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Following is a speech by the Financial Secretary, Mr Antony Leung, at the Royal Institute of International Affairs (Chatham House) in London on "Market Reforms in China : Hong Kong and other catalysts for Change" today (November 26, London time):

Distinguished guests, ladies and gentlemen,

It is a great pleasure to join you this morning to discuss a topic that has great implications not only for Hong Kong, but also for the entire global trading system. China's rapid opening up and economic development - spurred by WTO accession last year - has already caused a significant shift in trade and investment flows. And still to come are another four years of opening up and market reform under the WTO accession agreement.

But before I go on talking about the situation nowadays, let me talk about a few interesting facts in history. If we look back at 5,000 years of Chinese history, there were times when China's influence extended far and wide. During the Han and Tang Dynasties, China was a world economic power. But our country was unable to give birth to capitalism and a market-led economy. During the late Song Dynasty in the 11th Century, the renowned statesman and scholar Wang Anshi introduced sweeping administrative, fiscal and economic reforms that would not be out of place in today's world. But they failed to take root either.

In past centuries, China was a very successful trading nation selling goods and wares throughout Eurasia, the Pacific and the Middle East. I read the other day that China's influence may have extended as far as Africa in the early 14th Century. But it was the Europeans and Americans who become today's leader in world trade. Chinese science and innovation gave the world gunpowder, the compass, movable type and paper. But the industrial revolution began in Britain, not in China.

I mention this because it is interesting to ponder why, in the past, China was unable to capitalize more fully on its advantages as an economic power and a country rich in resources and creativity. There were, of course, various reasons why the Chinese nation was unable to cross the thresholds of opportunity in the past. And even in a whole day I would not be able to explain the politics and intrigue of the Imperial Court that inevitably came to bear during periods of reform and opening up in centuries past.

The best I can offer is a macro-perspective. One often cited reason was the introspective and non-competitive tendencies of the Middle Kingdom, which hampered engagement with the wider world. This, in turn, hindered the development of market forces. Another stumbling block was the lack of a legal framework and institutional support for the development of incorporated business and financial markets.

Now, the situation has changed and we have reached a tipping point. China is fast transforming itself into a real, market driven economy. In the past few years there has been a convergence of catalysts - increased globalisation, advanced information technology, WTO accession and most important of all - the economic flows that Hong Kong has been providing for the Mainland of China.

For the past 20 years, Hong Kong has been the most important facilitator of trade and investment flows into the Mainland. Our robust institutional framework and competitive market environment under a predominantly Chinese population has been the best example available for Mainland reformers and entrepreneurs. But now that China has joined the WTO, some have questioned Hong Kong's continued relevance. My answer is that I strongly believe that Hong Kong matters more than ever. That is because we have a number of advantages that no other city in China has, or will have in the foreseeable future. Let me provide some insights as to the situation now, and what we can expect in the post-WTO environment in the economic flows of people, goods, capital, information and services between Hong Kong and the Mainland.

First, people. There are already extremely strong people-to-people links between Hong Kong and the Mainland. Hong Kong is also a focal point of activity for the overseas Chinese community. They feel comfortable in Hong Kong, and know that this is the best place from which to access the Mainland market. Hong Kong enterprises are the largest, single investors in every Mainland province - why do you think parts of Shanghai resemble the glitzy retail and residential developments in Hong Kong? In adjoining Guangdong Province, there are about 65,000 Hong Kong-linked enterprises employing some six million people. And there are strong links between family and friends. During last year, there were about 120 million visitors going back and forth between Hong Kong and Guangdong. And we have also seen an explosion in Mainland tourists visiting Hong Kong. So, there has already been a significant transfer of knowledge, expertise and business culture from Hong Kong to the Mainland. When Mainland enterprises look for international experience and know how, they naturally look to Hong Kong.

Post-WTO, we expect more Mainland enterprises to use Hong Kong as a bridgehead to the international market. We see Hong Kong developing a role as a hub for Mainland talent and Mainland enterprises. We also expect to see more Mainland tourists coming to Hong Kong. As living standards in the Mainland rise, so will their spending power and ability to travel. Hong Kong is a destination in its own right, as well as one of the world's major aviation hubs.

