BANK CONFIDENTIAL
7 The invisibles account is expected to remain roughly in balance. Mounting net exports of non- factor services will be cancelled out by mounting cif payments. IPD payments and receipts are both expected to increase rapidly as China becomes increasingly integrated into world financial markets.
8 Buoyant inflow of foreign investment and continued foreign borrowing will allow the authorities to accumulate reserves and thereby boost China's import cover. A substantial positive level of errors and omissions has been retained in line with historical trends. Foreign investment will move in line with economic cycles. Net short-term debt as a proportion of total imports is forecast to fall to historically low levels as a consequence of outward flows of short-term capital.
9 China's debt position is expected to improve slightly over the forecast, with the debt/GDP ratio falling from 18% to less than 7.2% by end-forecast, the debt/export ratio falling from 87% in 1991 to 31% by end-period, and the debt service ratio falling from 12% in 1991 to 6% in 2001. At the same time, the authorities will accumulate reserves to generate import cover of 5.5 months by 2001, compared with 3.8 months in 1992. On the basis of the forecast, the calculated default probability is just over 10%; however, since the bulk of the downside risks are political (and therefore difficult to reflect in the figures; see para 9), we should perhaps work with a figure of at least 20%
Hong Kong Forecast
10 Hong Kong's economy is dominated by its roles as an entrepot (mainly for trade with China), and as an international financial centre (finance for trade and investment with China and off-shore banking for Japan). Because of these roles, Hong Kong's trade flows and its gross external assets and liabilities dwarfs its GDP. Hong Kong's economic fortunes are increasingly intertwined with those of China, and this is reflected in the forecast, with dynamic links between the two forecast spreadsheets to show the effects of China's economic cycles on Hong Kong's trade and investment flows and GDP.
11 Although Hong Kong is not shown in IFS, it publishes abundant data on trade flows, GDP and the financial sector (although imports are only quoted CIF). But the invisibles data cover only non-factor services, and capital account data are non-existent, making debt ratios and IPD flows difficult to estimate. I have therefore as far as possible retained capital account and debt estimates agreed in the last ESG forecast. One welcome addition to the pool of data is the publication of the summary balance sheet of the Exchange Fund, which holds the official foreign currency reserves.
12 The underlying financial policy assumptions are that the exchange rate stays linked at HK$7.80 per USS, that interest rates consequently have to track a fraction of a percent above USS rates. Public sector finances are assumed follow the path projected in the HKG budget's medium range forecast until 1997, with modest budget surpluses after retrocession. Private sector investment and consumption are expected to follow China's economic cycles, but government
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