Slipping Out of Zhu's Squeeze

By Barbara Rudolph

HEADQUARTERED IN A SPRAWLING, 1950s-era complex just outside Beijing, the Shougang steel company is a symbol of China's economic prowess -- and its problems. Earlier this year, when credit was easy and the economy was steaming ahead at a 17% annual clip, the state-owned conglomerate and its 270,000 employees could hardly keep pace with consumer demand. Profits soared. Then came the credit crunch orchestrated by economic czar Zhu Rongji, and Shougang felt the sting at once. Customers slashed their orders, and soon Shougang could not pay its bills. The company last month was forced to take out a $70 million loan from the government to keep operating.

The fate of Shougang and other state-owned behemoths was much on the mind of China's rulers last week, as they launched a de facto turnaround in Vice Premier Zhu's austerity measures, coupled with a bid to broaden and deepen medium-term economic reforms. A communique issued by the party's central committee indicated that the government was loosening the restraints on credit and growth that it imposed only last July. But the statement also made a significant nod to the importance of the market as "a fundamental factor in the disposition of resources." And it went on to endorse speedy reforms in taxation, banking and investment to provide a more sophisticated financial system for the nurturing of sustained growth. But those reforms will take time to bite. In the short term, it was far from clear how Beijing could control a renewed torrid growth rate without setting off a new round of inflation and speculation.

& The 10-point central-committee blueprint outlined the basic themes of reform but was vague on key details. A new system of taxation will require the 30 provinces to pay more to the central government, which collects only about 13% of all taxes paid in a chaotic system rife with inequities. Credit will be somewhat restrained when commercial banks are freed of various obligations to support money-losing state enterprises, but that will be some time coming. Finally, privatization of state-owned companies was acknowledged as a distant prospect -- though the communique made it clear that for the moment public ownership would remain the "mainstay" of the economy. Says a Chinese economist: "They're making the blueprint now, but we're going to call 1994 the year of economic reforms."

The stop-go cycle of austerity and relaxation results from a paradox. China's reformist economy "suffers not from too much central control but too little," notes Richard Margolis, an executive at the Smith New Court Far East investment firm in Hong Kong. Much of the country's inflation last year, for example, resulted from Beijing's malnourishment by the primitive taxation system. With more than 80% of all tax revenues left in provincial coffers, the central government simply printed more money to finance its major infrastructure undertakings. At the same time, provincial authorities launched an orgy of speculative development projects that took money away from such essential functions as paying peasants for their crops. As prices soared, unrest in the countryside quickened, until Zhu stepped in last summer.

Zhu did address one of the economy's central problems, the unquantifiable and unregulated credit that was coursing through the system and fueling inflation. In May he cut interbank lending and ordered the recall of $17.5 billion worth of short-term state-bank loans that were largely in speculative schemes. But Zhu's credit squeeze soon led state-owned companies like Shougang to scream.

So the government blinked: during the month of October alone, banks and credit cooperatives extended more than $12 billion in new business loans. One sign that Beijing intends to retain such political discretionary power is the lack of independence for the central bank, even as the institution is given a higher profile. The bank will be placed "under the leadership" of the Communist Party-dominated State Council.

The greatest source of fiscal instability, however, remains the inefficient | state-owned enterprises, with 106 million workers on their payrolls. More than a third of those huge companies are still dripping with red ink. So far, the government has been unwilling to enforce a five-year-old bankruptcy law that would require the firms to cut featherbedded staffs and losses. Privatization remains the government's great and enduring taboo. Says Milton Friedman, the Nobel-prizewinning conservative economist, who completed a trip through China last month: "The answer to the question of how to go about getting a free- market system is very straightforward. You get the government out of the way and privatize, privatize, privatize. The Chinese have the words, but do they know the tune?" The latest reforms signal that they do know the score. They are just not quite willing to play it yet.

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With reporting by Sandra Burton/Hong Kong and Mia Turner/Beijing