Manufacturing sector continuing to upgrade while financial sector still not strong enough

Between 2001 and 2003, the high-tech manufacturing industry in Guangdong grew at an annual rate of 36.9%. In addition, heavy industries, like steel, petrochemical and automobile industries, also grew 10.8 percentage points faster than the light industries and become the main driver for Guangdong manufacturing industry. This upgrading activities in the manufacturing sector directly fostered Guangdong GDP to grow at an annual rate of 12.4% between 2001 and 2004. This not only presented a great contrast with the weak economic growth in Hong Kong, Guangdong even outpaced Hong Kong in size last year.

Looking into the future, Guangdong has projected its GDP per capita to reach US$3,500 by 2010 and US$7,000 by 2020. By that time, the GDP per capita in the Pearl River Delta region should even reach US$18,000, a comparable level to the western developed countries. Based on the current growing trend, Guangdong's target for 2010 can be achieved simply by maintaining a 7.8% annual growth rate in the next five years.

Guangdong's industrialization is now transforming into the advanced stage. At this stage, the competitiveness of the manufacturing industry will rely more and more on the support of the services industry; especially the financial industry can foster industry upgrading and better capital utilization. However, the development of the services industry in Guangdong still lags beyond its manufacturing and overall economic development. The services industry only grew at an annual rate of 10% between 2001 and 2004, pushing its share of total GDP from 40% to 36.9%. This is also different from the situation in Hong Kong where the services industry contributed 88.5% of the total GDP.

Though Guangdong has the largest financial market in China with a market size of over RMB$2,000 billion, its financial industry remains weak. The added value for the financial industry in Guangdong was only RMB$46.2 billion last year with 8.4 percentage points lower than its GDP growth. This also led its share of the total GDP decline to 2.9%. In the contrary, the added value for the financial and insurance industry in Hong Kong reached HK$199.1 billion while its share of Hong Kong GDP grew to 13.5%. Furthermore, Guangdong financial industry also lagged the development of the Yangtze River Delta. In Shanghai, the financial industry added RMB$74.1 billion value in 2004, boosting its share of GDP to around 10%.

Indeed, there are several reasons contributed to the laggard development of the financial industry in Guangdong:

The household saving deposits of Guangdong rose to a record of RMB$1.76 trillion last year, around one-tenth of national scale. Its annual growth rate reached 25.3% between 1990 and 2003 which is much faster than the income growth rate there. Since 2003, the deposit growth rate has moderated considerably. It is because of the rising popularity of wealth management services that help divert deposits into some high-yield assets. Nonetheless, the excess deposits in Guangdong still have huge potential to develop.

Since strong economic growth creates huge demands for funds, the total loan balance is now over RMB$2 trillion in Guangdong. However, the pace of loan growth has slowed remarkably recently. Its loan-to-deposit ratio has also fallen from 74% in 1997 to 60% in 2004. In fact, prosperous groups and SMEs in Guangdong now demand better liquidity, value-added and integrated management. The traditional loans service provided by the financial institutions there can no longer fulfill their requirements.

On the other hand, rising of the wealthy middle class and the promotion of household consumption pattern leads to rapid development of the consumer credit business. In recent years, the consumer credit business grew at an annual rate of 20% and reached RMB$200 billion in 2004. Nevertheless, its scale remains limited with the share merely around 14% of the total loan size in Guangdong. Furthermore, mortgage loan is its main pillar with a dominant share of 88%. Other loans, like car loan, revolving loan and private loan etc are still elementary.

In addition, even though the insurance and securities industry has developed rapidly, its total size is still rather small. The added value for the insurance and securities industry was only RMB$11 billion with a share of around 26.2% of the finance industry.

State-owned banks still monopolize Guangdong finance market. In 2003, 89.7% of the financial businesses were owned by the State, with only 2.4% owned by individuals or private corporations.

Though Guangdong is one of the earliest opened markets in China, its openness progresses slowly. Currently, the scale of foreign banks in Guangdong only rankes fifth in China. Their shares in foreign currencies transactions and total added value to the financial industry are only 15% and 2.9% respectively. It is totally different from counterparts in Shanghai that have done nearly half of the same businesses there.

Risky financial environment remains a concern in Guangdong. At present, the financial institutions in Guangdong still suffer from the problems of non-performing loans. A sound and holistic social credit system and banking regulations have yet developed.

Obviously, the financial industry development in Guangdong has unmatched its accelerating strutural promotion. As mentioned above, Guangdong is now leaping to an economy with a per capita GDP of US$3,000. Based on international experience, it is a stage of rapid industry transformation, especially the services industry. When the services industry in Guangdong cannot achieve its upgrading needs, Hong Kong should grab the opportunities to provide those services to Guangdong.

