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By Thomas A. Sancton

Peking axes the budget--and some major foreign contracts

"China's economic work will be able to free itself from the age-old malady of seeking quick results. Instead it will base itself on actual economic conditions, putting the stress on practical results and step-by-step development." With these words, spoken before the standing committee of China's National People's Congress Feb. 28, Vice Premier Yao Yilin described a watershed decision by the country's economic planners. Specifically, Yao announced a drastic 13% cutback of the 1981 budget; capital construction, the hardest-hit sector, would be chopped almost in half. Peking, it appeared, was scrapping much of the philosophy behind the ambitious Four Modernizations* development campaign launched with great fanfare three years ago.

The retrenchment came as no surprise to foreign companies that in the past month alone have had Peking cancel or suspend five major projects worth $2.5 billion. Most seriously affected are Japanese and West German firms that rushed into the Chinese market in 1978 and 1979, at the outset of Peking's ambitious drive for industrial expansion. Japanese companies, including Toyo Engineering K.K. and Mitsui Petrochemicals Co. Ltd., have lost $640 million worth of contracts to build seven turnkey petrochemical plants in Nanjing, Shengli and Peking. Of its five contracts for similar plants, Lurgi Gesellschaften, a Frankfurt-based engineering combine, expects to lose at least three, worth $450 million.

Even more devastating was Peking's decision last month to halt work on the second phase of the giant Baoshan Iron and Steel Works near Shanghai. That grandiose $5 billion undertaking, seen as the cornerstone of industrial modernization in China, was contracted in 1978 to various consortiums, including one headed by West Germany's Schloemann-Siemag AG. The scuttled portion of the project includes plans for a $650 million cold-rolling mill, to have been built jointly by Schloemann-Siemag and three other West German firms, a $425 million contract with Mitsubishi Heavy Industries, and a $140 million project for Nippon Steel.

The jilted trade partners are understandably piqued. Said one Japanese businessman with characteristic understatement: "If China fails to solve the problem, the Japanese people will be very disappointed." A senior Bonn economics ministry official was more blunt: "When we sign contracts, we honor them, even if it is a tremendous hardship for us. We expect our business partners to do likewise." Only the prompt payment of "sufficient compensation" could alleviate "doubts about Chinese reliability," said Heinrich Weiss, the board chairman of Schloemann-Siemag.

Any compensation will have to await the outcome of complicated negotiations. Japanese Trade Representative Saburo Okita visited Peking last month to discuss the cancellations, and a Chinese delegation is in Tokyo this week laying the groundwork for talks. Special Chinese envoys are also expected in Bonn later this month.

In addition to damaging China's commercial credibility, the cancellations represent a staggering financial loss for Peking. According to one Japanese report, China had already imported and paid for 29% of the Japanese equipment, and much of the rest had been constructed and was awaiting shipment. A large quantity of machinery has also been built and sent to China from West Germany and elsewhere; experts doubt that much of it can be resold, or even warehoused, except at prohibitive costs.

Trying to put the situation in the best possible light, Chinese officials argue that retrenchment now will create a sounder footing for future expansion. The sudden cutbacks, they explain, were necessary to curb the inflationary effects of large budget deficits and a growing foreign debt.

There is no doubt that planning blunders as well were responsible for some of the current problems. The site chosen for the Baoshan complex, for example, had such inadequate port, land transport, and power facilities that an additional $9 billion would have been required to create such essentials. The push to establish the petrochemical plants was based on a projected annual oil output of 730 million bbl. by 1985. Analysts now doubt that Chinese production will reach half that figure by then.

Western companies are not blameless either. In their eagerness to break into a market of 1 billion people, observes Louis Kawan, the European Community's top China expert, Western exporters ignored signals of impending cutbacks that were evident over a year ago. Even earlier, a few skeptics like West German Economics Minister Count Otto Lambsdorff had cautioned that China simply did not have the economic capacity to absorb such an enormous volume of business. The warnings went largely unheeded.

There are nonetheless a few bright spots in China's otherwise gloomy economic picture. The most positive sign is the healthy state of China's overall foreign trade, which rose by 20% in 1980 and is expected to grow by about 10% this year. Concludes Roger W. Sullivan, vice president of the National Council for U.S.-China Trade: "I certainly would not advise anybody to sit it out during China's current period of readjustment. If you do, your competitors will move ahead.''

--By Thomas A. Sancton.

Reported by Richard Bernstein/Peking

*In early 1978, at least 120 projects were outlined to upgrade industry, agriculture, defense, science and technology.

With reporting by Richard Bernstein/Peking

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