TNAG-2749-FCO40-3964-Economic-situation-in-Hong-Kong-1993 — Page 74

BANK CONFIDENTIAL

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3 Data: Post-1991 reserves are calculated according to the new official format (i.e. excluding reserves held by Bank of China). Since it is felt that the official exchange rate does not satisfactorily reflect the experience of exporters, the forecast adopts the Fund's weighted exchange rate for exports (an export-weighted average of the official and swap market rate; see SM/93/56 p.95). 1992 preliminary estimates (mainly IFS) are used throughout, except debt figures (World Debt Tables until 1991) which have been forecast from 1992 onwards. Historically, there have been large errors and omissions in the balance of payments ($8.2bn in 1992), reflecting large unreported outflows. Trade data are somewhat problematic, as much trade involving joint ventures and foreign firms in special economic zones (SEZS) is not included, but for lack of any suitable alternative we have used IFS data. FDI data, too, are conceptually flawed since there is a large quantity of inward investment of illicit funds originating from China (motivated by tax breaks on FDI) which the figures fail to differentiate.

4 China's growth remains cyclical, with a forecast trend growth rate of 8-9%. The economy is presently at the peak of a cycle which began in 1990. However, there are a few signs that austerity measures introduced this summer may be beginning to bite, reining in liquidity and curtailing investment in speculative activities. Anecdotal evidence suggests that activity is already slowing down, even in the foreign assisted sector, where local joint venture partners are having difficulties meeting financial commitments. But it is still too early to jucge the success of these measures. Following 93H1 growth of 14% (YoY), the forecast predicts growth slowing to 11% in 93H2 and to 12.9% for 1993 as a whole. The economy is forecast to reach the bottom of the present cycle in 94Q4-95Q1 when growth could dip to 5%. Thereafter, policy easing will allow renewed acceleration in investment, domestic demand and economic growth.

5 Inflation is projected to fall from 14% in 1993 to 7% in 1994 and fluctuate over the forecast period in line with economic cycles. Official domestic interest rates are forecast to rise from an average of 9% in 1993 to 10% in 1994, yielding rare positive real interest rates which will help attract savings into the banking system, tighten liquidity and cool the economy. Over the forecast period, interest rates will fluctuate between 7-10% according to the stage of the economic cycle. The fiscal position is expected to remain in deficit throughout at between 1-3% of GDP.

6 Despite bottlenecks, prospects for China's external trade remain buoyant and the forecast envisages double-digit growth in both imports and exports. Gradual effective depreciation of the yuan in the early part of the forecast' will bolster export competitiveness, while strong growth in above-subsistence incomes boosts import demand. Imports are forecast as a function of domestic demand, which also acts as a constraint on exports through absorbtion of potential exports during periods of high growth. Hence, the trade balance will fluctuate in line with the economic cycle around a modest average trade surplus of $2bn.

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In the first few years, the proportion of transactions conducted at the swap rate will increase, thereby depreciating the weighted average rate. The official and swap rates are assumed to be unified in 1996 (China is committed to doing so by 1997), resulting in repatriation of funds held abroad for speculative purposes.