The Global Crisis: China - Prosperity looks fragile: The next domino ready to topple?

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The Independent Online
WANDER THROUGH many parts of China and what do you see? Shiny new buildings. But look closely - they are often empty or unfinished. You will also spot smartly dressed people with mobile phones. But they walk along streets lined with newly unemployed state workers and jobless farmers desperately hawking goods or their labour.

Factories churn out goods, but stockpiles are growing because exports have fallen recently and domestic demand is at its weakest this decade. It is a worrying picture. Eighteen months into the Asian financial crisis, could China be the next economic domino to topple?

The country recorded a healthy 7.8 per cent increase in gross domestic product for 1998,so what is the problem?

Some figures seem too good to be true. Even the central government has admitted that raw statistics can be inflated by local Communist Party cadres fearful of missing targets. Analysts point to what seem to be inconsistencies: if growth is so strong, how come electricity consumption rose by only 2 per cent and rail freight was flat.

In the West, much of the concern about China surrounds the likelihood of devaluation. No one inside China expects the yuan to be devalued, but that is scant comfort, given the awesome problems of an insolvent state banking sector, unemployment at levels which officials admit threaten social stability, a state sector in which at least half the enterprises lose money, and institutionalised corruption that undermines policies for tackling these challenges.

Even the Finance Minister, Xiang Huaicheng, has said there is "no room for optimism" on the economy. Crackdowns have been launched on smuggling, tax evasion, counterfeit goods, corruption and illicit foreign borrowing.

Against this background, in January it was revealed that the debts of the failed state-owned Guangdong International Trust and Investment Corporation (GITIC) were far higher than previously thought, with assets of $2.58bn (pounds 1.56bn) against debts of $4.35bn (pounds 2.64bn). As the biggest bankruptcy since the Communists took power in 1949, the GITIC case is a turning point. It is one of 240 investment corporations used by state bodies to raise foreign capital in the early 1990s when China enjoyed breakneck growth. Foreign bankers were persuaded by party officials that they were in effect lending to the state. In the case of GITIC, where the ultimate borrower was a big provincial government, foreign lenders felt secure. But money was being diverted into investment scams, property schemes and the overheated stock market. A fair chunk also disappeared into suitcases taken overseas as the newly rich built nest-eggs abroad. From Peking's point of view, the investment corporations are merely the tip of the debt iceberg. The rogue lending and squandering of state money was mirrored throughout the state banking system.

For the time being, China is trapped by conflicting demands. To sort out the banking sector it must deal with debt-ridden state enterprises, but to sort those out it will have to throw millions more out of work, risking growing unrest. Fear of unemployment has prompted everyone to save more and spend less, exactly the reverse of what the government wants.

Peking's answer is to spend, spend, spend. Investment by state enterprises jumped 22 per cent last year, with much of the money coming from state banks. Maintaining public confidence is one reason Peking will try to hold the yuan stable. Strict controls are now in place to limit the movement of foreign exchange.

China has watched the collapse of neighbouring Asian economies and learnt some swift lessons. The odds are that the government will negotiate a path through the hazards ahead, but the going will be perilous. In the 50th anniversary of the Communist revolution, the leadership in Peking is taking nothing for granted.