The Sunday Review

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Is the Chinese miracle on the wane?

By MARTIN JACQUES
THE OBSERVER

BEIJING -- Six months ago, China was the new global star. While virtually every other country in East Asia had devalued its currency, China resisted, cushioning the effects of the regional crisis.

When Premier Zhu Rongji visited London last April, he was embraced warmly by British Prime Minister Tony Blair as a fellow moderniser. US President Bill Clinton and a succession of other Western leaders trod the increasingly obligatory path to Beijing. Economic reform, notably the restructuring of the debt-laden state-owned enterprises, was proceeding apace, and prominent dissidents were being released.

Yet now the picture is less rosy and far more uncertain.

Two weeks ago, the English-language China Daily quoted analysts as suggesting that a devaluation of the yuan "would not definitely be a bad thing and may not trigger a fresh round of devaluation".

It seemed as if Beijing was testing the water for an imminent devaluation. The report sent shock waves around world currency markets and led to renewed speculation about the underlying state of the Chinese economy.

One of the great ironies of the crisis that first engulfed East Asia and spread to Russia and Brazil, leaving a large question mark over prospects for the global economy, was that China -- fortunately for everyone else -- remained immune precisely because the yuan is not convertible and the mainland's capital account on the balance of payments remains closed.

This makes it virtually impossible for speculators to take big and easily liquidated positions against the currency. The global economy has been shored up by the most important country that stands outside it.

That does not mean, of course, that the Chinese economy has been unaffected by the other devaluations, which is why the collapse of the Brazilian currency provoked fresh speculation about the yuan. Dai Xianglong, the head of China's central bank, sought to calm the markets, saying that the yuan "will be devalued only when there is a great imbalance in the balance of payments, but I do not think that this is the case this year".

Hardly a resounding no, but for now at least, it looks as if a yuan devaluation has been ruled out.

While Chinese exports rose by only 0.5 per cent last year -- compared with 20.9 per cent in 1997 -- the trade surplus grew by a healthy 7.9 per cent, rounding out at US$43 billion (S$72.9 billion).

The main problem was Asian markets, where Chinese exports fell by 6.3 per cent: By contrast, exports to Europe and the United States increased significantly, the latter by 14.8 per cent. This suggests that the main difficulty for Chinese exports is not price, but demand. The key remedy for this would not be a Chinese devaluation, but an Asian recovery.

None of this is to suggest that the Chinese economy does not face serious and growing difficulties: Indeed, it is now facing its greatest challenge since the reform era was ushered in by Deng Xiaoping in 1978.

During the 1990s, its extraordinary growth rate has been in steady decline: Whereas in 1992 gross domestic product grew by 14.2 per cent, last year it had fallen to 7.8 per cent and this year it will be more like 7 per cent. True, Western analysts are sceptical about these figures, but there is no reason to believe such statistics were more accurate a few years ago.

With the outlook for exports grim, last year, the government tried desperately to boost growth by issuing bonds worth US$12 billion to fund a massive fiscal stimulus package. It told state banks to match this with a similar amount in loans.

Given that the growth rate has continued to fall, albeit only slightly, it is clear that the package has had a significant but limited effect.

One reason is that the Chinese are becoming more reluctant to spend and keener to save. This is not surprising: They are worried about the future. Unemployment is mounting as growth slows and, with the reorganisation of state-owned enterprises, millions are being thrown out of work. They are concerned that they may have to buy their homes, pay more for medical bills and fund their own retirement.

To allay the effects of the enormous structural changes, the Chinese economy needs a growth rate of not less than 8 per cent, say most commentators, otherwise, it will become difficult to sustain social cohesion and stability.

To add to these difficulties, China's ability to attract foreign investment has been thrown into doubt by the recent collapse of the Guangdong International Trust and Investment Corporation (Gitic) and Beijing's decision not to underwrite foreign investors, the most prominent of which were European, Korean and Japanese banks (in that order).

"ITICs," as they are known, were an integral part of Mr Deng's bid to outflank the central bureaucracy and encourage the coastal provinces to raise funds directly from abroad. It is now clear that many of them are debt-ridden, casualties of the Asian crisis, the economic slowdown and reckless investments. Mr Dai, the central bank chief, has suggested that the ITICs (excluding Gitic) have an aggregate debt of US$8.1 billion. Given that Gitic owed US$4.3 billion -- much more than anyone anticipated -- this seems over-optimistic. Some analysts suggest it is closer to US$50 billion.

The Gitic experience has acted as a wake-up call for Western investors. They had assumed that somehow their investments would be guaranteed by the government: Instead they find themselves mired in China's first financial bankruptcy since 1949 and forced -- quite rightly -- to take their place in the queue of creditors.

They have been left wondering just how many investments of the last few years may prove equally worthless. For all the hype about China being the largest market in the world, it remains a very risky place in which to invest.

The country's problems are manifold: growing unrest; the prospect of foreign borrowing becoming more difficult and more expensive following Gitic's collapse; a declining growth rate; the danger of an American backlash against its trade deficit with China; stagnant Asian export markets; and an insolvent banking sector whose indebtedness grows by the day as it is required to prop up loss-making state enterprises.

Against that, the Chinese still enjoy the fastest growth rate of the major economies.

Liao Qun, the China analyst at Standard Chartered, remains optimistic. "My forecast for 1999 is a 7.5 per cent increase in GDP. The government will continue with the fiscal stimulus, investing mainly in infrastructure and this will keep the economy moving."

Over the next year or so, China must look to its own resources if it is to sustain the kind of growth rates it requires to carry through its huge structural reforms and contain the social dislocation these will entail. For 1999 at least, it seems that the global economy has been spared a devaluation of the yuan.

But next year may be different.

Liberalise study of Chinese further