China Holds Its Ground, Despite Economic Warning Signs
November 15, 1998
By ERIK ECKHOLM
EIJING -- First Thailand, then Malaysia, Indonesia and South Korea collapsed. Then Hong Kong and Singapore fell ill. Japan, the onetime powerhouse, sank back into recession. Not to mention neighbor Russia's fall into the gutter.
Through it all China has continued to slog along, its economy bowed but not entirely broken.
If its growth so far this year, officially said to be something more than 7 percent, is sluggish by recent Chinese standards, it looks spectacular compared to the rest of Asia's economies. And despite months of intense global speculation, China's currency has not been devalued.
Monday, President Jiang Zemin will go with some pride to Malaysia for a summit meeting of Asian and Pacific leaders.
Yet China has definitely entered a politically dangerous era of slower growth and rising unemployment. The signs of trouble are everywhere: it is hard to find a family in which at least someone has not been laid off in the last year or two, and in cities like Shanghai and Beijing, new commercial buildings stand half-empty. Around the country, protests by laid-off workers or retirees demanding overdue welfare or pension payments are almost routine.
Still, there is no sense of panic, and for every empty building, another restaurant or shopping center seems to open.
China's leaders, anxious to head off a severe slump and social unrest, are using every Keynesian tool at their disposal to stimulate domestic investment and demand. At the same time, they have delayed the badly needed overhaul of bloated state industries and overstretched banks. Critics say China is creating even bigger, more costly problems later on for its banks and industries. But officials say they had no choice.
"Maintaining growth and fighting unemployment had to get the top priority," said Li Shantong, a senior economist at the Development Research Center of the State Council, or Cabinet. "Unless these two goals are met, you can't address the other problems like banking and state enterprise reform."
The program of monetary and fiscal stimulus measures has already pushed tens of billions of extra dollars into state enterprises, and data from the first nine months of this year show that investments in capital projects, technology and real estate have jumped 20 percent over last year and are accelerating.
A central question is just how soundly the extra funds are being spent. How much is going to build needed roads and irrigation canals and innovative factories, as the government says it intends? How much to build unnecessary office space and to help doomed companies produce unsalable stockpiles, as critics charge?
Because of some deft policy moves, longstanding controls on currency trading and the sheer size of its economy, China does not appear to face an immediate risk of repeating its neighbors' debacles. Rather, the main concern involves the longer-term costs of its all-out program to wrench up the 1998 growth rate to an arbitrarily set target of 8 percent.
"The danger is not a short-term economic collapse," said Barry Naughton, an economist at the University of California at San Diego, "but excess slackening of pressure on state-owned firms, leading to serious problems a few years down the road." Still, Naughton praises the stimulus program as sensible.
When Zhu Rongji became prime minister early this year, he boldly vowed to speed reforms that are essential to future prosperity. Outmoded, money-draining state enterprises would be drastically pruned and the survivors made to stand on their own. The giant state banks, courting insolvency because they had long funneled money to dubious state industries, would only lend on sound commercial terms.
These changes, and the inevitable layoffs of tens of millions of long-loyal and cosseted workers, would be difficult under the best of conditions. Now they have been put on ice as the government pumps a new flood of money through the banks into public companies and projects.
"Political pressures have forced the Chinese leaders to make some decisions that will come back to haunt them," said Nicholas Lardy, an economist at the Brookings Institution in Washington, one of China's sharpest critics on this subject.
Lardy credits the Chinese with some skillful moves of late, like curbing foreign debt by imposing new limits on foreign borrowing by companies and banks. But he warned, "The dangers of a banking system failure are going up."
Other experts say the banking problem should be manageable. But at best, after the current frenzy of government-induced spending, shaking out the state-owned companies and ridding banks of their albatross of bad loans will be all the harder, the ultimate price all the higher.
The Asian crisis hit at a time when China was already facing an economic slowdown. Earlier in the decade the country had spectacular double-digit growth, but also spectacular inflation.
Tight monetary and fiscal policies tamed the inflation dragon without a recession -- China's renowned "soft landing" -- but by 1997, with an 8.8 percent economic growth rate, the country entered a time of deflation and excess production capacity. Some said the tight policies had overshot the mark.
