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Will This Chinese Wall Hold?

International -- Asian Business: CHINA


Beijing tries to shut off capital flight

Chinese leaders had enough trouble plugging the dikes along the overflowing Yangtze River this summer. They may be fighting even bigger floods now. The Asian economic crisis is causing tidal waves of cheap imports to wash into China. At the same time, money is flowing out--$20 billion last year, and probably much more in 1998. The two phenomena are related: Imports are putting pressure on Beijing to devalue the currency to make Chinese exports cheaper. And people and companies inside China that fear devaluation is inevitable are moving money out.

All this adds up to a massive challenge. Chinese officials are enacting protectionist measures to stave off devaluation as long as possible. These include cracking down on unauthorized currency trading, supporting prices in such areas as steelmaking, petrochemicals, cars, and televisions, and erecting new barriers to imports and foreign investment that threaten local industries. The Chinese are gambling that good old-fashioned state controls can blunt the worst effects of global capitalism and keep the bulk of China's enormous savings inside the country. It's a very Chinese idea: wall yourself off from the world and rely on domestic demand and public works to pull you through. But this time it may prove impossible for a country whose huge export industries are so in synch with the global economy.

Already, the whisper in China's bazaars is that a devaluation of the yuan in 1999 is inevitable. In Beijing's silk market, the yuan is trading at 8.9 to the dollar--7% less than the official rate--as average Chinese convert their savings into dollars, smugglers buy up hard currency, and trading companies try to get their hands on foreign exchange. Beijing University economist Song Guoqing predicts a rate of 12 yuan to the dollar by 2000. "It's a losing game. They can't stop it," says Song.

But they can try to postpone it. In late September, the powerful State Council cracked down on unauthorized foreign exchange dealings. Banks and trading companies had been spiriting money out of the country in anticipation of a devaluation. The usual method: Trading companies over-declare on import values and pocket the extra foreign exchange. Chinese authorities say they have discovered several billion dollars' worth of falsified documents. Other companies have kept foreign exchange earnings in overseas accounts rather than repatriate them. Meanwhile, massive smuggling of everything from petroleum to cars has been largely carried out in dollar transactions, further siphoning off foreign reserves.SIDE EFFECTS. Beijing's State Administration of Foreign Exchange (SAFE) announced it would give companies until Oct. 1 to bring back the money or face punishment, but analysts say that would be hard to enforce. "We are now offering them a chance to correct their wrongdoings," says SAFE Director General Wu Xiaoling. SAFE ordered a nationwide inspection of all foreign trades, as well as stiff new penalties for black- market money changers and any sticky-fingered officials involved in illegal foreign exchange. The government plans to link all customs offices and foreign exchange administrations throughout China by computer to monitor all capital flow. Beijing has banned companies from paying off foreign debts early, a major source of foreign exchange drainage out of the country, and wants to limit the size of short-term foreign debt.

But this stricter scrutiny has bad side effects. Guangdong Province's booming exporters rely on imports of materials, cheap assembly, reexport, and lots of foreign currency. Now the red tape is hampering legitimate commerce. Hong Kong's VTech Holdings assembles electronics in a Guangdong factory, for example. But where it once took two days to get components through customs, the new regulations stretch this out as long as two weeks, says one VTech official.

Beijing is also confronting outside enemies: foreign companies and smugglers peddling cheap steel, petrochemicals, cars, televisions, and computer components. These products, often 15% cheaper than China-made goods, are ruining business for local state-owned producers, which are already struggling to unload $500 billion worth of stockpiled goods.

So in September, China's State Economic & Trade Commission announced "voluntary" minimum prices for 15 industries to give some protection to weak local factories competing with smuggled goods. The SETC announced new penalties for local and foreign companies caught dumping. "Dumping incrEases state company losses, disrupts market order, and must Be stopped," announced Chen Bangzhu, a vice-minister at the SETC. However, says Jonathan Woetzel of McKinsey & Co. in Shanghai: "These companies are responding to market pressures. If they don't cut prices, they will be left sucking wind."DUD LOANS. Of course, propping up industry means that the once-vaunted reforms of state enterprises are on hold. At the same time, Beijing is encouraging banks to open the spigots and forget about cleaning up dud loans. "These days, no one is talking about bad debt," says Beijing University's Song.

The changes are affecting big multinationals, too. China State Power Corp. has reiterated its intention to stop imports of power-generation equipment for factories under 600 megawatts--a blow to General Electric Co. and Siemens. Provincial telecom operators must now buy locally made equipment when possible, rather than imports produced by Nortel, Lucent Technologies, and NEC. A recent government circular suggests a ban on foreign participation in telecom services. Such involvement is technically illegal, but until now authorities looked the other way while Sprint, Siemens, and Deutsche Telekom skirted the rules. A ban would jeopardize millions of dollars of foreign investment. "Until the government makes a clear statement on the future of China's telecoms, investors should view this as the worst news in years," says Ken Zita, a New York-based telecom consultant.

The risks Beijing runs with such harassment are that foreign investors will fight back, or just go elsewhere. And if investment tapers off, that's bad news for economic growth. Already, Jim Lam, chief representative of ABN-Amro Asia in Shanghai, predicts it will be a full percentage point below Beijing's goal of 8% this year. Any rate less than 8% will fail to generate enough new jobs. Export growth is fading, as is domestic consumption. "China is not as attractive [for investment] as before," says Lam. China needs growth--and it needs the outside world to achieve it.By Dexter Roberts in BeijingReturn to top

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