Second, goods. Hong Kong is China's largest trade entrepot, handling about one-third of all the Mainland's imports and exports. China was the world's sixth largest exporter in 2001, and the largest percentage of exports from China originate from the Pearl River Delta, Hong Kong's hinterland. About 80% of those exports are routed through our container port, which is the busiest in the world, or our airport, which is also the busiest in the world for international air cargo. Hong Kong-developed consumer goods have also established a respected foothold in the Mainland market and are renowned for their quality and value for money.

In post-WTO China, there is bound to be more than one major hub. Trade and investment flows will mushroom over the next 10 to 20 years. Obviously, Shanghai will become a major hub. But the Pearl River Delta, with Hong Kong as its prime services and financial center, will continue to be one of China's most important trading hubs. I will come back to this later.

The third area is money, or capital flows. Hong Kong is already an international financial centre, with a freely convertible currency and no controls at all on the flows of capital and goods. We are the international banking centre for China, and will remain so for some time to come. We account for almost half of the External Direct Investment into the Mainland, and 90% of China's syndicated loans. We have a well-regulated and liquid stock market. Quality Mainland companies have used our bourse and banks to seek global equity and debt funding for their enterprises. We have a Growth Enterprise Market, which is a funding platform for emerging companies, many of them technology related ventures. This year, for example, we have seen the successful listings of the Standard Chartered Bank, which has a primary listing in London but wanted to raise its profile in Hong Kong and China, and the Bank of China, the first major financial institution ever listed outside of the Mainland.

I believe that many former socialist countries envy China for having such a well-developed international finance centre in Hong Kong. As these formerly closed and planned economies opened up to the world, they did not have the same ready-made knowledge base that China had in Hong Kong. They had to start from scratch, but China did not. There is no doubt that having ready access to the financial expertise and systems in Hong Kong has been a great help to the Mainland.

Going forward, we expect to see a significant increase in two-way money flows. The Mainland announced earlier this month the Qualified Foreign Institutional Investors (QFII) programme, which provides foreign investor access to China's domestic equity and debt markets. Other proposals such as Qualified Domestic Institutional Investor (QDII) are also being studied. More Mainland banks are likely to list in Hong Kong, or seek strategic partnerships with Hong Kong or international banks. We also see Hong Kong becoming an increasingly important centre for venture capital, fund management, insurance and bond market development.

My fourth point relates to information flows. Hong Kong is already a broadcasting, media, telecommunications and Internet hub. One of our greatest strengths is that the information needed to make sensible business decisions is freely available in Hong Kong. We expect this role to continue in post-WTO China, and private enterprises are upgrading the physical infrastructure needed to cope with any increases in information traffic to and from Hong Kong.

A fifth point is Hong Kong's strength in the services sector, which accounts for about 86 per cent of our GDP. We have a broad and deep pool of professional talent, servicing international clients in Hong Kong as well as Mainland companies looking to meet international standards of corporate governance and financial reporting. Lawyers, accountants, managers, insurance brokers and actuaries, financial advisers and fund managers, marketing and public relations, transportation and logistics professionals can all be readily found in Hong Kong. They draw on years of experience dealing with business and capital flows between Hong Kong and the Mainland.

At present, the services sector accounts for less than 35% of China's GDP. So we can see that in the post-WTO environment, the call for these services will increase rapidly. Hong Kong is ideally positioned to help fill that need. And indeed, legal and accounting firms in Hong Kong are already making headway.

So, we have already established substantial experience and penetration in the Mainland market as a facilitator of trade, investment and business. And we will continue to leverage these strengths.