On top of this, global economic strains and the collapse of regional trading partners took their toll. This year the growth in exports has slowed sharply, and the inflow of foreign investment has fallen.
These twin reversals alone would cut two to three percentage points from economic growth, said Yukon Huang, Beijing representative of the World Bank. The government's stimulus package is intended to recapture as much of that potential growth as possible, Huang said.
"The Chinese are walking a fine line," he added. "They need to keep the economy growing so they can pursue the reforms.
"One lesson of the Asian crisis is that in a seriously contracting economy it's difficult for basically sound enterprises, as well as bad ones, to repay their loans."
But the stimulus measures have definitely come at a cost. In a series of changes this year and last, China's banks were told they would be held responsible for bad loans, and would no longer be forced to dole out funds uncritically to state enterprises and local governments with pet projects.
But over the summer, as part of the emergency program to bolster economic activity, banks were directed to expand lending to state companies, again exposing the financial system to trouble as it propped up moribund industries.
This fall the government has used more direct fiscal methods, issuing $12 billion worth of bonds to support infrastructure projects and requiring the banks to lend an equivalent amount for the same purpose.
Ms. Li, the State Council economist, acknowledged that the lending standards of banks had been relaxed, but again said that without economic growth, all else would be lost.
Official statistics show that both lending and investment have jumped, but there is no way to sort out how that money is being spent, and how soundly. Much of the extra punch may be seen next year, experts say.
Critics like Lardy ask why more of the new lending was not directed to the emerging private sector -- virtually ignored by Chinese banks for years -- which might spend it more productively. Government officials say that is impractical on such short notice.
In that, the officials are supported by Ma Guonan, co-director of Asia-Pacific research at Salomon Smith Barney in Hong Kong, who notes that a transition to a sound system of private commercial lending will take time.
"Most state banks only know how to lend to state enterprises," Ma said. "They just don't have the training to know how to evaluate risk in lending to private companies."
This year's growth rate has become a matter of some contention. Seeking to exude confidence, Zhu, in the best old style of the planned economy, has firmly declared and repeated that growth this year would reach 8 percent. Some critics say that even the 7 percent-plus figures registered in the first nine months do not seem credible, compared with other indicators like falling imports and slower growth in power use and freight transportation, as well as declining prices.
Last week even a senior government economist, Lu Benqiang, also of the State Council's Development Research Center, told Chinese journalists that local governments might be fabricating numbers or investing in useless projects simply to increase the growth rate.
If output in the final quarter of this year truly rose enough to pull the annual average up to 8 percent, that would actually be "terrible news," said Naughton, because it would imply such a high level of wasteful investment.
China's neighbors, and the United States, are closely watching for signs that the government might relent in its political determination not to devalue its currency, the yuan. Over the last year, China was said to be suffering a competitive disadvantage as other Asian countries devalued, making their exports relatively cheaper.
In fact, there has been lengthy debate among economists as to whether China, with its particular mix of imports and exports, would benefit from a weaker yuan.
Many experts feel that the case for a devaluation will strengthen next year if countries like Thailand and Indonesia, still reeling from the current crisis, begin to recover. So far, stricken countries in the region have been in such turmoil that few companies have been tempted to move in to take advantage of the low exchange rates, investing in export industries.
But if those countries stabilize, with exchange rates still lower than in the past, they may begin to reap some of the competitive advantages -- at the expense of China's foreign investment and exports.
With sluggish growth, declining prices and large unused productive capacity, China's economy would benefit more generally from a devaluation and the modest inflation it would promote, said Andy Xie, chief China economist at Morgan Stanley Dean Witter in Hong Kong.
Expert opinion is divided as to whether there will be growth next year at close to this year's level, whatever it really is, or somewhat lower -- a dismal prospect for a country that is trying to refashion its economy and that has so many underemployed people. Much will depend on trends in the region and world, affecting China's trade and foreign investment prospects. A prolonged global slump could be China's undoing, since this year's stimulus measures cannot continue indefinitely.
Since his audacious announcement of reform measures last March, Zhu has kept a low profile on that topic, saying little in public as many of his hard-won goals have been set aside.
Still, there is no indication that China's leaders have dropped the goals in principle, and no indication that his power as economic czar in this perplexing time has diminished.
"There's no alternative to Zhu Rongji," Xie said, "and Jiang Zemin knows that."
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