In early 1998 we asked four China specialists this question. Their responses follow. Two (Gene Chang and Thomas Rawski) were updated in July.
 

Gene Chang
University of Toledo

1. The banking and financial systems in China are deficient. The percentage of bad and non-performing loans in total outstanding loans is estimated to be 20%, which is larger than Korea's 17%. The danger of a major crisis in the domestic market does exist.

2. However, a crisis is unlikely to occur in the coming years. The external macroeconomic indicators are within the safety ranges. The Chinese government is currently taking a series of precautionary measures to avoid a banking or financial crisis, including closing many investment trust corporations.

3. Most Chinese economists seemed to be more concerned with the recent slow-down of the economy. It is true that most macroeconomic indicators show signs of an economic slow-down. This would worsen the already bad unemployment situation. Chinese economists called the current state "insufficient effective demand."

4. The government cut the interest rate in October 1997 and relaxed control of credit by commercial banks in January 1998. However, China is in somewhat of a "liquidity trap." The increase in money supply may not give an effective stimulus to the economy.

5. Many Chinese economists thus suggest that the government increase fixed asset investment. The government is taking measures to do so. More new projects are expected to start in 1998.
 

Gary Jefferson
Brandeis University

Responding to Asia's slumping growth, China's growth has weakened and will continue to weaken. The two workhorses of China's high industrial growth have been FDI and trade that resulted from the open door policy and TVE growth that arose from the rural reforms. Since half of TVE exports had been destined for Southeast Asia and about half of FDI originated therefrom, FDI, exports and TVE growth will continue to fall.

The challenge for China's policymakers is to undertake its agenda for enterprise and banking reform while simultaneously managing an expansion of domestic investment and government spending to compensate for decline in the other national income aggregates. While directing credit to urban collective, cooperative and private enterprise may promise two or more jobs for every one save in the state sector, the "a bird in the hand is worth two in the bush" mentality may prevail, leading to more dead birds in the banking system down the road.

Slow growth need not be so problematic. As Schumpeter noted, recession has the virtue of squeezing inefficiencies out of the system. The pursuit of high rates of growth results, in some measure, from a lack of political legitimacy.

Still, from a longer term perspective, the crisis that is rocking the rest of Asia could not offer a more vivid, relevant and terrifying lesson for China's leadership of the urgency for enterprise and banking reform. Five to 10 years from now, the Chinese economy promises to be better inoculated against the flu that it would have been without this challenge.
 

Nicholas Lardy
The Brookings Institution

China already has the Asian flu. I say that because I believe that the underlying problem is a weak banking system that has lent excessive amounts that will not be repaid. The build up of bank credit relative to gross domestic product in China has been far greater than in Korea, almost as great as in Thailand, the share of non-performing loans is greater by a substantial margin than in either Thailand or Korea, and excess capacity in many industries appears to exceed that in other countries in the region. The real estate bubble in China is substantially larger than in Thailand and Chinese banks clearly have a heavy exposure to property lending.

China, however, will not manifest the same extreme symptoms of the flu as in Korea for several reasons, of which the most obvious are the lack of capital account convertibility and greater reliance on FDI than borrowing. Cumulative FDI in place in China at the end of the third quarter of 1997 was about US$210 billion, almost twice as large as officially reported borrowing. In Korea external borrowing as officially reported is nine times cumulative FDI, 15 times if borrowing by Korean subsidiaries abroad is included in the external debt figure. In addition, most of China's borrowing is medium and long term, in distinct contrast with Korea and Thailand. Finally, China is currently recording record surpluses on both the trade and current account.
 

Elliott Parker
University of Nevada, Reno

Will China catch the "Asian Flu"? While China will remain among the fastest growing countries in the world, China's growth rate will probably slow significantly from the rapid pace of 1992-1997, perhaps by one or two percentage points. Most of this slowdown is internally driven, however, as efforts begun two to three years ago to tighten credit have finally had an effect. The financial crisis in Asian economies will probably force China to devalue the yuan again to remain competitive in the U.S. market, and this will have repercussions not only for its neighbors and trading partners but also for those foreigners who have invested or consider investing in China. But China will not need an IMF bailout, and it will not rock the world's stock markets to the same degree.

China certainly shares some of the early symptoms of the flu with other countries in Southeast Asia. China is a high growth economy on a "bubble" of speculation largely fueled by excessive bank lending for risky, low-return investments, and such a growth pattern is difficult to pursue without a dramatic correction in expectations. China's banking system also probably has a higher share of nonperforming loans than any other Asian country. Yet China's currency is not strictly convertible so capital flight is more difficult, China has less capitalization through the stock market and less foreign equity investment to be repatriated by nervous investors, and China relies less on short-term loans from abroad that will become more expensive to repay if devaluation occurs.