Expaning the scope of financial cooperation

Financial cooperation between Guangdong and Hong Kong can be dated back to the time when the manufacturing industry in Hong Kong moved north. In the past, the scope of financial cooperation was mainly limited to attract the capital in Hong Kong to develop manufacturing industry in Guangdong. It is only a matching of loan demand and supply. According to the statistics of HKMA, the registered banks in Hong Kong provided around HK$20 billion worth of loan to China in 1985. This then rose to HK$71.1 billion in 1997 and is now down to around HK$33 billion.

As the Pearl River Delta has been developed and the industry transformation in the region is continuing, there should have more and deeper financial cooperation between Guangdong and Hong Kong. Indeed, CEPA can facilitate Guangdong and Hong Kong to better allocate their financial resources and improve their financial structures in a regional perspective. Furthermore, the development of cross-border currencies transactions and real-time clearing systems will form the foundation of future development.

On the one hand, Hong Kong should actively participate in Guangdong market in order to grab more business opportunities:

1. The large scale and rapid increase of Guangdong trade activities provides huge opportunities to Hong Kong's trade finance businesses. Currently, the HK$130 billion trade finance businesses in Hong Kong are mainly related to the Pearl River Delta. In order to better adapt to the transformation of Guangdong, banks in Hong Kong should know their customers better and offer more flexible trade financing products. The use of RMB as a denomination in trade transactions should be a natural outcome of future integration.

2. Heavy industrialization, large-scale infrastructures and Asian games facilities all offer huge opportunities to Hong Kong syndicated-loan businesses. Banks in Hong Kong can partner with Guangdong's counterparts to make full use of their mature experiences in syndicated-loan management and operation on one hand and on the other hand minimize disadvantaged competition and market risks.

3. Development of high-tech industry in Guangdong also needs financing services. Based on the cooperation between Guangdong and Hong Kong high-tech industry, Hong Kong can also fund them. For example, Shenzhen high-tech industrial region can work with Hong Kong Cyberport to develop a venture fund system so as to foster combination of both technology and capital.

4. The fast growing SMEs also provide new markets to the banks in Hong Kong. Hong Kong is the largest venture capital centre in Asia with more than 90 venture capital funds mainly invested in the mainland. This can provide both the needed capitals and property transaction skills to the SMEs there. Additionally, Hong Kong banks can leverage on its strong experience in SMEs financing in order to capture more potential businesses.

5. Hong Kong banks have the advantage to help both the large and small corporations in Guangdong to better utilize their capital. Hong Kong banks can leverage on its experience in cash management, assets management, financial derivatives and other financial services to help them to manage and utilize their capital more effectively.

6. Personal financial market in Guangdong also presents new opportunities to Hong Kong wealth management and private banking businesses. In addition, Hong Kong banks can rely on its holistic, flexible and diversified product structure and marketing experience to develop businesses in Guangdong, especially for the mortgage businesses.

7. Hong Kong even has a larger room to develop insurance business in Guangdong. Currently, Hong Kong can start developing high-yield insurance products, like trade insurance, property insurance, reinsurance, risk diversification and management etc. Hong Kong banks can both educate the Guangdong customers about modern insurance and expand the target customers through promoting their insurance products there.

8. Hong Kong banks can participate in securities, assets management, bond issuance and IPO services in the future. This can not only satisfy the investment desires of wealthy individuals, but also provide the wanted capital for business expansion.

In order to enter Guangdong's market, Hong Kong financial institutions can grab the opportunities to develop stronger regional cooperation with Guangzhou and Shenzhen by setting up branches in the major cities of the Pearl River Delta. In addition, Hong Kong banks can also acquire commercial banks in Guangdong or set up joint venture securities, assets management, insurance, trust or even car financing companies in the Guangdong province. This will both foster the opening of Guangdong financial market and even break the state monopoly there.

On the other hand, Hong Kong also needs to attract Guangdong to use its financial services to achieve a grander economic transformation:

1. Well-developed securities markets and internationalized economy in Hong Kong is the perfect place for Guangdong enterprises to raise capital for growth and to realize internationalization. A survey showed that 70% of private-owned Guangdong enterprises would like to set up company or list in Hong Kong. Their investment amount may reach several billion dollars.

2. The developing bond market in Hong Kong can also help Guangdong corporations to raise funds. The target corporations which would like to issue bond in Hong Kong should not only be limited to the growing enterprises, reforming commercial banks can also raise funds through here. Currently, the Chinese Government Treasury Bonds Clearing Company has already linked with Hong Kong bond markets. This provides new investment opportunities for the HK dollars accumulated in Guangdong. As most of the circulating HK dollars are concentrated in the Guangdong province, the development of an offshore Hong Kong dollars market in Guangzhou or Shenzhen does worth further consideration.

