China must seek out the missing billions

THE Renminbi, the People's Money? If ever there was an illustration that on China's Orwellian farm some people's money is more equal than others' it is the fate of the official currency - not to mention the IOUs handed out to the peasantry.

Party boss Jiang Zemin has discovered that corruption could threaten Communist party rule in China. Clever fellow. What is he doing about it? It may be hard to discipline extortionate officials in rural Hunan. But has he been asking his men in Hongkong,Zhou Nan and company, to try to track down guilty parties and missing billions? The single most remarkable and almost totally ignored fact about China's economic situation is this: China has been the source of the most dramatic capital flight at least since that from Latin America circa 1980, and perhaps since the 1930s. This is notsomething which happened in the past two months because of the collapse of the yuan in the swap centres. That collapse was the effect not the cause of the capital flight.

Massive outflow from China was taking place long before the currency debacle. China statistics leave substantial margins for error. But they cannot disguise the bottom line: over the three years 1990-92 something between US$30 billion (HK$230 billion) and US$40 billion has been shifted out of China by enterprises and individuals. The arithmetic is simple. China recorded foreign direct investment which was not less than US$15 billion - and probably more as much from Taiwan via Hongkong goes unrecorded - and increased its foreign debt by some US$17 billion.

Over the same period, foreign exchange reserve rose by US$30 billion to US$47 billion. (Published reserves have recently been cut by US$20 billion to exclude the foreign assets of state institutions but this makes no difference to total flows.) Netting out these figures shows that outflow of capital was not less than around $35 billion. To this must be probably added unquantifiable sums accumulated offshore by under-invoicing of experts via Hongkong.

Part of the outflow has gone into well-publicised acquisition of Hongkong assets by Beijing-controlled companies such as China International Trust and Investment Corporation (CITIC). These investments are partly motivated by a desire to increase political clout in the territory through economic means. In the process they have driven up Hongkong asset values. It may make little long-term economic sense for a capital short nation to be buying high-priced Hongkong assets, but it is at least a result of a conscious state policy.

On the other hand large amounts of capital flight are attributable to the beneficiaries of corrupt deals, salting away new wealth in Hongkong or Swiss back accounts, or Hongkong or Californian condominiums.

EVEN bigger sums are traceable to mainland corporations and foundations which appear to be under the control of central or provincial government enterprises but whose actual beneficiaries are the well-placed individuals who operate them. The relatives ofwell-known figures have been acquiring assets at least as rapidly as did those of President Marcos, or China's own Soong dynasty in the 1930s. The purchase by CITIC chairman Larry Yung - son of Chinese vice-president, Rong Yiren - of the 335-hectare Birch Grove estate, once home of the British prime minister the late Harold Macmillan, is a case in point.

The currency crisis is the result of capital flows not, as is usually claimed, the trade account. The current account has moved into deficit as the domestic investment boom has fuelled imports. But even at US$10 billion a year it could easily be financed by foreign capital inflow. The shift in the trade balance from large surplus to modest deficit has merely exposed the capital flight.

''Flight'' not outflow is the appropriate word. Opportunities for making money in an economy growing at 8 per cent to 12 per cent should be much greater than in Hongkong, or the United States. Indeed foreigners have been prepared to pay high prices to get into China. But Chinese with money - which seems to include most senior party people want nest eggs outside, safe from political turmoil, personal vendetta or clampdowns on capital movements. That is one reason for Hongkong's liquidity and also helps explain why Hongkong Tsingtao Brewery and Denway are absurdly oversubscribed while China B shares languish.

Negative real interest in China rates add to the flow, but they are not the prime cause. Nor will the problem be easily resolved without restoration of tight central discipline. The pent-up demand by China's new affluent class to acquire overseas assets is likely to remain strong and will be partly alleviated by higher local interest rates.

INVESTMENT in housing and factories making cars and consumer durables may be able to satisfy most of China's material wants. But it is likely to need sustained political and currency stability to staunch the desire of the elite for security overseas. Theless affluent will keep buying gold.

Capital flight has other effects. It casts doubt on the bona fides of the rulers associated with it - particularly for a Communist Party which claims legitimacy from its nationalism as well as its largely discarded socialism. It may be tolerated so long as the economy at large is flourishing, but in the longer run it will politically undermine the beneficiaries.

By depressing the exchange rate, capital creates inflation and alters the internal terms of trade further in favour of the coastal provinces and of the cities. Last year, as also in 1990, rural incomes have been growing at only about half those in the urban areas, and the interior provinces at half those of the coast. Capital flight has no affect on investment by export-oriented coastal enterprises. But it raises the cost of imports needed to build the railways and power stations if the interior is not tofall further behind.

None of this necessarily detracts from China as a place for foreign investment - indeed, it may, increase returns on foreign capital. Money outflow may dwindle as currency stability returns and be balanced by increased inflow. (Credit Lyonnais Securitiesestimates that Hongkong public companies alone have direct PRC investment commitments of US$2 billion).

But ultimately, contentment of the masses rests on the righteousness of the rulers. At present that is US$30 billion short.