What China does have is an export-reliant economy that relies on low-price production, and recent drastic devaluations among China's competitors will cost Chinese exporters significant market share. Expectations that this will force a devaluation will lead potential investors to wait, and encourage capital flight for those with access to hard currency. Devaluation therefore seems probable, even though China has significant foreign reserves at present, but a major financial crisis is less likely. In order to maintain investor confidence and sooth its worried neighbors, China's government has recently committed to a stable yuan for 1998. How fast this commitment changes may be a key factor in determining how much China's growth rate will fall.
 

Thomas G. Rawski
University of Pittsburgh

1. The short-term effects of Asia's economic crisis on China's economy are negative. The growth rate of China's economy, already falling, will continue to decline, for three reasons. First, devaluations elsewhere slow China's export growth and dampen China's attractiveness as a site for foreign investment. Devaluation of China's renminbi would produce a further drop in the value of other Asian currencies, and would therefore not stimulate Chinese exports. Second, some potential investors, notably Overseas Chinese businesses and Korea's chaebol, have suffered big losses. This reduces the supply of offshore funds available to China. Third, potential investors from OECD nations (and international banks) will exercise greater care before committing to China ventures because they have watched the unraveling of apparently sound situations elsewhere in Asia.

2. Longer term effects on China's economy may be positive. First, China may benefit from the lessons of the Asian crisis (about the need for sound financial structures, the dangers of "crony capitalism," etc.) without paying the huge price now inflicted on Korea, Thailand, and Indonesia. Second, in the policy tug-of-war between "growth advocates" (who favor low interest rates, big investment, high growth rates) and "reformers" who press for stronger efforts to consolidate and restructure banks, to free up resources trapped in state enterprises, etc., the Asian crisis shifts the balance of power toward the latter group. Chinese politicians may not pay close attention to balance sheets and debt-asset ratios, but collapsing governments and images of failed business leaders blubbering on global television do attract their attention. When leaders in Peking ask their advisers: "Can these things occur in China?" and are told "Yes indeed!," the next question is "How do we prevent this from happening?" (The answers do not come from the proponents of big investment.)

Lastly, regardless of who controls the Hong Kong Monetary Authority, the Chinese have gained valuable first-hand experience in the management (or mismanagement) of financial crises. Chinese leaders received daily reports concerning the Mexican crisis, but these were essentially digests of world press reports. Now they have an inside view, which will help them prepare for a future crisis in which China is directly involved.

3. Asia's crisis highlights the impotence of institutional change, and not simply growth rates, in determining medium- and long-term economic prospects. Market-oriented institutional change has already gained considerable momentum. Consider the example of layoffs. Behind every episode of layoffs, pension arrears, or wage shortfalls stands a banker who refused some manager's plea to help meet a payroll. Such acts were unthinkable only a few years ago. They are routine today -- as we see from the escalating unemployment figures.

Such market-imposed adjustments are critical for China. Like Japan and Korea, China has long operated a dual system in which favored insiders (the urban sector, especially state enterprises and their workers) get special breaks (e.g. access to cheap credit). Unlike Japan and Korea, China has no effective means of pressuring beneficiaries of this largesse to "deliver the goods" in the form of new technology and higher productivity. Market discipline is the main force separating China's of "insider preference" from an environment of pure rent-seeking. This means that the fate of reforms designed to expand the scope of market entry, bankruptcy, mergers & acquisitions, dismissal of redundant workers, transparent corporate governance, etc. takes on extraordinary importance in determining future productivity and efficiency in China's economy.

Fierce competition fueled by rivalry among provincial and local governments, direct foreign investment, improved transport and communication, declining barriers to domestic and international trade, and entry of defense industries into civilian markets is one key element underpinning the gradual emergence of market-linked institutions and the growing effectiveness of market forces. Another is the fiscal weakness of the state, especially at the central level, which drives increasing numbers of agents to pursue their interests in the marketplace rather than the yamen. For this reason, the marginal social benefit of additional government revenue, particularly at the national level, is almost certainly negative.

4. Asia's crisis highlights the instability of systems that conceal officially-directed resource allocation behind a veneer of market institutions. Despite China's impressive reform accomplishments, market arrangements remain shallow. This is evident from the current barrage of ad hoc interventions in which top leaders betray the principles of "separating government from enterprises" and "separating government from banks" in the name of ensuring an 8 percent rise in GDP for 1998. Giving new prominence to the practice of imposing quotas, demands, and requirements on economic agents undercuts the reform principles to which the government remains formally committed. Benefits from these interventions will be modest and transient. The costs will emerge rapidly; they will be large and enduring.

5 . Asia's crisis reveals strong resemblances between China's transitional economy and Asia's "market" systems. These newly recognized similarities show how much China's reform has accomplished. Who predicted in 1988 or in 1993 that, five or ten years down the road, resource allocation in China would appear quite similar to what we observe in Korea or Japan? But the crisis also exposes deep flaws in what we now recognize as semi-market systems. As this is written in July 1998, China's central government is floundering in a rip tide of conflict between the short-term objective of maintaining 8 percent growth and longer-term goals of market-oriented reform. Sacrificing reform policies in an effort to preserve short-term momentum and social stability escalates the risk that China's economy will soon encounter the roadblocks now widely visible across Asia.