Red Storm Rising

THE world's fastest developing, most admired, seemingly invincible economy is in serious trouble. The signs are everywhere. In Standard & Poor's recent downgrading of the ratings of four of China's largest financial institutions from "stable" to "negative"; in the slowing down of GDP growth and foreign direct investment; in galloping unemployment; in falling productivity and rising prices; in a banking sector that could actually be bankrupt.

Above all, there is no rule of law as there is no legal framework. Says Professor Tan Chung of the Department of Chinese Studies at the Jawaharlal Nehru University: "China's legal framework is almost nonexistent as the concept of supremacy of law is not recognised. The government and the party have always controlled everything and their decision has been the law. But this is resulting in chaos in a market economic situation." With no legal redressal system and no free media, Chinese agencies can renege on contractual obligations, and leave the foreign investor watching helplessly. Chung cites the case of US fast-food giant McDonald's, which was apparently given prime real estate in Beijing, and one fine day, discovered that the land had been sold off to a non-resident Chinese. End of story.

Indeed, many analysts are beginning to question China's spectacular foreign direct investment figures. A large chunk of it, they say, may actually be black money in the hands of China's vast bureaucracy (corruption in China is on a different level of magnitude from India's) being siphoned off through a maze of subsidiaries based in places like Macau and Taiwan, and then redirected back into China, posing as nonresident-Chinese FDI, which gets a lot of concessions from the government.

The other disaster waiting to happen is the rising economic tensions between the cities and the countryside, between industry and agriculture, between impoverished inland provinces and the wealthy coastal areas. Urban migration of the type never witnessed in history is taking place as starving farmers move to cities to look for work. Three hundred million farmers—more than the entire population of the US—are looking for alternative employment. Some analysts predict that this diversion of farmers to other professions could lead to China having to import 75 per cent of its food by 2002.

The other powderkeg China is sitting on is its banking sector. According to the Bank for International Settlements (BIS), all big banks should have capital equal to at least 8 per cent of their assets. However, with the possible exception of the Bank of China, none of China's banks meet BIS standards. The governor of China's central bank has already admitted that 6 to 8 per cent of all loans were unrecoverable, a majority of which were to public sector enterprises. However, these are only estimates as no concrete study is available or is allowed to be conducted; the real figure could be much more. Some China experts put it at even 80 per cent, the writing off of which could cost China 30 per cent of its GDP. Huge bank loans have also been made against minimal collateral from non-resident Chinese. There is no official or unoffi-cial estimate of how much these add up to.

All arrows point downwards. According to the Chinese Academy of Social Sciences, this year, China's GDP growth will definitely miss its 8 per cent target, landing up somewhere around 5 per cent. This, it says, is primarily because the state sector has remained stagnant and has had no growth; unemployment is on the rise and has already crossed the 30-million mark with another 30 million about to be laid off. Says an expert: "Today, Chinese workers do not even enjoy minimum social guarantees and their demand has already reached the stage of calling for the right to eat."

Investment by foreign parties other than non-resident Chinese has slowed drastically. Says economist S.L. Rao: "Foreign investors are wary of investing in China now because their earlier investments have not borne fruit." Increasingly thus, potential investors from the US, Japan and Europe are looking towards India, he says. "China's GDP growth rate is falling for the last two years and is set to fall further this year. The economic debacle of Southeast Asia will create problems in China too and it is in for a massive devaluation towards the end of the year which is likely to make macro-economic management even more difficult for the Chinese government."

 China, which has a long history of controlled economy under the Communist Party, took a plunge into market economy in 1974. The late Deng Xiaoping developed a new model of the "authoritarian market economy". Then came the Tiananmen Square massacre on June 4, 1989, resulting in wester n sanctions. To overcome these, China had to open more of its markets like real estate and retail banking to foreign investors. Also a bigger share of the consumer market. Says Chung: "China willingly accepted the absorption theory which says if you expose yourself to capitalist orientation and culture, you will be sucked into the system and become part of it. Once in it willingly, China has prepared itself to get into this socio-Darwinistic world of survival of the fittest, where 20 per cent people get richer while the remaining 80 per cent poor are pushed further into misery."

Chung believes that one of the main reasons for China's success was its decision to make the world's sunset industries its main engine of growth. These labour-intensive industries, shed by the US and Japan, have now become Chinese monopolies. China today supplies products from these industries—small everyday use and household products; dolls; consumer items like torches, shoes, staples and low technology products—to the entire world. Western corporations have found the country a great source of cheap labour.

