Is China Next?

By Terry McCarthy/Shanghai

Bad things seem to be happening way too fast in the world economy. Countries no longer slide into recession; they plunge headfirst over the cliff, faster than a fund manager can hit the redial button on his phone. Now that Russia's finances have imploded, the worriers are turning their attention to the other onetime communist colossus grappling with economic reform: China. Since the once vaunted "Asian miracle" has taken on the aura of a curse, a lot of investors and governments are asking if the People's Republic of China will be the next to fall.

The parallels between the two Marxist alumni are eerie. China, eight times as populous as Russia and with an economy that last year expanded 20 times as fast as Russia's, suffers many of the same infirmities. Its banking system is just as rotten, corruption flourishes beyond the central government's control, labor unrest is widespread, a budget deficit is growing, taxes can't be collected, and an inefficient network of state enterprises still hamstrings a full transition to the free market.

Now come credible reports that the Chinese government, facing unprecedented deflation in the rest of Asia, is preparing to renege on its year-long pledge not to devalue the renminbi. China has earned credit overseas for holding its currency steady, providing some stability in the region. But as its export growth and foreign investment slow under competitive pressures, Beijing seems to be nearing its pain threshold. According to an economist with access to China's leaders, they are contemplating an early 1999 devaluation that could reach 30%, depending on how far the Japanese yen drops. With the rest of Asia struggling to find a way out of recession, such a move could set off a new round-robin of devaluations. China knows the stakes for itself as well: it has seen how lowering rates in Thailand, Malaysia, South Korea, Indonesia and Russia gutted those economies.

Two weeks ago, Premier Zhu Rongji swore to former U.S. Trade Representative Carla Hills that there would be no devaluation "for at least two years." Hills was stunned. She says, "I told him that's very different from just saying, 'I'm not going to devalue.' I said I think investors would like to know that. And he said, 'Yes. You can say, Not within at least two years.'"

Naturally China is eager to reassure potential foreign investors at this parlous moment. But another steep drop of the yen against the dollar, making the renminbi less competitive, would force Beijing's hand. Even if China does go ahead, experts say, the effect would be less severe than the shock of the ruble's fall.

Unlike Russian President Boris Yeltsin, President Jiang Zemin maintains tight political control. The reform-minded Zhu might take some heat if the currency sinks, but in contrast to the unruly Duma, China's pliant National People's Congress is not going to threaten a constitutional crisis.

In China economic reforms are real, already deeper and broader than Russia's. Deng Xiaoping initiated capitalist changes back in 1979, when he legalized farmers' markets. As a result, China's agricultural sector is far more productive than Russia's. Diverse village and township enterprises have spread what is effectively private enterprise deep into the grass roots of the country, in a way not yet imagined outside Russia's major cities.

Most important, says Andy Xie, chief economist for Morgan Stanley in Hong Kong, 85% of China's exports are manufactured goods, whereas Russia still relies on the sale of natural-resource commodities to earn foreign currency. "This means people on the top in Russia focus on stealing the money," he says. "In China they have to focus on producing something first."

In Beijing the political signaling has already started. Two weeks ago, Jiang pointedly told visiting Japanese officials that China was "paying a great price and taking a risk" by not devaluing, and then added, "I cannot be 100% certain of how things will go in this world." China hopes to shift the blame for the consequences of a devaluation onto Japan's shoulders.

The Clinton Administration believes the Chinese have been a lot smarter than the Russians in reforming their economy and that Zhu's management still enjoys popular support. What no one in the U.S. or Asia wants is a sudden fiscal crisis in China that could further spook world markets. The strongmen in Beijing, who at least have their hands on the country's economic and political levers, should be able to contain any domestic fallout, but even they may not be able to control the global consequences.

--With reporting by Jaime A.FlorCruz/Beijing and Douglas Waller/Washington

With reporting by Jaime A.FlorCruz/Beijing and Douglas Waller/Washington