Features : Growth Pains - Global Finance Magazine

COUNTRY REPORT / CHINA

China’s continuing economic expansion may be a bumpy ride, but the country’s prospects still look remarkably good.

Just as Chinese authorities began spending millions of dollars this summer to prepare the country for the 2008 Olympic Games, which Beijing hopes will improve its international image, several US companies issued recalls for a variety of Chinese products ranging from tainted foods to toys covered in lead-based paint. News of bridge collapses, mining accidents and slave labor did not help the country’s public relations blitz. While the Chinese government unleashed a damage-control plan, such reports point to a need for changes that will have to continue long after the Olympic torch is extinguished.

Beijing established a top-level panel to oversee food and product safety issues and, in an unprecedented move for a country known for keeping tight reins on the media, invited journalists to visit affected factories and vowed to give them greater access to key officials. “We should enlist the media in any emergency plans,” Wang Quoqing, deputy minister of the State Council’s information office, said in July. Though some say the visits included scripted speeches by factory managers, they nevertheless indicated that the State Council, the country’s cabinet, was aware that the eyes of the world, which they had hoped would be set on China’s spanking new sports venues, were instead focused on some of the country’s weaknesses.

Some foreign analysts charge that the product recalls highlight China’s ongoing quality-control problems. The country’s rapid economic expansion has shifted much of its manufacturing base to small local producers throughout the country, paving the way for bribery and lax supervision in the interior. As the country tackles the problem, however, there are indications that some of its neighbors, including Vietnam, may be ready to pounce by offering cheap labor and similar quality.

Dissidents Focus On Olympics
US President George Bush urged Beijing to use the Olympics as an opportunity to bring greater openness and tolerance for religious groups and political dissidents as well. The government says it will not allow the games to be politicized in any way but may be concerned over the growing number of street protests cropping up in major cities. Dissidents, it seems, may have a public relations agenda of their own for the event.

Corruption is at the core of much of the growing disgruntlement. Just prior to the October 15 inauguration of the Chinese Communist Party’s 17th congress, the government stepped up its anti-corruption campaign, establishing the National Corruption Prevention Bureau. The new agency reports directly to the State Council. Anti-corruption measures, the government says, had already led to nearly 100,000 officials being disciplined nationwide last year. The State Council now demands that government officials’ assets be made public, though it is doubtful that the financial system has the means to provide accurate information in a standardized manner nationwide.

In two high-profile cases, Zhang Shaocang, former head of the Anhui Province Energy Group, was sentenced in September to life imprisonment for embezzling the equivalent of just over $1 million, while Wen Mengjie, an official at the Agricultural Bank of China, was sentenced to death for embezzling some $2 million. Zheng Xiaoyu, former head of the country’s food and drug administration, was also executed in July for accepting $850,000 in bribes from drug companies in exchange for fast-track approval of their medicines.

Chinese press reports claim that 8,010 cases of commercial bribery were investigated between January and October 2006. Of these, they allege, 81% led to prosecution for taking bribes, though only 17% were prosecuted for giving them. Since September 2005, anyone found guilty of taking bribes has been banned from participating in public works projects, although enforcement remains erratic.

The fact that the Chinese economy is booming has led some foreign and domestic investors to resort to such methods to gain a piece of the action. The World Bank predicts China’s GDP will grow by 11.3% in 2007 and 10.8% in 2008, with a current account surplus of around 12% of GDP, or some $378 billion, for this year. The National Bureau of Statistics in Beijing predicts the economy will grow at an average annual rate of over 8% through 2010, then slowing to an average of 7% a year through 2020.

“For the first time, we expect China to be the largest contributor to global GDP growth, measured at market exchange rates, as well as in purchasing power parity terms,” said Charles Collyns, deputy director of the IMF’s research department at a press briefing to release the April 2007 World Economic Outlook. In purchasing power parity terms, Collyns announced, China represents 15% of the global economy this year and accounts for about a third of global GDP growth.

Exports Fuel Economic Boom

Much of the boom has been fueled by record-high exports. During the first seven months of 2007, exports grew by 29% year-on-year in dollar terms, while imports grew by only 20%, producing a trade surplus of $137 billion that is 80% higher than during the same period last year. Trade boosted international reserves by $267 billion during the first-half of the year to an unprecedented $1.33 trillion. Industrial production grew by 13.6% year-on-year during the same period.

