A Prudent Beijing Stays the Course

The National People's Congress rumbled with threats to Taiwan and calls for economic cooling. That doesn't mean things will really change

By Dexter Roberts

In what has become an annual rite of spring, China watchers are busy parsing the speeches that emanated from the 10-day National People's Congress, which closed Mar. 14, for hints of new policies or important changes in economic direction. The big news: an anti-secession law aimed at Taiwan that the rubber-stamp NPC passed, along with an increase in defense spending. Both indicate an aggressive stance toward Taiwan that may set back cross-strait relations. And Premier Wen Jiabao's announcement of a shift from a "proactive" to a "prudent" fiscal policy shows Beijing's determination to tame its still fast-growing economy.

It sure looks like China intends to maintain its threatening posture toward Taiwan. In his opening address on Mar. 5, Wen warned that the planned law shows the "strong determination of the entire Chinese people to safeguard the sovereignty and territorial integrity of the country, and never allow secessionist forces working for Taiwanese independence to separate Taiwan from China under any name or by any means." In response, Taipei criticized the new law, calling it a "blank check" for Beijing to attack.


  But appearances may be deceiving. It's unclear whether the law will actually worsen relations in the longer term. China, after all, has long threatened that any move toward independence would be met with military action. Indeed, many analysts in Beijing see the law as providing political cover for moderates in the goverment who want to continue the dialogue and open relations across the Strait.

"They are trying to throw a sop to the hard-liners in the government, but Beijing will continue to try to improve the relationship," says Andy Rothman, China macro-strategist at CLSA Asia-Pacific Markets in Shanghai. "This does not represent a real change in policy," he says, predicting it will be of much less significance within a few months than continuing efforts to improve trade, transportation, and investment links between the mainland and Taiwan.

Similarly, dramatically lower numbers on gross domestic product and investment growth shouldn't be read as hard targets that will usher in a significant cooling of China's economy. Wen said he wants to keep GDP growth to 8% -- down from 9.5% last year -- and fixed-asset investment at 16%, well below 2004's 25.8% rate. It's clear that Beijing continues to worry about last year's rampant spending growth in the provinces, with local expenditures up some 18.1% last year, compared to 11.8% in 2003.


  But Wen and President Hu Jintao are well aware that their employment goal of 9 million new urban jobs this year will require continued strong economic growth. "If the government reduces investment in many big projects like steel, aluminum, [and] coal, there will be a lot fewer jobs," says Chen Naixing, an economist at the Chinese Academy of Social Sciences.

The lower targets may really be a warning to provinces to not reinvest in already overheated sectors such as real estate, steel, cement, and aluminum. And Beijing has deliberately lowballed its growth goals, fully aware that provincial leaders will inevitably try to outdo them. "These are not targets -- they are baselines. These guys are just as happy as their predecessors were to have rapid growth," says Arthur Kroeber, managing editor of Hong Kong-based China Economic Quarterly. He predicts that actual GDP growth will be 8.5% or even higher. "That affords them the luxury of tackling other things, like the problems in the economy they want to fix."

It's clear that Hu and Wen are pushing a new people-oriented, rather than a growth-oriented, development strategy. Some $1.3 billion is to be spent on reemployment in 2005, while an additional $360 million will go toward improving safety in China's dangerous coal mines. Investment will also be made in education for the poorest students, and in an effort to ensure rural incomes grow by at least 5%, all agricultural taxes are to be abolished by 2006, two years earlier than originally planned.


  All of this is aimed at preventing possible social instability stemming from the widening income gap between urban and rural China. "We will strive to solve outstanding problems vital to the immediate interests of the people, safeguard social stability, and build a harmonious socialist society," Wen said, using Beijing's newest party catch phrase.

Does the combination of expanded social programs and reduced taxes for farmers signal a dangerous increase in the budget deficit? Surprisingly not. A combination of big profits by China's largest state enterprises in sectors like oil and steel, plus vastly improved tax collection mean government revenue is now equal to about 21% of GDP, up from only 11% a decade ago.

As revenues last year grew by 21.4% -- outpacing the 15.1% growth in expenditures -- the budget deficit actually shrank in 2004 to 1.5% of GDP and is expected to come in at $36 billion this year, $2.3 billion less than in 2004. "Officially, they are better than half of Europe," points out Stephen Green, senior economist at Standard Chartered Bank in Shanghai.


  Watch out for those appearances, though. While finances look fine now, that could change over the next couple of years. When the economy begins to slow -- as inevitably it will -- the budget deficit will grow. And don't forget that bad debts in the banking system, in additon to China's underfunded pension obligations, will become much more urgent in coming years. "Beijing is running down their debt as fast as they can in the short term, so they have room to run it back up in the future," says China Economic Quarterly's Kroeber.

So as you parse the torrent of words from the Great Hall of the People, expect little change from previous years: Taiwan will get more of both carrot and stick, the mainland will get continued rapid growth. And for now, at least, China gets a remarkably responsible fiscal policy.

Roberts is BusinessWeek's Beijing bureau chief

Edited by Phil Mintz

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