1,562 new jobs would be further created in Hong Kong in 2007 and beyond.

At present, most Hong Kong factories on the mainland are producing under original equipment manufacturing (OEM) arrangements for overseas markets. Even though some companies have developed their own brands and started selling to the mainland domestic market, most are positioned at the middle- or upper-middle end of the market. In light of the zero-tariff arrangement, Hong Kong companies might be interested in starting a new product line of premium products or new brands in Hong Kong to target the higher end of the mainland market.

It is agreed that although a "Made in Hong Kong" label can be of a higher price for certain lifestyle and fashion products in the mainland market, it must be complemented by a strong or premium brand image. This is because, for most mass-market products on the mainland, price is an important factor of consideration in purchases. Even for branded products, once the brand is accepted, its place of origin is of less importance. Hence, setting up a mass-market product line in Hong Kong might not be feasible or profitable.

Industries that are likely to benefit from CEPA's zero-tariff arrangement and justify production in Hong Kong for selling to the mainland market would need to fulfil one or more of the following criteria.

Likely Criteria for Industries to Benefit from Zero Tariff

Admittedly, only niche and high-end products of traditional industries will benefit from CEPA. Lifestyle products, such as high fashion and accessories, stylish watches and spectacles, are likely to be able to capitalise on the strength and reputation of Hong Kong in design and quality control, and to develop upmarket brands or products for the mainland's emerging middle class. Lifestyle products aside, a "Made in Hong Kong" label may be crucial for certain processed food products, which have the upper hand over mainland brands in terms of quality and safety of consumption.

Apart from traditional industries, Hong Kong may also be able to attract some new local and foreign investment in industries that require strong protection of their proprietary technologies, formulae or inventions. This is particularly true for some industries that are still restricted from forming wholly-owned foreign companies on the mainland. For example, foreign investors must form joint ventures if they invest in the "restricted industries"⁴, such as production of certain medicinal materials, small crawler dozers and small truck cranes, on the mainland. Since the IP value of the proprietary technologies or inventions of these industries is high, foreign investors may prefer investing in a wholly-owned venture in Hong Kong to forming a joint venture on the mainland.

Even for some industries that do not have any restrictions in shareholding by foreign investors in manufacturing projects on the mainland, foreign investors may still be attracted to set up R&D facilities or production of proprietary products in Hong Kong if they are targeting the mainland market, or making use of the advantage derived from the economic synergy of Hong Kong and the mainland. This is particularly true for medium-sized foreign companies which are not familiar with the mainland's business environment, and cannot afford to invest in their own independent R&D facilities on the mainland. Hong Kong's high standards of IPR protection, its status as a free port and the added advantage of CEPA that allows tariff-free and more efficient trade with the mainland, would be an edge in attracting foreign companies to invest in Hong Kong.

Trade in Services

Recent Developments

A total of 40 liberalisation measures covering 28 CEPA services sectors, including 17 existing services sectors and 11 new sectors, are provided in the latest CEPA V liberalisation package. Consequently, the total number of services sectors covered by CEPA has expanded from 27 to 38, with the new CEPA provisions to become effective from 1 January 2008.

Specifically, the Chinese mainland has agreed to relax market access conditions in the following 28 areas, namely: legal, medical, computer and related services, real estate, market research, services related to management consulting, public utility, job intermediary, building-cleaning, photographic, printing, translation and interpretation, convention and exhibition, telecommunications, audiovisual, distribution, environmental, insurance, banking, securities, social services for the elderly, tourism, cultural, sporting, transport (including air, road and maritime) and individually owned stores as a result of the liberalisation measures in trade in services committed under CEPA V.

Services Benefiting from CEPA