Scrip Tease

TERRY McCARTHY ShanghaiThey stand outside banks in China's big cities, mobile phones clipped to their belts, electronic calculators in their hands, eyes shifting constantly in search of potential customers. They are the black-market currency traders. Their dealings are illegal, but business, after all, is business. Having been vanquished four years ago when the last renminbi devaluation wiped out the parallel market, they have begun to regroup as pressure grows for another currency adjustment. One such trader, a heavily built man in a blue T shirt who calls himself Wang, plies Beijing's busy Sanlitun street. He is offering to buy dollars for 8.885 renminbi apiece--about 7% above the official rate. People believe it will go to 9 soon, he says, shying from the summer heat under a large yellow parasol. Who knows what the bottom will be? We're not economists, we're not officials.But they are leading indicators of change. Although the Chinese government has invested considerable political capital--and won plaudits from around the world--with repeated pledges not to devalue the renminbi, there are strong pressures to do so. Beijing knows the dangers: it has watched as devaluations in Thailand, South Korea, Indonesia and, most recently, neighboring Russia have gutted those countries' economies. But signs are growing that Beijing has reached its pain threshold and, according to a private economist with sources close to the leadership, the government is considering a devaluation of the renminbi early next year to stop further erosion of exports. The devaluation could amount to as much as 30%, depending on external factors, in particular the value of the Japanese yen.Beijing's strategy is similar to the one adopted when the renminbi was quietly devalued in 1994, according to the economist. The authorities will allow an effective depreciation through the black market, followed by an official devaluation--presented almost as a post facto recognition of something that has already taken place. And since the government can keep tight reins on the black market precisely because it is illegal, it can prevent a currency meltdown like those experienced in Indonesia or Russia. The convenient whipping boy for the policy change will likely be Japan, where a domestic banking crisis is expected to weaken the yen further against the dollar. China's leaders would thus be able to argue that Tokyo's mismanagement of its currency forced their hand.The political semaphore has already started. Two weeks ago President Jiang Zemin took the opportunity of a visit to China by former Japanese Prime Minister Toshiki Kaifu to reiterate that China is already paying a great price and taking a risk by not devaluing. I cannot be 100% certain of how things will go in this world, he added, giving the first official hint that a devaluation was no longer ruled out.For the moment, the case against devaluation is still argued forcefully in Beijing. As recently as two weeks ago Premier Zhu Rongji told former U.S. Trade Representative Carla Hills over dinner in Beijing that China would not devalue for at least another two years. Beijing's leaders know devaluation would itself be painful, particularly for companies importing raw materials and machinery from overseas. Conventional wisdom among seasoned China-watchers in Hong Kong--leavened, no doubt, with a large dose of self-interest--is that devaluation isn't necessary. The mainland's large domestic market, the renminbi's lack of total convertibility and Beijing's tight control of the financial system will enable China to escape most of the fallout from the crisis ravaging the rest of Asia, or at least so goes the argument. But the reality is that China can no longer isolate itself from global economic forces, as it relies heavily on exports to propel growth. Last year exports accounted for more than 20% of China's gdp, compared with just 12% in the U.S., for example. And after growing by an annual average of 11% between 1993 and 1997, China's economy is slowing at an alarming rate. Officially China is still sticking to its target of 8% gdp growth this year, but some independent analysts expect it will be only about half that.Hard macroeconomic statistics suggest that Jiang's new-found uncertainty is more than a passing attack of nerves. Export growth in the first half of this year was just 7.6%, compared with 21% for all of last year. Some exporters now are pleading with the government for a devaluation, saying the alternative is a mass layoff of workers. Domestic demand is also shrinking: the retail price index fell 3.3% in August, the 11th straight monthly drop. Utilized foreign investment fell 1.7% in July from a year ago. And despite continuing trade surpluses, China's $140 billion in foreign-currency reserves aren't growing, despite expanding 33% in 1997. That's evidence that companies are hanging onto their dollars in anticipation of a depreciation, according to Schroders Asia strategist Andrew Ballingal. Many multinationals operating in China are allowing for a devaluation in their 1999 budget forecasts, says Melvin Chua, general manager of advertising agency McCann-Erickson's Shanghai office. All my clients are expecting it to happen. The signs are already