China: The Storm Is Blowing Reform Off Course

It shifts to quick fixes in a bid to preserve stability

Chinese microwave manufacturer Amproluck Electrics Co. was keen on gaining market share, so earlier this year it slashed prices by a third and jumped into China's vicious price war for electronic appliances. But today Amproluck is a casualty of that war: It is now bankrupt. Not long ago Beijing officials might have applauded such a battle, but now, they fear price slashing will drive more and more manufacturers out of business. So some officials are calling for a ban on steep discounting. While they want to halt bankruptcies, they also want to stem deflationary pressure that may force a devaluation of the currency.

Such is the mood in Beijing these days. With the Asian crisis hitting China much harder than first anticipated, Beijing's leaders are finding their heralded economic reform plans running smack into the reality of a slowing economy. Just a few months ago, reforms such as privatization of housing and state-run factories were proceeding. Now, with declining foreign investment, sagging export growth, and tepid consumer demand at home, momentum for reform is slowing as leaders instead put a premium on maintaining stability.

The souring outlook, especially for exports, is contributing to the pressure on China to devalue the yuan, which it has steadfastly pledged not to do in order to help keep the rest of Asia stable. Instead the Chinese are "trying every conceivable microeconomic measure before biting the bullet and devaluing," says Enzio von Pfeil, chief economist for Clarion Securities in Hong Kong.

Some officials now want to slow down Premier Zhu Rongji's privatization plans, fearing mass unemployment and unrest. They want Beijing's debt-ridden banks to prop up ailing industries and pump money into shaky infrastructure programs. "The statements of top leaders certainly suggest that there has been a shift in attitude," says Yukon Huang, head of the World Bank office in Beijing. For reformist leaders like Zhu, the shifting winds could result in a dangerous loss of political support that could lessen their ardor for painful economic reforms.

Chinese officials had hoped it could withstand the worst of the Asian economic fallout and continue with growth led by exports and foreign investment. That, it's now clear, will be impossible. Economic growth, initially forecast at 8%, is likely to be closer to 6% this year as foreign investment has tumbled. In the first six months, exports have grown at a mediocre 7.6%, a third of last year's rate. Most drastic has been the slowdown in exports to the rest of the region--by 30% to South Korea and 12.9% to Southeast Asia. Meanwhile, prices fell 3% in June, continuing a nine-month slide.

To bolster hard-hit export sectors, the Chinese are trying remedies such as tariff breaks for capital-goods imports, export rebates, easier export licensing, and expanded access to credit. Beijing is printing money to cover these subsidies, but with prices falling, a little inflation may be a good thing. Beijing has also accelerated plans to stimulate the economy through massive infrastructure investment, possibly as much as $250 billion this year. Analysts fear, however, that efforts to maintain exports and boost infrastructure may be the wrong use of scarce resources and will allow ailing industries to postpone reforms.

CONFUSED SIGNALS. One of the only reforms squarely on track is the massive bureaucratic restructuring that will see Beijing lay off an estimated four million people over the next few years. But even that is proving an obstacle. With bureaucrats reeling under a wholesale reorganization, there's little time or impetus for economic reforms. "If the signals [on reform] become too confused, the enterprises and banks will start to think it's back to business as usual," says Huang.

Of course investment, even if poorly placed, will still stimulate the economy to some degree. And given China's massive infrastructure needs, much investment could ultimately prove productive. But for now, at least, the Asian crisis seems to be throwing China's plans off course. The best Beijing's leaders can hope for is that small measures here and there can help stave off a devaluation and that before too long, reforms can get back on track.