Authorities are taking action to halt an imminent overheating of the economy. The People’s Bank of China, the nation’s central bank, raised the benchmark one-year lending and deposit rate by 27 basis points in September to 7.29% and 3.87%, respectively. This was the bank’s fifth rate hike in 2007 to curb inflation and temper consumer spending. The government even cut import tariffs on electronic goods from 17% to 13% in a move to fuel imports in order to tame the trade surplus and rebalance its international payments.

Inflation is a problem. Beijing officials are concerned that recent food price hikes could spill over into wages and generalized inflation. Consumer price inflation was up 6.5% year-on-year in August, from 5.6% in July, more than double the central bank’s 3% inflation target. August’s rate was the highest in a decade. While non-fuel inflation dropped to 0.9% in July as a result of price controls on fuels and utilities, the price of eggs alone rose by an annualized 34.8% in June and another 23.6% in August. Pork prices rose more than 70% year-on-year in August.With food accounting for 37% of average total urban household spending, according to 2005 government studies, China is concerned about the economic and social implications in a country where price hikes sparked pro-democracy protests in 1989.

“Authorities are rightly aiming at avoiding excess demand and the spillover of high food prices into generalized inflation, and mopping up liquidity and raising interest rates will continue to be needed,” according to the World Bank’s China Quarterly Update for September.

The World Bank, however, notes that the environment remains appealing for foreign investment, though recommending that China optimize its use of foreign direct investment (FDI) by leveling the taxation playing field, opening up the service sector further to competition and FDI, maximizing technology transfers and improving the investment climate in the interior regions. China reportedly received some 25% of all FDI to developing countries over the past decade and is projected to welcome another 30% of the expected $250 billion in FDI flows to emerging markets in the 2006-2010 period.

Financial markets are also booming. The World Bank reports the country’s A-share index gained 95% during the first eight months of the year, on the heels of a 130% rise last year. Chinese citizens are now allowed to invest freely in the Hong Kong Stock Exchange, in a move that has boosted Hong Kong-listed shares of Chinese companies that were previously valued below their price levels on the mainland.

Companies are lining up for IPOs in Shanghai. In September the China Construction Bank raised $7.7 billion in what was then the country’s largest IPO to date. But the record was soon shattered by an IPO for Shenhua Energy, China’s second-largest coal producer, which raised almost $9 billion. To avoid speculation, the government tripled the tax on equities trading in May, hoping to stave off a market bubble.

A new draft law for the administration of pension fund insurance was announced this year, while a final draft of a new financial leasing law was recently completed. Credit cards in circulation have doubled between 2006 and 2007 to more than 40 million in a country where only 14% of eligible customers hold credit cards, compared with 81% in Hong Kong.
By year-end, authorities are expected to release new rules allowing several international investment banks to establish joint ventures with local securities firms in what is considered to be a pilot program. Under the revised rules, foreign investment banks will be able to own up to 33% of joint ventures in the securities sector. Morgan Stanley, Goldman Sachs and UBS already have joint ventures with local partners, while JPMorgan and Merrill Lynch are reportedly in talks for similar investments.

In September the government launched the China Investment Corporation, its new foreign exchange investment unit funded by the finance ministry, to invest part of the country’s foreign currency reserves. With initial capital of $200 billion, the investment fund is one of the world’s largest and will focus mainly on a portfolio of financial products. Part of Beijing’s aim is to diversify its investment portfolio away from low-yielding US treasuries and help temper the ongoing appreciation of the yuan.

“China and other emerging economies should introduce more flexibility in their exchange rate management,” EU economic commissioner Joaquin Almunia said ahead of the EU finance ministers’ monthly meeting in Luxembourg in October. China loosened the yuan’s peg to the dollar in 2005, but the currency still trades within bands against major currencies. The yuan has gained more than 9% against the US dollar over the past two years but has dropped more than 5% against the euro.

So when the Olympic fireworks have passed and the athletes return home laden with medals and souvenirs, China will still have much work to do. Some might say that, just like its growth rate, the country’s tasks ahead will reach Olympian proportions.

Antonio Guerrero