3. As Hong Kong is an international financial centre, it can attract Guangdong financial institutions to establish foreign exchange centres or branches directly or acquire local financial institutions in Hong Kong. They can also make use of possible QDII status to participate in Hong Kong markets. Currently, China Merchants Bank is the only Guangdong-based bank that has a branch in Hong Kong. It only provides simple loan and deposit products that would have huge potential to grow in the future.

4. In order to satisfy the investment needs of corporations and individuals, China will continue to loosen their capital restrictions. At the same time, the abolition of estate duty in Hong Kong should be an added advantage to attract Guangdong capitals to Hong Kong. They can rely on the wealth management and asset management experience in Hong Kong to satisfy their investment needs.

5. As the economies between Guangdong and Hong Kong become more and more integrated, the need to expand the scope of RMB businesses in Hong Kong will be intensified. Hong Kong might be able to develop into an offshore RMB centre, which will also benefit Guangdong.

6. The development of financial innovation can help Hong Kong to share the economic successes of Guangdong. For example, DBS Bank plans to set up a Real Estate Investment Trust (REIT) in Hong Kong that mainly composes of high-quality real estate in the Pearl River Delta region.

Meeting the challenges and paving the road for successes

Even though the financial cooperation between Guangdong and Hong Kong has a rosy outlook, it still has to tackle many challenges. In fact, Guangdong does not completely expect to rely on Hong Kong's services industry, even though its own services industry lags far beyond its economic development. Guangdong hopes to build up its own services industry and even aims at modernizing and internationalizing it in the next five years. Its services industry has planned to become the economic driver with 45% and 50% share of total GDP in 2010 and 2020 respectively. This might substitute some service activities in Hong Kong through competition.

On the other hand, the above cooperation cannot be successful without the following prerequisites.

1. Although Guangdong and Hong Kong have cooperated for years, financial cooperation did not take off until China's accession to the WTO. After the signing of CEPA for around two years, Hong Kong financial institutions still need more time to understand mainland, set up businesses there, gather client information and identify the target customers, etc.

2. It is relatively difficult for Hong Kong banks to accelerate expansion by acquiring local banks in Guangdong on its rather state-monopolized market with very few well-developed private targets there. In addition to the four state-owned commercial banks, Guangdong only has three nationwide join-stock commercial banks and six city-based commercial banks. Moreover, almost all of them have assets quality and management problems. Without support of local government, they may be not worth merger.

3. Opening of the financial market in China is a gradual process. Even though banking market has to be opened by 2006 under the WTO's agreement, the rationalization and development of proper rules, procedures and regulations are still a lengthy process. Furthermore, opening of the financial market would encourage more competition. Hong Kong banks might not necessarily have advantages over foreign banks.

4. As China does not have a well-established credit risk management system, the problems of non-performing loan remain an issue. Hong Kong banks have to bear higher risk in developing business there. They might not necessarily have advantages over state-owned banks.

5. China is expected to practice its capital restriction requirements for a considerable time. It is especially the case for overseas investment by private corporations. This would adversely affect the capital inflow to Hong Kong and the related business development.

6. The development of offshore RMB businesses is closely related to China's exchange rate and interest rate reform progress. Even though Hong Kong can carry out some RMB businesses in a trial basis, the Chinese Authority would still act in caution.

7. In order to expand the scope of financial cooperation between Guangdong and Hong Kong, the development of financial infrastructure takes time. For example, a connected real-time RMB clearing system needs to be developed in order to ensure smooth fund flows.

In order to tackle the above challenges and achieve a win-win situation in a regional and country perspective, Guangdong, Hong Kong and the Central Government need to have more communications and develop the prerequisite for future cooperation. Indeed, Guangdong does not rule out the possibility of financial cooperation with Hong Kong. They also stress on leveraging Hong Kong capabilities as an international financial centre to help Guangzhou and Shenzhen to improve their financial systems, capital utilization and financial services quality.

It is believed that the outlook for the financial cooperation between Guangdong and Hong Kong remains rosy under the CEPA arrangement. However, we should be aware of the following possible trends.

1. There must have some inconsistencies between the government-led Guangdong development style and the market-led Hong Kong style. Additionally, the opening of Guangdong market would also attract foreign services providers that may weaken Hong Kong's complimentary role.

2. It is expected that more banking professional and management staff may have to station in the mainland, as there are more and more businesses there. Moreover, the back office facilities, like data processing and training centres, etc should also be moved to Guangdong under the principle of comparative advantage. As a result, Hong Kong financial even services industry may face the same restructuring problem as the manufacturing sector has experienced.

It does worth more considerations on how the above trends would affect the financial cooperation between Guangdong and Hong Kong, together with how it will affect Hong Kong's economy, employment and social structure.

Deng Hui
Analyst