BANK CONFIDENTIAL
investment and consumption will be counter-cyclical and smoothen total domestic investment and total domestic demand. The resulting real GDP growth will follow a trend growth rate of just over 5%, dipping to 4% in 1994 and 4.6% in 1998, and peaking at 5.6% in 1996 and 5.4% in 2000. Inflation is expected to fluctuate between 6% and 8% in line with the fluctuations in growth
13 Hong Kong's trade flows are driven largely by the China ESG forecast, which feeds directly into the Hong Kong trade module. This module looks separately at trade related to out- processing in China, other trade to/from China, and trade not touching China.
(a) Buoyant growth in the out-processing trade is forecast to fluctuate at between 10% and 20% in line with China's economic cycles. The trend growth rates with decline from around 30% in 1991 and 1992 to around 14% by the end of the forecast, reflecting diminishing returns and capacity constraints. The out-processing value-added in China will rise from $14bn in 1992 to $44bn in 2001, while the value-added in Hong Kong will rise from $16bn in 1992 to $32bn in 2001. The change in the distribution of the total value added away from Hong Kong towards China reflects rising costs in Southern China, as well as competitive pressures on Hong Kong's currently high re-export margins.
(b) Other trade with China is forecast to grow in line with China's total trade. Hong Kong is expected to retain its share of China's trade by adjusting its re-export margins downwards. Excluding out-processing trade, Hong Kong's bilateral trade surplus vis-a-vis China will stay roughly constant at $6bn.
(c) Hong Kong's non-China related trade position is forecast to deteriorate. Non-China re- export trade is forecast to stagnate in 1997 and beyond, retained imports are forecast to grow broadly in line with domestic demand, and domestic export growth will stay in low single digits. The resulting overall trade deficit will widen modestly from $3.8 bn in 1992 to $12.4 bn in 2001, as both import and export values grow at around 10%.
14 The invisibles surplus is expected to widen from $3.7bn in 1991 to $20.6bn in 2001, as the service sector expands and concentrates on higher-value added services, with many back-office operations gradually being transferred to neighbouring Southern China. But Hong Kong will also be importing non-factor services in the run-up to 1997, to build the airport and port extensions, although this will fall back slightly in 1997. IPD earnings depend in large part on China's economic cycles, as these affect the stock and profitability of foreign investment in there, whereas IPD payments are forecast to grow at a steady pace.
15 On the capital account, the high degree of volatility of net foreign investment in response to the economic cycles reflect the small size of the net figure relative to the unknown, but presumably far bigger, magnitude of the flows in both directions. There is expected to be a small inflow of debt before 1997 associated with the new airport and other infrastructure projects, and again after 1997 to finance other infrastructure needs. The authorities will be able to add modestly to reserves in each year, so as to maintain total import cover at over 3 months and retained import cover at about one year.