Mon, May 10, 2004 page11

• Will China's boom end in a crash?

  HAPPY LANDINGS The global economy has much at stake as Chinese leaders aim for a `soft landing' in cooling down an overheated economy

  • NY TIMES NEWS SERVICE
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  After a decade with the economic throttle wide open, China's growth is overheating, and the country's leaders are grappling with ways to slow the expansion's breakneck pace without choking it off.

  Being able to apply the economic brakes to achieve what is known as a soft landing after a spectacular boom is a difficult challenge for any country. It may be doubly so for Beijing's leaders, who are fairly new to the market economy game and who lack many of the finely honed policy tools available to central bankers in the West and Japan.

  Indeed, economists are split over whether a soft landing or a hard landing is more likely for China.

  

  A Chinese vendor sleeps next to a poster of the late Chairman Mao Zedong in Beijing on Saturday. Items bearing the communist leader's likeness are popular items in China's current capitalist economic boom.

  PHOTO: AP

  Prime Minister Wen Jiabao (溫家寶) has sought to assure foreign investors that China is taking steps to achieve a soft landing. During a visit to Brussels last Thursday, Wen said his government would pursue "forceful" measures to "reduce the speed" of the economy -- "but not a sudden braking."

  He promised to slow increases in the money supply and in bank lending that have fueled the recent acceleration in growth, but said that a loosening of the peg of China's currency to the dollar would have to wait for banking reforms.

  Much is riding on Beijing's efforts. The global recovery now depends on China as one of its main engines, along with the US. A hard landing -- a steep decline in economic growth leading to higher urban unemployment and a sharp drop in imports -- would rattle economies around the world.

  But it would probably bear little resemblance to the last economic crisis in the region, the cascade of financial and currency collapses that swept through many East Asian economies (but not China) in 1997 and 1998, a memory still fresh and painful for many investors.

  If China runs into serious trouble, experts say this would be likely to take months to unfold rather than present a relatively rapid financial collapse, as happened in Thailand, Indonesia and South Korea nearly seven years ago.

  "The problem is more of a long-term affair," said Desmond Supple, managing director of Asian research at Barclays Capital. "If we get a hard landing, it wouldn't be anything like" the last Asian crisis.

  A soft landing is more probable, according to the IMF and some investment banks, with growth gradually slowing to a bit more than 7 percent annually from the 9.7 percent annual pace recorded in 2004's first quarter.

  Seven percent a year would still be a scorching growth rate in most economies. But Chinese experts say that is the minimum the country needs to keep urban unemployment from worsening, as millions of migrants from rural areas pour into cities, straining the social fabric and possibly fertilizing the seeds of political unrest.

  "We don't think a really hard landing is a likely scenario" for the economy as a whole, said Huang Yiping, a Citigroup economist in Hong Kong. But there may be crashes in a small number of industries where over-investment has been greatest, he said, and in particular, "You probably will see a very, very hard landing in steel investment."

  The central bank has raised bank reserve requirements twice in two months to discourage lending, and is strongly hinting at its first interest rate increase since 1995.

  China's most important step, but also the hardest to fine-tune to avoid overdoing it, lies in sending police and prosecutors after local officials who have gone on pursuing grandiose projects despite warnings since June from senior economic officials in Beijing. Because China lacks functioning bankruptcy laws and foreclosure proceedings, the government must rely on criminal fraud investigations to deal with wayward companies, said Andy Xie (謝國忠), a Morgan Stanley economist.

  "Yesterday's entrepreneur is today's `you stole money, you didn't pay taxes,'" Xie said. He added that this approach can chill investment quickly in ways that might be hard to control.

  The Chinese economy faces several more significant structural problems, some experts say. The country enjoys an immense trade surplus with the US, with its exports exceeding imports by a ratio of 8 to 1. But with the world as a whole it has fairly suddenly slipped into deficit, in large part because it has rapidly outgrown its domestic resources of raw materials like iron ore and oil, and now must import them at prices driven up by its growing appetite.

  Chinese trade statistics, more-over, probably err on the rosy side. Many Chinese companies exaggerate their export volume to claim tax credits. Many imports go uncounted because of widespread smuggling to avoid customs duties, which remain steep despite China's pledge to the WTO to bring them down in stages by 2007.

  Xie estimates that China's true overall trade deficit this year will be about US$90 billion -- just as big, relative to the size of its economy, as the American trade deficit.

  China does not loom large as an export market for the US. But many Asian nations now depend heavily on selling to China, especially after its overall imports jumped 40 percent last year.

  China accounted for a third of all the growth in Japan's exports, and a similar share of South Korea's, according to Stephen Roach, Morgan Stanley's chief economist, and it took two-thirds of the growth in Taiwan's exports. A sharp slowing of growth in China would hit these economies hard.

  To finance its trade deficit, China must continue to attract substantial foreign investment. Unlike some Southeast Asian nations before 1997, China relies heavily on long-term investments instead of "hot money" flowing into stocks. Nor does it have another Southeast Asian nemesis: large-scale, short-term borrowing by banks in dollars to finance domestic loans.

  Unlike Thailand and Indonesia in 1997, China fully guarantees bank deposits, making it far less likely that the country will see crippling runs on banks by depositors demanding their money. And China still links its currency to the dollar, limits its convertibility into other currencies and imposes restrictions on large capital flows -- all steps that insulate it from the global economy.

  Bankers say that the way multinationals are financing their investments has changed sharply in the last two years in ways that increase China's vulnerability to sudden outflows of capital.

  Multinationals used to borrow as much as possible of their investment costs from Chinese banks in the yuan. But more recently they have borrowed in dollars or euros, betting that the yuan will appreciate in value and make it cheaper to repay their debts. Because of this change in financing, China has been hit with large inflows of foreign currency that are being swapped for yuan. The same companies would have the legal right, under Chinese laws, to convert large sums back into dollars to repay these debts.

  Even without this risk, the last time China's economy slowed, in 1994, its foreign exchange reserves plunged. Companies resorted to a wide variety of tactics, like overcharging their foreign subsidiaries for export shipments, to get money out of the country.

  "All the elements of a meltdown are evident, including balance-of-payments risk," wrote Carl Weinberg, chief economist of High Frequency Economics, in a report last week. "The only question for us is when something might break."

  Others, like Liang Hong (梁紅) at Goldman Sachs, are more sanguine. They suggest that the government can slow some industry sectors without harming consumer confidence and without cutting back on infrastructure investment to address the economy's bottlenecks.

  The most crucial bottleneck is electric power. Shortages have become so severe that the Chinese have started importing power from Russia, according to a Xinhua report last Wednesday.

  Multinational companies, which do not depend on the country's banks to finance their projects, are still building factories in China at a brisk pace: Volkswagen and DaimlerChrysler announced plans for additional assembly plants last week.

  Overall, investment in fixed assets in China rose 43 percent in the first quarter, a pace that makes the US telecommunications and Internet investment booms of the late 1990s look modest by comparison. It took the US economy several years to work through its excesses when the bubble burst.

  The biggest risks are that China will find itself with another large round of nonperforming loans in an already limping banking system, and that economic troubles could stir political unrest.

  The last true hard landing in China occurred in 1989, around the time of mass demonstrations in Beijing that ended with the killings in Tiananmen Square.

  With that memory, Supple said, "The government's very afraid of the unemployment consequences of a hard landing."

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