In The Tiger Eye

Chairman Mao Zedong once reportedly remarked that Hong Kong was no more than a pimple on China's backside. In economic terms at least, the perspective today is not quite so unflattering, even if the mainland still dominates. Hong Kong's economy is a quarter the size of China's and the two are closely intertwined.

Long before the handover was even dreamed of, Hong Kong played an important role for China as a source of foreign exchange. Economic interdependence has grown since the Cinese reforms of 1979 opened up the Pearl River delta to Hong Kong manufacturing investment. Most analysts assume that the trend towards economic integration will intensify after July 1, even under different systems.

 

China's own growing significance in the world economy means the Hong Kong business cycle is driven by developments north of the border. Gone are the days when Hong Kong's economic affairs reflected the state of demand in North America.

With US$99.3bn of paid up foreign investment in China, Hong Kong accounts for more than half the overseas investment in the mainland. About 36 per cent of its trade involves transshipment to and from China, a share, which, according to trade, has been edging up.

According to Mr Wang Wende, head of Hong Kong affairs at the trade ministry in Beijing, the territory will continue to play an important role as a provider of infrastructure, capital and services for China after the handover. Its role as a gateway will last for many years, he says, not least because Hong Kong's sophistication as a financial centre puts it well ahead of anything China can offer.

Evidence that businessmen in Hong Kong agree is there for all to see. The territory's port are full of Chinese goods; its banks are busy arranging share issues for mainland companies and finance for large infrastructure projects; its companies, often backed with mainland capital, are setting up deals to build new power stations, roads and telecommunications installations.

Not all agree, however, Mr Rajiv Lall, of E M Warburg PIncus in Hong Kong, argues, that China will need Hong Kong less as it develops its own centres, further away from its newly industrialised south. Already, he says, the share of China's trade that passes through Hong Kong is leveling out. Eventually it will fall, forcing Hong Kong to look outwards again towards the Pacific.

"As the Chinese economy becomes larger, the relative importance of Hong Kong will diminish anyway," says Mr Fan Gang, a Beijingbased economic consultant. "But I don't think that this will have a big impact on Hong Kong itself. It is only relative."

Thus, even as China develops ports and financial centres, Hong Kong will still make a living by providing services to southern China.

But if the two economies are already well integrated, the handover comes at a time of mixed performance on the mainland. While growth is sluggish by recent standards, inflation appears well under control and China's economic leaders believe they have achieved a soft landing from the economic overheating of 1993 and 1994.

Announcing the budget in March, Mr Liu Zhongli, the finance minister, said he expected the economy to grow by 8 per cent this year, a rate still high by western standards, but one that in China marks a continuation of the economic consolidation phase established last year.

While overall retail sales remain buoyant and exports are picking up, China's recent economic performance has been marked by excessive inventory accumulation. Mr E C Hwa of the World Bank in Beijing calculates that inventories at the end of last year amounted to some 6 to 6.5 per cent of gross domestic product.

This only about 1 per centage point above their long-run average, but

unwinding them will create a drag on the economy at a time when investment spending is running at relatively low levels and overcapacity has emerged in sectors such as passenger cars.

Such a sluggish economic climate might prompt reflationary measures, but the

government is keen to maintain an investment squeeze on state-owned industries to encourage them to reform, and the people's Bank of China is concerned that further monetary relaxation might provoke a bubble in China's already fizzing stock markets.

Still, such conservatism appears welcome in Hong Kong. In the short run, surplus liquidity in China has spilled over into Hong Kong's financial markets.

In the longer run, China's government has demonstrated a new sophistication

in the current economic cycle in the way it has engineered a soft landing. Given the high level of economic independence, economists say that this can only be good for Hong Kong.

China may have granted the territory economic independence for the next 50 years, but now, more than ever before, its actions at home will determine whether the experiment will work. Two systems cannot flourish in one country without the confidence inspired by sound economic management in Beijing.