coming from the government: 'Be prepared.'PAGE 1|The strains on China's economy are also prompting the government to slow its ambitious reform plans. After a tour of northwestern provinces this summer, Premier Zhu conceded that deflation--shrinking demand and falling prices--was already occurring in some regions. This means that despite increased government spending, the hoped-for boom in domestic consumption to compensate for slowing export growth is not happening. Stalled are his plans, articulated barely six months ago, to revamp state-owned enterprises, clean up the banking system and initiate a vast house-buying program by the masses. And last week President Jiang made another of his elliptically foreboding comments, saying it would be arduous for China to achieve its economic targets for the year.Arduous may appear an understatement to the millions of workers from ailing state-owned enterprises who have been laid off all over China. Travels through the heartland reveal that labor unrest is commonplace in urban areas. Anger bubbles up with little prompting from an array of urbanites, ranging from disgruntled taxi drivers in Luzhou, to retired women in Chongqing who no longer receive pensions, to fired light-bulb-factory employees in Wanxian. In Wushan, workers laid off after a chemical factory closed now dig sand from the banks of the Yangtze River and load it into trucks for the equivalent of $24 a month. On street corners in Wuhan unemployed men hunker down with small boxes of tools and set up notices advertising their services: plumbers, electricians, painters, all willing to work for a day's wages that will put food in their stomachs. This doesn't feel like a country that's growing at 8%. And outsiders, including the U.S. government, are looking on with some initial twinges of concern. If China falls, the repercussions would be dramatic and would change the way we talk about the economic crisis in Asia, says a Clinton Administration aide. Worker unrest would be far more dangerous for the system to survive than the intellectual unrest we saw with the Tiananmen Square revolt.For all its problems, however, China isn't likely to become the next Russia. Despite the similarities between the two former communist giants--dysfunctional banking systems, ineffective tax collection, implacable resistance to central government edicts by regional power centers and huge problems in privatizing state-owned enterprises--the differences between Russia and China are even starker. First, China still maintains tight political control, brooking little dissent. Zhu might take some heat if, after all the promises to the contrary, the currency is devalued. But China's rubber-stamp National People's Congress won't threaten a constitutional crisis if Jiang refuses to fire him. Second, China's economic reforms, especially in the countryside, are far more entrenched than Russia's. And Chinese industry, unlike Russia's, actually makes useful products. Andy Xie, chief economist for Morgan Stanley Dean Witter in Hong Kong, figures that 85% of China's exports are manufactured products. Russia, by contrast, still relies predominantly on natural resources to earn foreign currency. People on the top in Russia focus on stealing money, says Xie. In China corruption is also an issue, but because China is not rich in natural resources, the bosses cannot simply steal--they have to focus on producing something first.Still, the specter of large-scale labor unrest worries Chinese officials--enough to have prompted steps toward biting the bitter pill of devaluation. It is a highly sensitive issue, not least because of the potential loss of face involved. They need a damn good cover story, says Schroders' Ballingal. (One possibility: 160 yen to the dollar.) But events have overtaken the analysis of the region that led to Beijing's initial pledge not to devalue. I think they colossally underestimated the deflationary forces in the region, says Ballingal.The renminbi squeeze has already begun. Two weeks ago the central bank announced curbs on acquiring foreign exchange, making it harder for companies to get dollars legally at the 8.28 rate to stop leakage of foreign currency overseas. This has driven many firms to the black market, where they have to pay more renminbi to buy dollars--tantamount to an unofficial devaluation. Beijing didn't abandon controls on the black market, however: it also announced that companies found trading more than $5 million would be prosecuted. Hong Kong firms operating in China with big import costs are feeling the pain, says Shan Weijian of Newbridge Capital, a U.S. investment group. To change their earnings into foreign currency, they now have to go underground. They can't convert at the official rate, says Shan. They're getting squeezed hard. In Hong Kong talk of devaluing the renminbi is almost taboo, as it would probably spell the end of the Hong Kong dollar's peg to the U.S. dollar--a prospect many in the territory fear. But these are desperate times in Asia, and if China has to choose between massive labor unrest across the country and the prospect of some property tycoons in Hong Kong losing their shirts, it is not overly arduous to guess where Beijing will come down.|PAGE 2