China's economic growth potential is overstated due to a heavy dependence on unsustainable increases in fixed-asset investment, according to Bank of China International Research (BOCI Research). The mainland urgently needed to adopt micro-level reform - reforming banks and the corporate sector - or high rates of growth will be a thing of the past, said Ho Cheuk-yuet, head of research and strategy at BOCI Research. 'The era of economic reform since 1979 is completed. The next step for China is the fine-tuning process. It needs to carry out micro-level reform on the banking system and corporate sector,' Mr Ho said. 'The coming few years, from mid-2003 to 2005, are crucial for China . . . It has no choice but [to continually] reform.' Despite a strong growth record in the past five years, Mr Ho raised concerns stemming from what he called the 'balance sheet growth paradox' and 'system leakages', which are undermining the quality of growth. According to his report, there was a surge in total assets and shareholder funds of some listed firms in recent years despite a decline in corporate earnings. Last year, aggregate earnings of the 20 most profitable listed A-share companies dropped to 94 million yuan (about HK$88.1 million) from 8.88 billion yuan in 1996. However, during the same period, on the back of bank lending and capital-market activities, total assets and shareholders funds soared 100 per cent and 50 per cent, mirroring the top-line growth of nominal GDP. Also, bank credit advanced for fixed asset investment and incorporated in GDP accounting was often double counted since funds were later used for different purposes. 'I won't say the high GDP growth in China is a fraud, as it is the result of a different way of calculation. I will rather say it is an inflated growth,' Mr Ho said. 'Excessive reliance of overall GDP growth on fixed asset-investments raises questions in the quality of growth and the sustainability of the economic miracle.' Leakage of money going back to the banking system also undermined the effectiveness of monetary adjustment mechanisms. According to the report, corporate lending has not increased despite eight consecutive interest rate cuts since 1996. In fact, rising bank deposits have persistently outpaced loan growth. 'The prescription for stable economic growth is structural changes, not monetary or fiscal stimulus,' Mr Ho said. With micro-level reform, he expects China will have average GDP growth of of 6.5 per cent in the coming few years. At the same time, Mr Ho warned about the diminishing role of Hong Kong with China's World Trade Organisation entry. The coming years would see so-called factor price equalisation as many services that could be performed across the border leave Hong Kong. Mr Ho said Hong Kong might go the way Venice, once a major trade centre in Europe but now reduced to a tourist attraction.