Don't Buy It

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PHILIP BOWRINGSeek truth from facts, as Chairman Mao once advised. In that spirit, I urge: don't believe the myths about China's economy. China is neither a threat to the world, an island of stability in Asia nor an example for anyone else to follow. It is big but still mostly self-contained. It is troubled but not in deep crisis. Unfortunately there are glib views out there about China that are not only misconceived but dangerous.Myth 1: China's economy is still growing rapidly and will help pull Asia out of its crisis.Chinese Premier Zhu Rongji is sticking to his promise of 8% GDP growth this year. And many independent forecasters still expect growth to exceed 7%, an impressive level given China's size, its devastating floods and the woeful state of its neighbors' economies. The growth estimate is mere political rhetoric.At the other extreme are the China bears, who focus instead on the available data for inflation (falling), power consumption (rising at a feeble rate) and imports (static). Toss in losses from the flooding, and these analysts conclude that growth must in fact be near zero.No one really knows the truth because much of the data is unreliable. China's official growth figures, for example, are wildly inflated because they overestimate the input of small and medium-sized enterprises. But let's split the difference between propaganda and extreme skepticism and say China's growth this year will be 4%. That's low, and not nearly enough to get a grip on unemployment. And it's bad for Zhu's image as a can-do leader: for his sake, it's a political imperative that the economy perform better next year. On the other hand, 4% would not be a disaster for China, Asia or the rest of the world. China is not an engine for Asia's growth, and 4% is far better than rates elsewhere in the region.Myth 2: Zhu's state-enterprise and banking reforms will bring about a new surge of growth.The reality is that his attempts at reform have so far only contributed to China's slowdown. Urged by Zhu to take a more commercial attitude to loans and face the consequences of bad ones, banks have tightened lending policy. That means less money for real investment, as most new credits have gone to finance losses or fund the accumulation of unsold inventories. Reforms at state-owned enterprises (SOES) have increased unemployment, prompting nervous workers to spend less and save more. Consumer demand is low, production capacity excessive, yet SOES keep churning out unsaleable goods.PAGE 1  |  
Wholesale reform--widespread shutdowns and layoffs in creaking and inefficient plants--would cause a deep recession of the sort that Thatcherism brought to Britain. Closing all the persistent loss makers would be disruptive economically and socially. It's politically unacceptable. So real reform stays on hold while Beijing emphasizes the need to preserve social stability and tries to apply some economic stimulus. At best, even piecemeal reforms aren't likely to restart until growth actually gets back to 7%. And even then reforms are sure to proceed slowly.Myth 3: The Chinese banking system is in danger of a catastrophic Japan- or Thailand-style collapse.The reality is that China's banking system cannot collapse because the state controls it. Banks' non-performing loans amount to a troubling 30%, according to estimates. Banks need restructuring and massive injections of money for recapitalization. If these don't occur, China will have to ease money supply and risk the return of high inflation. But for now the problem is deflation, a consequence of excess capacity. There are too few buyers for an increased supply of goods and low or negative returns on existing investments. This deters new investors.Myth 4: The renminbi is overvalued as a result of devaluations elsewhere in Asia.This notion is promoted by Beijing's rhetoric, which has it that China is prepared to suffer in the interests of global stability. Yet continued rises in China's export volumes belie this myth. Even though enterprises are dumping some inventory overseas at a loss, China is still a competitive exporter. A developing country with a current account surplus should not need a weaker currency and more reserves. However, that does not mean there won't be a devaluation. Such a move would help the domestic economy by boosting the profitability of exports, improving enterprise cash flow and offsetting deflationary forces.Myth 5: A renminbi devaluation would be disastrous for the world, setting off a new round of competitive devaluations.This notion is especially dangerous, as it could become self-fulfilling. Most Asian currencies are already so competitive on world markets that the impact on their trade of a weaker renminbi would be minimal. Asia's problems are shaky banking systems and the collapse of domestic demand--not foreign trade. Since the renminbi is not convertible, devaluation should make scant difference to capital flows, other than to Hong Kong. This would be the final straw to break its peg to the U.S. dollar. But a renminbi devaluation would probably shake Hong Kong free of a system that is now crippling the economy. In that sense, a renminbi devaluation might actually be a positive step, for China and the rest of the region.  |  PAGE 2