Inflation Has China Running Scared

After two years of double-digit growth, Beijing technocrats will have a hard time convincing real estate developer Zheng Yufeng that it's time for the Chinese economy to cool off. An executive at Shenzhen Huapeng Properties Co., Zheng also is a general in the Armed Police. Talk that Beijing will clamp down on bank lending to the red-hot property sector doesn't worry Zheng, who has government friends with access to cheap loans. Even Shenzhen's heavy traffic doesn't bother him. When cars start to slow Zheng down, he simply speeds his Mercedes 600 through a bicycle lane.

Getting China's "red capitalists" to play by the government's rules has become a serious challenge for Beijing. Communist Party General Secretary Jiang Zemin is warning colleagues that China faces serious instability if it can't contain runaway growth. Jiang is spooked by double-digit inflation, an overheated real estate market, a new trade deficit--and officials such as Zheng who aren't listening to their superiors in Beijing. The leadership's biggest fear is that the superheated economy could help spark demonstrations similar to those that erupted during the 1989 democracy movement. Those protests led to the Tiananmen Square massacre and the downfall of Zhao Ziyang, Jiang's predecessor.

Efforts to gain control of the economy are being complicated by the latest power struggle in Beijing. Premier Li Peng hasn't been seen since late April. He reportedly has suffered a heart attack, and rumors abound that the hardliner is now being ousted from power. Li reportedly angered Deng Xiaoping by disagreeing with the paramount leader's demands for faster growth. With Deng's blessing, the economy grew 14% in the first quarter, fueling a burst of inflation. After three years of stable prices, the inflation rate is approaching 20% in China's biggest cities.

HEAVY TOLL. While it faces the possibility of political tension over inflation at home, Beijing also has to worry about the repercussions with its trading partners. The surge in prices has taken its toll on China's currency, the renminbi (chart). The semi-official exchange rate for the renminbi has decreased 10% in the past five months. That's an ominous sign to policymakers in Washington, already angered by an $18.3 billion trade deficit with China last year. On May 25, the U. S. Treasury Dept. said that China is depressing the renminbi to impede imports. The currency fluctuations are hurting some U. S. exporters. "Most customers are holding back until they know how low the renminbi will go," says Michael C. Y. Lung, Dow Chemical Co.'s general manager for China.

But even a lower renminbi is not helping improve China's overall trade picture. The country's current-accounts surplus, an impressive $13.3 billion in 1991, was more than halved in 1992 as imports of everything from steel to stereos to luxury cars far outstripped the 20% growth in exports. For the first four months of 1993, China reported its first trade deficit in four years, $1.7 billion. Factor in the estimated $5 billion to $8 billion in smuggled foreign goods, notes Hang Seng Bank senior economist Joann Yim, and China's trade deficit looks even more serious.

The problem, Chinese officials say, isn't that imports are out of control. It's that state enterprises, which receive 80% of bank loans, are stashing hard currency in real estate and securities in Hong Kong and the U. S., rather than putting it into export-oriented manufacturing. Capital flight last year soared by two-thirds, to $30.5 billion, according to the official China Daily.

While the strains in China's economy are serious, the situation today isn't nearly as bad as in 1989. Consumer goods are plentiful, and the income of many urban dwellers is keeping pace with inflation. Free-market reforms, which have boosted competition and unleashed prices of most goods in the past few years, are likely to make the swing from boom to bust less severe.

WHITE KNUCKLES. Yet managing a soft landing for the economy will be difficult at best. Jiang's exhortations aside, Beijing's main tool for restraining growth is its control over the banking system. The Finance Ministry has been urging a clampdown on bank lending to slow the 30% annual expansion in money supply. But that's a tall order when half of China's lending is now believed to be done by local banks and foreign investors, who are outside the confines of the state banking system.

What really worries China-watchers is that Deng Xiaoping, after so many decades of political warfare, seems to view any attempt to slow growth as an attack on his reforms. "There should be a tightening of the growth in money supply now," says a Western economist in Beijing. But until Deng agrees, white-knuckled technocrats can only hope the frail patriarch will take his foot off the accelerator before China veers out of control.

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