Can Beijing Hang Tough?

Pressures mount for China to devalue or face turmoil

For a few terrifying hours, traders in Asian markets thought they were witnessing the start of the next Asian crisis. On Jan. 25, bourses from Seoul to Singapore plunged after an article in the Chinese press suggested a devaluation of the yuan could boost the sagging economy. Nervous traders quickly concluded a devaluation was coming that could force battered countries like Thailand and Indonesia to devalue their currencies again to remain competitive--and just when things were starting to look better in Asia. Only vigorous denials by Beijing officials, including central bank Governor Dai Xianglong, restored calm.

But no one should be fooled by the official promises: There's real cause for concern. As much as Chinese leaders would prefer to hold the line, they may be forced to devalue as early as the second half of 1999. Exports, which make up 20% of the economy, are dramatically slowing, while unemployment is sharply on the rise. That's leading more and more workers to take to the streets in protest. And foreigners are losing their appetite for the China market and scaling back direct investment and lending. The result will be slower growth this year--perhaps just 4.5%, nowhere near Beijing's forecast of 7%.

LAST RESORT. If Beijing can't stimulate the economy enough with new public works over the next few months, it may have to seek devaluation. The hope is that a readjustment would help exports, boost consumer spending, and create enough jobs to absorb this year's record number of unemployed, which some estimates put as high as 15%. That's an option of last resort. Right now, "the goal is maintaining social stability," says Joydeep Mukherji, an analyst with Standard & Poor's Corp. Yet the fear is that even a modest devaluation could trigger a worldwide panic, wipe out Asia's fragile recovery, and send the U.S. trade deficit soaring.

Beijing's efforts to clean up its shaky financial sector could dampen growth further and force authorities to resort to devaluation. The Jan. 10 bankruptcy of Guangdong International Trust & Investment Corp. (GITIC) has spooked foreign lenders, who may not see a penny from their loans. So international bankers are calling in some China loans early, refusing to roll over others, and balking at lending new money. That has caused defaults at other investment companies. At the same time, investor aversion to Chinese companies is delaying some public offerings. "Banks will take some time and let the situation settle before lending again," says Jim Lam of ABN Amro Asia Ltd. in Shanghai. "They will be very discriminating, and Chinese companies will definitely see tightened credit."

For now, the authorities are trying Keynesian-style fiscal stimulus to keep the economy's vital signs healthy. They are pumping billions into infrastructure projects, building everything from highways and telephone lines to irrigation projects. "The investment binge may help in part to deal with problems and absorb job losses," says Mukherji. "But it's proving less and less effective."

LOSE FACE? Yet if a devaluation were to take place, it would be engineered by China's authorities, not forced by outside pressures. China is no Brazil. Despite its mounting economic woes, the country still has a huge, $45 billion current-account surplus, not to mention $145 billion in foreign-currency reserves. "There is no need to devalue now," states Chi Lo, senior international economist at hsbc Economics in Hong Kong.

Beijing does not want to rattle its own consumers and spark a run on the domestic banks, which rely on $644 billion in savings deposits for their survival. A devaluation "would hammer domestic confidence," says Dong Tao, senior regional economist for Credit Suisse First Boston (Hong Kong) Ltd. China's leaders also realize that a devaluation could trigger an attack on the Hong Kong dollar, which is pegged to the U.S. dollar.

Finally, devaluation would represent a loss of face. Beijing has won kudos from the U.S. and others for holding its currency firm as the crisis swept through the rest of Asia. China's official press is pushing the line that the country's economic behavior should be rewarded with more international respect. By weakening its currency, China would undermine these efforts when it is already under fire for its latest crackdown on human-rights activists.

Yet there are doubts that fiscal stimulus will be enough. China is dealing with serious overcapacity in most of the goods it produces. Inventories have swelled to $500 billion, or half of the total economy, and fears of skyrocketing unemployment have put a big damper on consumer spending. Prices have dropped for the 15th straight month. Real interest rates are estimated at 8%, inhibiting new investment. "Deflation pressure is huge," says hsbc's Lo.

Boosting exports may be the only way out for China's factories. Its hard-hit exporters already face stiff competition from other Asian countries whose currencies have devalued sharply. So on Jan. 24, China announced export rebates that amount to a de facto devaluation for exporters. Exporters of electronic goods can now get a full tax refund from the government. Previously they paid an 8% tax. Agriculture and textile exporters will also get hefty tax rebates. U.S. trade officials are calling foul. They insist rebates are, in effect, export subsidies that violate World Trade Organization rules.

As long as China's consumers keep their wallets closed, the pressures mount. At the five-story Scitech Plaza, one of Beijing's most popular malls, desperate retailers including Benetton Group and Esprit Holdings Inc. offer discounts of up to 50% on clothing. Downstairs, Samsung TVS now sell for 35% off, and Siemens washing machines have been reduced 12%. Already, six Beijing department stores have gone bankrupt in the past few months.

Across town, in a black market in northeast Beijing, currency traders expect a brisk year as the economy keeps slowing and locals scramble for hard currency. Amid clothing stalls selling counterfeits of North Face outdoor wear, one 60-year-old black marketeer is offering 9 yuan for $1: The official exchange is 8.3 to the dollar. She worries about police raids: "The government is cracking down hard." But she also figures a devaluation is coming, and that can only be good for business.

China may be able to stave off a devaluation for now. But growing fears over the economy's health will continue to spook skittish markets. Not to mention Beijing officials themselves. How long they will be able to hold off is an open question.

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