OREANDA-NEWS.  June 04, 2013. The Bank of East Asia (“BEA”) has today released the May 2013 issue of its Economic Analysis. According to the report, it may be appropriate for China to consider following a “twin engine” approach to accelerate the development of the service industry, pushing through reform while allowing for greater involvement from Hong Kong.

China’s 12th Five-Year Plan sees private consumption take over as the engine of future growth, as the contribution from investment and exports moderates. Since income growth is the key factor affecting private consumption, growth in disposable household income is a better indicator of the future direction of China’s economy than GDP.

To maintain the speed of income growth, the government should prioritise the development of the service sector. In this regard, China has been encouraging urban migration. However, in the long run, workers from rural areas should be allowed to have full residential status in second-tier cities in order to stimulate demand for consumer services. There are additional obstacles hindering the development of the consumer service sector.

Chinese households tend to save a significant portion of their income to prepare for the future needs of education, medical care, retirement, and housing. Another hurdle is low investment returns in the absence of stable and mature investment markets. Chinese households do not enjoy positive wealth effects that could fuel consumer spending.

Moreover, inflation encourages households to save even more. During the era of economic expansion, bottlenecks and structural problems in the business services sector have compounded, as have the resultant costs to the economy. There is increasing urgency to enhance the efficiency of business services. The key to successful reform is increased competition, in particular from experienced overseas firms. This will not only lead to direct expansion of individual businesses, but also contribute to lower costs and higher efficiency in the overall economy.

Reform of the financial industry would have the most far-reaching impact on the economy. It has become increasingly difficult for the banking industry to meet funding needs. To fill the funding vacuum, many companies opt to raise funds through issuing trust products. Since it is very difficult for retail investors to evaluate the creditworthiness of the underlying borrowers, the price discovery process is far from optimal. This not only hinders economic expansion, but also increases the level of risk within the overall financial system.

To facilitate China’s financial reform, Hong Kong can play a bigger role to bridge the funding gap. Hong Kong’s banking and equity sectors continue to be the fund raising centre in China. Meanwhile, the development of offshore Renminbi (”RMB”) business paves the way for using RMB funds accumulated in Hong Kong to meet the financing needs of Mainland companies. With the fast pace of liberalisation of the capital account, Hong Kong could do a lot more to relieve the stresses in the country’s financial system. Hong Kong is an advanced service economy. The Mainland service industry could duplicate Hong Kong’s success by adopting its blueprint. However, this will require greater access for Hong Kong’s service industry to the Mainland market. The two administrations have already agreed to remove all barriers to trade in services between the Mainland and Hong Kong by 2015. The focus now should be on ensuring that the implementation matches the promise.

Published on a quarterly basis, BEA’s Economic Analysis provides investors with an in-depth look into current market and economic issues. Copies of the report can be downloaded via BEA’s homepage: www.hkbea.com / Corporate Information / Economic Research.