Downturn? What Downturn?

Beijing is determined to keep the economy growing fast, even if the rest of Asia hits the skids

Global markets are jittery, Japan's economy continues to flounder, and the U.S. may soon be sliding into recession. It's a triple-strength tsunami that already is crashing into much of Asia, pummeling exports and prompting predictions of a prolonged period of sluggish growth.

Will the wave wash over China, too?

The quick answer is no, at least if one believes the optimistic numbers emanating from Beijing. The Chinese government is projecting economic growth of 7% this year, down from 8% in 2000 but well ahead of what most other emerging-market economies will achieve. Retail spending is up, foreign direct investment continues at record levels, and China's booming domestic market is producing tens of thousands of new jobs.

TROUBLED. But China is not completely immune from the rest of the world's troubles, as top officials acknowledged in recent discussions with BusinessWeek. After surging 28% in 2000, export growth may slow sharply. Crucial shipments of toys and textiles dropped 10% in the first two months of the year compared with 2000, while orders for such high-tech equipment as computers and telecommunications switches fell 20%. "I'm very concerned," says Shi Guangsheng, Foreign Trade and Economic Cooperation Minister.

The last thing China needs right now is a serious downturn. Such a development could undercut the government's economic reforms just as the nation clears the final hurdles to joining the World Trade Organization. That's why Shi and other top Chinese officials are determined to keep the mainland economy roaring along, much as it did during the 1997-98 Asian financial crisis. They also insist that a step-up in merger activity and continuing corporate reform will go ahead as promised.

As during the crisis, Priority A is ensuring that strong domestic demand continues unabated. In 2001, the Chinese government will float $18 billion in bonds to build roads, power plants, and railways, the third year in a row it has used public money to goose the economy. The medicine, for now, is working: Deflation, a worry since the crisis, has bottomed out in recent months as consumers began to spend again. In the first two months of this year, retail sales were up 10.4% over the same period in 2000. Another move that should boost spending is the government's plan to lavish more salary increases on teachers and other civil servants.

To reach the 7% growth target, China will also need to continue attracting a flood of foreign direct investment. That certainly should be no problem. Last year, it took in an impressive $40.8 billion in FDI, second only to the U.S. In January and February, investment was up 24% over the same period last year. Contracted investment--promised but not realized--was up almost 50%. Dai Xianglong, governor of the People's Bank of China, reckons that optimism over China's WTO prospects will spur annual FDI to $45 billion a year for the next five years. The No. 2 financial policymaker after Premier Zhu Rongji, Dai has broad latitude to oversee the banks and the macro economy.

Predictably, China is awash in hard currency after years of export growth. Dai says reserves total $160 billion and will grow to $200 billion "in the near future." That will allow the Central Bank to hold the yuan's hard peg to the dollar, even as the Asian currency markets get choppy. "I can say for sure the Japanese yen will devalue," says Dai. "This will bring about successive devaluations in Southeast Asian countries, and add to the pressure on the yuan." The fact that China held firm against devaluing its currency during the crisis was key to arresting the regional contagion. Dai swears China will hold firm again: "The rate will remain stable now and in the early days of our WTO accession," he says.

Reforms will also continue apace, officials vow. State-owned corporations will continue to modernize, shed workers, and be closed if they don't perform. China Securities Regulatory Commission Vice-Chairman Gao Xiqing hopes this year's crop of initial public offerings will match or exceed last year's tally of 145 companies. WTO entry, of course, is expected to further accelerate corporate reform. "What they've committed to," says a Western diplomat in Beijing, "is some very profound changes and opening up of their markets."

BANK REFORM. China's swollen, debt-ridden banks remain at the center of the reform effort--though analysts say it will be years before Beijing can reach its goal of listing the major banks on foreign stock exchanges. In a move aimed at helping prepare for foreign competition, banks are beginning to pay their employees salaries according to performance rather than seniority. More than 1,000 smaller bank branches were shut throughout the country last year, and the remaining banks are trimming employees. The Bank of China, one of the nation's four major commercial lenders, cut 5,200 staff last year, though its head count remains a bloated 190,000. BOC Chief Executive Liu Mingkang says the bank expects to trim 3,000 to 5,000 employees a year for the indefinite future.

If China's plans work out, corporate reform and bank reform will proceed hand in hand, regardless of Asia's economic ups and downs. Dai points out that the country's banks are rapidly shrinking their portfolio of nonperforming loans, as corporate debtors are either allowed to fail or their debts are shuffled into one of the new asset-management corporations, set up to acquire bad loans and devise workout plans for them. As a result, says Dai, the banks' ratio of nonperforming loans has declined every month since last September. Although China does not release detailed figures for nonperforming loans, analysts estimate that 25% to 40% of the country's loans, which total just over $1 trillion, are in trouble.

No one expects China to emerge from the global downturn unscathed. One worry: As China enters its third year of heavy deficit spending, the government's fiscal burden may be growing too heavy. At the recently concluded National People's Congress, the Premier defended the government's level of debt, saying it was well below the danger level. Even Dai admits, however, that the true number is "not a small figure" when unrecoverable bad loans and China's surging social security costs are added in. But what choice does Beijing have? "We have to bear the cost of the transition from a planned economy to a market economy," he says.

China's status as a command economy still forms its chief shield against the chill economic winds blowing across the globe. At the same time, officials understand that China's special protections will disappear with WTO membership. "Once China opens the door wide, it can never retreat," says the BOC's Liu. But as gloom settles over the rest of Asia, China seems safe for now.

By Mark L. Clifford and Dexter Roberts in Beijing

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