Mainland menaced with new problems

Having brought down inflation with a three-year austerity campaign late last year, the mainland started to ease credit and money supply. The results have been unexpected. Despite growth of 19.1 per cent in broad M2 money supply and 18.1 per cent in loans in the first half of 1997, gross domestic product in the period is only expected to grow at between 9.3 and 9.6 per cent, below the 9.7 per cent for all of 1996. Factory inventories have risen to record levels, thousands of workers have been laid off and the trade surplus has soared, with imports stagnant and many goods exported because they could not be sold domestically. What confronts the mainland's mandarins is a fundamental change in the economy and the means they must use to regulate it. An economy of shortage has become an economy of surplus. The old management rules that applied in the first 40 years of communism, when a slight relaxation in credit and money supply led to an immediate increase in growth, no longer apply. The mandarins are now confronted by a new set of problems which their state planning textbooks have not equipped them for - huge over-capacity of production and flows of billions of yuan in private and company accounts over which they have limited control. They earned praise for the austerity programme they launched in July 1993 to curb inflation, which reached a post-1949 record of 24.1 per cent in 1994. By restricting investment and curbing credit, they brought inflation down to 6.1 per cent last year and 4.1 per cent in the first half of this year but did it deftly enough to maintain GDP growth of about 10 per cent. The previous anti-inflation programme from 1989-91 was so severe that it cut GDP growth to 4-5 per cent and forced millions of workers to be laid off. With inflation tamed, the mandarins face new menaces. Official figures show that by the end of 1996, production of 93 per cent of goods was in surplus or adequate, with inventories reaching 540 billion yuan (about $501.98 billion), up from 460 billion yuan a year earlier and far above reasonable levels. By 1995, two-thirds of the production capacity of industrial goods was under-utilised. This explains why the increase in bank loans and money supply this year has not resulted in a comparable rise in economic growth. Loans to companies end up not as revenue from products sold but in goods sleeping in warehouses or as debt owed between companies. 'At the start of this year, everyone was expecting the start of a new economic cycle, with low inflation, two cuts in interest rates and a booming stock market,' the Economic Daily said on Friday. 'But this has not happened. There are even signs of a contraction, such as rising stock levels and higher losses of companies. What this means is serious imbalances in our economy, which is hampering its development.' Imbalances mean an industrial sector that is too big, especially textiles and machinery, and a services sector that is too small. They mean bad company management and poor use of credit so that bank loans are wasted, diverted and not repaid. To correct these imbalances, the mainland is encouraging a huge restructuring of industry through bankruptcies, mergers, takeovers and leasing to produce healthier and more market-driven firms. The result will be a further shrinking of the state sector, which accounted for just 32 per cent of industrial output last year and whose market share continues to fall. How to manage this down-sizing is one of the two biggest challenges: how to keep unemployment within tolerable limits and create new jobs to hire those laid off. The other challenge is managing financial risk. During the National People's Congress in March, Vice-Premier Zhu Rongji was asked by delegates from Liaoning province if unemployment was his number one preoccupation. No, he replied, it was the risk of a financial crisis. The flood of money into the stock market this year has taken the leadership by surprise. The mainland now has 30 million stockholders, with four million new ones added this year, the vast majority of them individuals. The rise in individual bank savings in the first half of the year was 170 billion yuan less than in the same period last year. By the end of June, the mainland's two stock markets had capitalisation of about 35.99 billion shares - more than double the 17.93 billion at the end of 1995 - while their asset value rose nearly six-fold to 461.108 billion yuan from 79.197 billion yuan over the same period. The rise of the markets this year has less to do with economic fundamentals and more to do with individuals having too few investment options, and illegal trading by state banks and institutions. Beijing is nervous of the speculative nature of the markets and the shortage of large-scale institutional investment. It has already taken steps to cool the market and more are expected before the 15th Communist Party Congress this autumn.