How Long Can Beijing Hang Tough?

Pressures mount for China to devalue or face turmoil

For a few terrifying hours, traders thought they were witnessing the start of the next Asia crisis. Bourses from Seoul to Singapore plunged Jan. 25 after an article in the Chinese press suggested a devaluation of the yuan could boost the sagging economy. Nervous traders feared such a move could prompt battered countries like Thailand to devalue their currencies again--and just when things were starting to look better in Asia. Only vigorous denials by Beijing restored calm.

But the official promises don't have investors, bankers, or people doing business in China breathing easy. 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. Unemployment is rising sharply, leading to more and more worker protests. And foreigners are losing their appetite for the China market and scaling back investment and lending. The result will be slower growth this year--perhaps just 4.5%, nowhere near Beijing's 7% forecast.

If Beijing finds itself with no other choice but 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 economists put at 15%. That's an option of last resort, however, since the fear is that even a modest devaluation could trigger a worldwide panic, wipe out the fragile Asian recovery, and send the U.S. trade deficit soaring.

But Beijing's efforts to clean up its shaky financial sector could dampen growth further and force devaluation later. 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 of their loans in China early, refusing to roll over others, and balking at lending new money. That's causing default at China's other investment companies. "Banks will be very discriminating," says Jim Lam of ABN Amro Asia Ltd. in Shanghai. "Chinese companies will definitely see tightened credit."

BUILDING BOOM. For now, Beijing is trying Keynesian-style stimulus. It's pumping billions into infrastructure projects, from roads and phone lines to irrigation schemes. "The goal is maintaining social stability," says Joydeep Mukherji, an analyst with Standard & Poor's Corp.

Yet there are doubts that will be enough. China is dealing with serious overcapacity. Inventories have swelled to $500 billion, or half of the total economy, and fears of skyrocketing unemployment have dampened consumer spending. Prices have dropped 15 months in a row. "Deflation pressure is huge," says Chi Lo, senior international economist at HSBC Securities Asia Ltd. in Hong Kong.

China, with its many strengths, is no Brazil. Despite its mounting economic woes, it still has a huge current-account surplus, not to mention $145 billion in foreign-currency reserves. If Beijing were to devalue, it would spark a run on domestic banks, which rely on $644 billion in deposits for survival. China's leaders also know they could trigger an attack on the Hong Kong dollar, which is pegged to the greenback. Devaluation would also mean a loss of face. China won kudos from the U.S. for holding its currency firm in the midst of crisis. By weakening it now, Beijing would undermine goodwill when it is under fire for its latest crackdown on dissent.

China is trying to ease the pain in other ways, such as export rebates that amount to a de facto devaluation for exporters. Electronics exporters can now get a full tax refund from the government rather than pay 8% tax. U.S. officials are calling foul. They insist rebates amount to export subsidies that violate World Trade Organization rules.

Beijing may be able to stave off a devaluation for now. But growing fears over the economy will continue to spook skittish markets--not to mention Beijing officials themselves. So count on more scary moments ahead.