Coming back to my point about the enormous potential in the Pearl River Delta. This is the most export-oriented economy in China, and the most prosperous and favoured location for external investment. The PRD covers an area of about 42,800 square kilometers, and is home to some 48 million people. The area is now a manufacturing or sourcing base for about 7,500 large foreign manufacturing enterprises and tens of thousands of smaller and medium establishments. Among them some familiar names - ICI, Swire, Nestle, Philips, Nokia, GE, Hitachi, Nikon and Honda, just to name a few. These companies are combining their own technical and innovative strengths with an abundance of world-class facilities and a steady, reliable and cheap source of labour.

The exports of the PRD, excluding Hong Kong, amounted to over 90 billion US dollars in 2001 - that's more than one-third of all the Mainland's exports. If added to Hong Kong, it reaches 283 billion US dollars, or nearly four times the exports of Shanghai and the Yangtze River Delta. Foreign Direct Investment received by the PRD, excluding Hong Kong, in 2001 was 14 billion US dollars, or almost 30% of the Mainland's total.

But many of the companies in the PRD maintain head-office functions in Hong Kong - logistics, information, management and financial services. The reason they maintain these functions in Hong Kong is because we already have the institutional software required for a successful market economy. The rule of law upheld by an independent judiciary, a level playing field for business, clear and transparent regulatory framework, a clean administration, the free flow of information, protection of intellectual property rights, limited liability of incorporations, low taxes, convertible currency, ease of travel.

Another reason is lifestyle. Hong Kong is Asia's world city. Expatriate business people live in Hong Kong because we have a great range of international schools for their children, we have quality medical care, English-language television, cinemas, theatres, some of the best restaurants in the world, fantastic transport infrastructure and efficient government services.

So what we must and will do is to promote the complementary strengths of the PRD and Hong Kong. That's why we are working hard with our Mainland counterparts to smooth the flows of people, goods and capital across our boundaries. There is no reason why business executives in Hong Kong can't leave home at 7.30 am, handle a problem or hold a meeting in their PRD factory and be home in time to have dinner with the family and watch the news on TV.

Ladies and Gentlemen, Hong Kong has been a unique catalyst for change in the Mainland, and the PRD has been the experiment ground. Within the space of 20 years, living standards in Hong Kong and the PRD have risen dramatically as the economic potential of this region has been slowly and purposefully unlocked.

In 1980, Hong Kong was a newly-industrialised economy, with one-third of GDP coming from the manufacturing sector. We had a per capita GDP of 5,600 US dollars, which put us at about 30th in the league of world economies. China, on the other hand, was an agrarian society with low-efficiency factories and in which the primary sector accounted for one third of GDP. Per capita GDP was only 300 US dollars, which put China 20th from the bottom in the table of world economies.

Today, Hong Kong is a services economy with a per capita GDP of 24,000 US dollars. This puts us at about Number 10 in the world. China is now a rapidly developing manufacturing economy with a growing services sector that accounts for about one-third of GDP. Per capita GDP now stands at 900 US dollars, but in the Pearl River Delta the figure is much higher. In Shenzhen it is well over 5,200 US dollars, while in Guangzhou it is just over 4,500 US dollars.

Within the next 10 to 15 years, I see an even more remarkable transformation taking place within the Pearl River Delta. And Hong Kong will be an important driver of that change. There will be:

* a conglomeration of world-class businesses and factories, with their front offices in Hong Kong and their manufacturing operations in the PRD;

* a huge consumer market of more than 50 million people with an appetite for premium international brands and top-quality local brands;

* new road, rail and ferry services linking Hong Kong and the PRD, with passenger flows significantly boosted by streamlined customs and immigration procedures;

* air and water quality greatly improved, and a wide range of cultural and sporting activities becoming easily accessible; and

* children receiving education at some of the best schools in Asia

By 2010 or 2015, China will certainly have other bustling commercial centres and cosmopolitan cities like Shanghai. But Hong Kong will remain the hub of economic activity for southern China, as well as China's only true world city. As we have proved in the past, we will remain a catalyst for change in the Mainland. And Hong Kong is not just serving China. We are and will remain an international financial and business centre, serving the whole Asia region and beyond.

Thank you very much.

End/Tuesday, November 26, 2002

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