DESPITE the drastic measures introduced by Zhu Rongji, the Chinese economy is not expected to stabilise any time soon. The rebound of the yuan in the swap market reflected confidence in the mainland's corporate sector over Mr Zhu's move. But the underlying economic conditions would not support the exchange rate if it were eight yuan to the US dollar. The confidence-boosting should only eliminate the speculative elements in the market, raising the Chinese currency above the rate of 10 yuan to the US dollar. It cannot help correct the current deterioration in China's trade balance. Nor will it curb rising inflation. As there is a time lag between a change in monetary policy and its real impact, the effect of the last round of credit relaxation is still being felt in the economy. With the extensive out-of-control credit expansion and fund-raising activities outside the state banking channels, the stringent monetary policy of the last four months of 1992 will need more time than the usual six to nine months time lag to restrain investment and production. Paramount leader Deng Xiaoping's untimely intervention against the deflationary policy of the State Council in January 1993 set the credit squeeze back by about two months. The turnabout in the economy might take a period of time longer than expected to occur. Panic buying caused by inflation has resulted in sales volume jumping to a peak of almost 30 per cent nominal growth, or 14-15 per cent real growth, in April and May. This is a reversal of the downward trend in real growth in the first two months of the year and the nine-per cent average growth for 1992 as a whole. This was accompanied by an increase in gross industrial output in the last few months, with year-on-year growth in June climbing to 30 per cent. Despite a credit squeeze by the state banks since March and the high interest rate of more than 20 per cent and as high as 40 to 50 per cent in the non-bank market, investment has continued to expand with 70 per cent nominal rate of increase in the statesector. Probably because of the acceleration, the average price index of industrial raw materials showed no sign of stabilising (51.3-per cent rise in May, up 3.5 per cent from a month earlier) even though stocks held by state enterprises increased tremendously (mostly due to hoarding) in the first quarter of this year. When prices of industrial raw materials are still climbing, one should expect prices of consumer goods to follow suit in subsequent months, probably with a time lag of six months. This would mean the inflation rate would have half a year to go up further from the present level of 12-14 per cent for the national average and 19.5 per cent for 35 major cities in May. Unless the central and local governments attempt to freeze prices, which would be much more drastic than the recent setting of price ceilings on key consumer goods by some provincial governments, inflation in China is expected to rise steadily in the coming months. In other words, panic-buying generated by inflationary expectations could very well continue at least in local markets of economically more developed regions where the local population has a higher purchasing power, like those coastal regions south of Shandong. With larger sales, money would be available for funding investment and production. And the increase in sales volume would also give hope (true or false) for local authorities and enterprises to beat up production and support investment projects against the deflationary wishes of the central government. If the circulation of capital through expansion in sales and production and investment in the coastal economies is not disrupted by central intervention, with capital siphoned off to support the rural sector and interior provinces, economic acceleration in these regions might be able to sustain further than is expected by the central government. If it happens in the months after the radical move by Mr Zhu in late June, it would discredit the deflationary measures undertaken by him as well as giving the local authorities of the coastal economies a breathing time to lobby politically for a modification or reversal of the adjustment policies. At the same time, the credit-deficit interior provinces would be hardest hit by the credit squeeze. In recent months, their production and consumption has been much below the national average, while inflation moved abreast with the coastal regions. The interior provinces would support the adjustment policies so long as central government would undertake redistribution of funds to subsidise their underdeveloped economies. If the credit squeeze brings only deflation in their regions while the coastal economies still maintain their acceleration and keep the circulation of capital within them, the interior provinces will put strong pressure on the central government for redistribution of wealth, or they will revolt against the central credit squeeze. The emergence of inter-enterprise bad debts, similar to those before 1992, would provide them with a very strong excuse to demand relaxation of credit supply. Moreover, Mr Zhu's drastic policies have all the support of the central leadership including Jiang Zemin, Li Peng and Qiao Shi, but they run against the policies of faster reforms and speedier economic growth of Mr Deng and his associates, including his powerful daughters. Until Mr Deng dies, one should be prepared for any strike-back from Deng's camp, either by himself, or using his person or his words. So long as Mr Deng, and his daughters, do not believe in the inevitability and benefits of business cycles and are blind in pushing economic acceleration - experiences of China's economic development since 1979 suggest Mr Deng has been rather consistent in this regard - he will not tolerate adjustment except when China is at the brink of political collapse caused by economic difficulties and chaos, like in June 1989. China at present is still far from the political crisis of June 1989. If health allows, Mr Deng will strike back to rescue his own Great Leap Forward in reform and economic growth. Mr Zhu is faced with a formidable task. He needs to insist on stringent monetary policy in order to cool down the economy. But to do so he has to overcome opposition from both the vested interests created during the fanatic economic liberalisation and MrDeng, the undisputed paramount leader. He has to hold his own for at least six more months so that the gradual stabilisation of the Chinese economy will turn out economic benefits to win him support from the population, the corporate sector and governments. Only then will he be in a more defensible position from the perspective of his policies and his own political career.