Economic turmoil strains China

At first many thought China would be spared, but the prolonged currency and stock market turmoil raises risks for the Asian powerhouse, writes Yojana Sharma of Inter Press Service.

HONG KONG (IPS): With its giant economy and nine percent growth, China at first seemed immune from the financial troubles that have wreaked havoc in much of Southeast Asia and now threaten to engulf South Korea.

But now financial and economic analysts in the region are no longer so sure.

While to some extent, China has been protected by the non- convertibility of its currency, the yuan, experts say the extent and duration of the financial crunch cannot leave even China unscathed.

Now economists even within the country say China's growth rates will be arrested, foreign direct investment will plummet and exports will be dramatically hit.

The Beijing government has been quick to point out that it has a huge current account surplus, with foreign reserves at a historic high of more than US$130 billion, and that inflation is down.

But when officials held a high-level emergency caucus to discuss how the financial turmoil could hurt China, analysts sensed some jitters.

State run media delayed any mention of the conference attended by President Jiang Zemin, Prime Minister Li Peng and Vice-Premier and economic tsar Zhu Rongji until a day after it had concluded.

Analysts in Beijing and Hong Kong said such a conference was a clear indication about deep worries over the health of the Chinese banking system at a time when losing state owned enterprises owe some $600 billion to China's banks. From 20 to 40 percent of that amount is unlikely ever to be recovered.

The official New China News Agency merely reported that it was necessary to be "sober minded" about the problems. It spoke of measures to "deepen financial reforms, sorting out the financial order and guard against and counter financial risks".

Beijing realizes that given the country's growing integration with the world economy, the "risk of being shocked by financial crises in foreign countries has increased", said the New China News Agency.

Whether or not China will be able to strengthen its banking system to deal with the crisis ricocheting around Asia will remain to be seen, but economists here are already predicting a major lowdown in the mammoth Chinese economy.

They say foreign direct investment will taper off, exposing the weaknesses in China's own industrial performance. Foreign investment has set up money making joint ventures in the industrial sector, which for more than a decade has masked the deep crisis in the country's industrial production and productivity, analysts say.

Some 70 percent of mainland's foreign direct investment comes from other Asian countries including Hong Kong, Taiwan, Japan and Korea. Thailand's C.P. Pokphand was one of the largest Asian investors in China, but that is now "at some risk", according to James Winder, chief economist at Merrill Lynch.

The newspaper China Daily reported that contractual foreign investment in China during the first 10 months of 1997 dropped 35 percent compared to the previous year, totaling just under $40 billion compared to $61.5 billion in the same 1996 period.

This is a worrisome trend because it is this sector that is sustaining the Chinese economy. Likewise, foreign direct investment contributes to 12 percent of China's GDP growth, says a report by Hong Kong based analysts Jardine Fleming.

With a massive and ailing state sector some 35 percent of enterprises are deeply in the red. The reform of the state sector means million of jobs must be created in coming years. In other words, the need for capital to stimulate the economy and create jobs is bound to increase in the future.

"They (the Chinese) have a pressing need for capital," said Bruce Seton of Peregrine Asset Management. "They have to be open to foreign capital investment."

Providing a signal to the world that it intends to strengthen its banking sector is as much a message that China is directing to investors, as to ward off and protect itself against speculators.

"And frankly, for China, the real danger is not that it may come under attack from speculators but that the flow of foreign investment will dry up completely as a result of problems in the region," said one banker.

Pulling back from Asia as it goes through a currency and financial crisis, overseas investors may turn cautious on China as well. The banker noted that in the United States in particular there was a "herd mentality" among financiers and a tendency to "tar whole regions with the same brush".

"Difficulties in Asia, particularly if they are prolonged, are bound to impact on how U.S. money sees China as well," he said.

Japan's economic problems, and now the spread of economic turmoil to South Korea, may also hit investment rates in China. The Korean giant Samsung alone has 18 joint ventures in China, representing an investment of more than $250 million in enterprises from shipbuilding to consumer goods and clothing. And much foreign investment funding comes from Japanese banks.

"There is already a severe credit crunch within China. Now there will be a severe credit shortage in the whole region which will affect China as well," the banker said.

At the same time, China's exports face increased competition from Southeast Asian countries whose currencies have been devalued in recent months.

Economists are predicting a decline in exports from China, which in this export led economy will mean a decline in overall economic growth.

"The continued flow in direct investment capital into China also cannot be taken for granted," said Bob Broadfoot of the Political and Economic Risk consultancy in Hong Kong. The Hong Kong stock market, the main vehicle through which this capital is being raised, has suffered a severe setback.

Steep and prolonged stock market declines "would be bad news for China which has grown dependent on this well of funds", the consultancy said in a recent risk report.

"Although Hong Kong was initially spared when the markets of Southeast Asia turned downward, the recent sharp correction has drastically changed sentiment," the report explained.

It added: "China's best efforts to dress up its state owned enterprises to make them look like sexy future corporate dynamos are now going to be much harder to sell to skeptical investors. China's whole state-owned enterprise reform program could therefore be slowed down."