This labour is cheap because they work in abysmal conditions and have no rights Thirty-two workers died. Conditions at the factory were similar to many other foreign-invested factories in China: workers are locked inside factories in which they work, eat and sleep (such buildings are referred to as 3-in-1 factories with the workshops, warehouse and dormitories all located in the same building). Conditions are similar to those found in prisons. American companies like Niké are already under tremendous pressure in their home country to raise wages in China, give workers better working conditions, or face boycotts.

CHINA has been the biggest success story of the last two decades and they have followed the Japanese model of development to the T," says economist Surjit S. Bhalla. According to him, the key to China's economic success was the bold step to get a comfortable trade surplus by restructuring imports and undervaluing its currency. "The Chinese effectively and actively used the exchange rate and trade policy as a major tool of their growth strategy and unlike India's swadeshi policy, opened up almost all sectors for foreign investment."

Says Amit Mitra, economist and secretary-general, FICCI: "China has used a different kind of a system under which they push an export obligation into every foreign investment or joint venture. These extra-market, extra-regulatory and extracting methods have got China a lot of exports. Today 57 per cent of their FDI is export-related. In India, it is just 3 per cent and that too by default." The other key factor, Mitra feels, is the level of government savings. They amount to almost 9 per cent of the GDP while domestic saving is negligible. In India government saving is negative.

China's statistics are spectacular: seventh in the world in terms of GDP growth, which has been the fastest in the world from 1993 to 1997 at an average of 11 per cent—3 per cent higher than the world average growth rate; 10th amongst the world's trading nations with a trade turnover of over $325 billion; foreign investment is the second highest after Japan. The country is ranked second in total foreign exchange reserves at $140 billion, after Japan.

However, many experts do not accept these figures and say that most of the data available on China is false. Says Mitra: "There is no standard system of data maintenance in China and the figures available are at best guesstimates." Mitra, who is conducting an extensive study on the Chinese economy, feels the state and the party still have considerable control over the country's affairs and the system followed is arbitrary. Local Communist Party officials continue to direct money from the state banks to their favoured projects.

AND the line is now blurring between corrupt officials and the Triads, China's secretive crime gangs, whose membership may now number one billion. According to China expert Frederick Dan-nen, the People's Liberation Army is in partnership with the Triads in business: in Shanghai, both the PLA and the Public Security Bureau—China's secret police—own nightclubs and even brothels with various Triad groups. It's believed the PLA is involved in a number of smuggling enterprises with Triad groups, including bootleg cigarettes, illegal aliens and possibly even arms and heroin smuggling to the US. Indeed, as long back as the early '80s, says Dannen, Deng, on three different occasions, publicly referred to the Triads as "good" and "patriotic".

The man to watch now is the new premier Zhu Rongji. Starting with a television address in China, Zhu has begun portraying himself as a global-minded leader answerable to his people. He has set a stiff three-year deadline to bring the economy back on rails and declared that "dilatory style of work will not be tolerated". Zhu's record is stunning. As mayor of Shanghai—China's financial and business hub—he earned the nickname "One chop Zhu" for starting an effective single window clearance for foreign investors. Following his recall to Beijing in 1991 by Deng, Zhu brought China's inflation down from 25 per cent to virtually zero in two years time.

Zhu wants to overhaul China's financial system, state enterprises and bureaucracy within this three-year deadline, a goal that has frustrated reformers for decades. He also aims to restructure the nearly insolvent banking system and wipe out hundreds of billions of dollars in bad loans. By the end of this year, Zhu wants to end China's system of subsidised housing—most Chinese pay $ 5 per month on employer-owned flats—to promote buying.

The government has already scrapped the forced credit quotas and ordered banks to lend only on commercial merit. The central government's workforce will be pruned by 50 per cent to four million people and this will trickle down to the provincial and local governments too. Zhu has also weeded out the old guard: of the seven party leaders, five have degrees from prestigious Chinese universities. President Jiang Zemin, Zhu and vice-president Hu Jintao are engineers. Three of China's four vice-premiers have extensive economic experience and many lower officials have been trained in the US.

Under Zhu's crash plan, 11 of China's 40 ministries may either be abolished or turned into corporations or even privatised. Zhu and his team are promoting the slogan: "Break state monopoly in all spheres and actively promote the non-state sector." But Zhu still has a very long way to go: corruption and mismanagement are deeply rooted in every aspect of Chinese life. As the coastal provinces get wealthier, and the hinterlands driven deeper into penury; as the Chinese government begins to lay off 30 million employees, most of them without any compensation, from the SOEs; as 300 million farmers turn destitute, China could be hurtling into a socio-economic catastrophe of titanic proportions.