China: Promise And Peril
Tara Murphy, 01.25.05, 2:55 PM ET
NEW YORK - No single issue occupies the minds of chief executives like China does. It will be a prominent topic at this year's World Economic Forum in Davos, Switzerland. Forbes.com Editor Paul Maidment discusses some of the economic trends and political challenges facing China.
Paul, what's the biggest issue?
Short-term, it is an economic one: Can China slow its breakneck speed of growth in a way that a provides a soft landing of slower but sustainable growth, rather than the hard landing of a recession. Longer-term, it is the big political issue: How long can Beijing continue with economic reform without matching political reform?
How well is the Chinese government doing in slowing the economy?
It is a difficult process. Communist parties traditionally control economies by fiat. They don't have many market mechanisms--like interest rates and credit supply. In China, much of the communist economic infrastructure is still in place, which means the macro-economic adjustment Beijing is trying to pull off works only fitfully. The latest quarterly figures show China's GDP growing at an annualized rate of 9.2%--barely any slackening of pace.
Is that uniform across the country?
No. And that's a problem. More prosperous regions, like the big conurbations around Shanghai and Guangzhou, are growing at around 20%. But poorer rural-inland areas are seeing little or no growth. And that is causing rising, if still manageable, popular dissent. That scares Beijing because traditionally overthrows of Chinese rulers start in the countryside among disaffected rural poor. The leaders in Beijing have to find a way to share the economic prosperity more broadly across the country and tackle official corruption at the local level.
How can they do that?
One way is to make sure that the economic reforms mandated at the top work their way down to the bottom of the system. There is an old Chinese proverb: The mountains are high and the emperor far away. Which means local officials like to do what they want, regardless of what Beijing says. One reason that China recently stopped 30 big construction projects--allegedly on environmental grounds--is that many of them were freelance operations approved by and funded by local officials well versed in cronyism. Another is to sort out the banking system, which is nearly insolvent because at the local level it is being used to prop up bankrupt, state-owned companies. To sort out the banks, you have to sort out the state-owned companies--that is, privatize them, merge them or close them. That is politically tough, because a lot of people will be put out of work. But without reforming the banking sector, China will never have a market economy.
Hasn't the government already started that process by injecting $45 billion of capital into the four major state-owned banks to clean up their balance sheets?
That is a Band-Aid. Two of those banks have managed to reduce their nonperforming loan portfolio to about 5% of their assets, thanks to that government handout. But you have to change the credit culture and learn to analyze credit risks on a market basis, if you are going to get a lasting cure. And that, in turn, means greater transparency in the accounts of the companies borrowing from the banks. China's corporate governance standards are, on whole, way below international standards. There is still a long way to go on all these fronts.
You mentioned that tackling the banking sector and state-owned companies risked putting lots of people out of work. What sort of safety net does China have to deal with that?
It doesn't. In effect, its social security system has been a job at a state-owned company. China is trying to build a social security system, but you have a funding gap a couple of generations wide. That said, there is a lot of liquidity in the domestic savings market, more than $1.6 trillion.
What are the prospects for growth in 2005?
My own view is that the government won't be able to rein in the pace of economic growth much if at all. In fact, I think the Chinese economy will grow faster this year than it did last, despite the central government's efforts to apply the brakes. One reason is that more sectors have been liberalized and certain tariffs have been removed since China joined the World Trade Organization.
What are the implications of the continuing depreciation of the U.S. dollar for China and its stance on currency revaluation?
The renminbi (yuan) is fixed against the dollar, though it can move within a band. I think it highly unlikely that China will revalue its currency in the short to medium term, for all the pressure being put on it by the U.S. Longer term revaluation is probably inevitable. But for now, it isn't in China's economic interest to do so. Because its currency is fixed against the dollar, it makes it a relatively more attractive place for dollar based investors than regions whose currencies are appreciating against the falling dollar. And China wants that foreign investment to fund its development.
What are the wild cards in China's future?
Two: the Taiwan issue and bilateral relations with Washington. Tensions across the Strait of Taiwan will remained strained, and Beijing will build up its military position vis-à-vis Taipei as part of a broader modernization of its armed forces. Keeping the Peoples Liberation Army on board is an important goal for the modernizers. It is also likely that political friction with Washington will increase. Remember how fractious relations were before 9/11, and China will be critical of American unilateralism when it sees it. But the economic realities of the relationship will underpin broad stability.
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