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Last Updated: Wednesday, 12 May, 2004, 06:46 GMT 07:46 UK
Is China's economic miracle in meltdown?
By Mary Hennock
BBC News Online business reporter

A builder in China takes a break
Construction projects are pushing up steel and cement prices
World leaders seldom stand up to dish the dirt on their country's economy.

But China's Premier Wen Jiabao has been doing just that on his European tour this week, warning that China's roaring juggernaut of an economy risks coming off the rails after growing 9.1% last year.

At dinner with 400 UK executives in London, Mr Wen compared himself to the driver of a speeding car, trying to avoid an emergency stop. "We cannot slam the brakes, we have to press the brakes gently," he said.

In Brussels, he was even more blunt, triggering headlines by describing aspects of China's growth as "excessive".

Change of tone

In his dark business suit, sober tie and lacquered hair, Mr Wen looked the textbook example of China's new post-Mao, pro-market leaders.

But his admission that China is "overheating" comes as something of a break from Communist Party traditions of celebrating ever-increasing output of everything from pigs to microprocessors.

Chinese Prime Minister Wen Jiabao
Mr Wen says better co-ordinated growth is a priority

So what has sparked Mr Wen's warnings?

And how has China switched so swiftly from being a miracle growth story, the darling of international bankers and businesses, to a potential meltdown?

Reckless investment in new factories by state firms which borrow from banks that operate minimal credit checks and are wide open to pressure from local officials is nothing new, but the focus on stopping it is.

Premier Wen and President Hu Jintao are relatively new at the top, having inherited the two most powerful government posts in March 2003.

Foreign economists agree with the new leadership's economic medicine.

But they are nervous about the consequences. Morgan Stanley chief economist Stephen Roach wrote that a slowdown in China's economy "should be viewed as a global event".

Investment cutbacks could "spread well beyond Asia", he said.

The Asian giant is the world's sixth largest economy and fourth biggest exporter; the US ran a trade deficit with China of $124bn (70bn) last year.

China's appetite for raw materials has pushed up prices worldwide, and factory gate prices at home. In 2003, China consumed 27% of world steel, 31% of coal and 40% of cement.

Since October 2001, the Economist all-items index of commodity prices has risen 59%, with metal prices jumping 50% and industrial raw materials 73%.

Factory glut

"China's biggest problem", said Mr Wen in London, is "excess growth in fixed asset investment" - in other words, too many factories and a real estate bubble that has sucked in raw materials and gridlocked the transport system, where rising prices hurt everyone.

Bang Bang
Officials face pressure to generate jobs

"We are now under pressure of inflation," admitted Mr Wen. Overall inflation rose by a manageable 2.8% in the first quarter of 2004, but factory gate prices jumped by roughly 7%, he said.

Mr Wen's confessional openness was aimed at wooing Western investors with a transparent, responsible image, whilst issuing a warning back home.

Investors certainly loved it. "He comes across as a very deep-thinking person," said Peter Nightingale, chief executive of the China-Britain Business Council.

Social reforms

But China's economic reformers may find themselves stranded without either a sufficiently developed market mechanism or enough old-style centrist clout to tackle overheating.

The trouble is that much reckless investment is being carried out by local officials who firmly believe they are doing what Beijing wants. Or who do not care.

Allan Zhang was an economist at China's foreign trade ministry for 14 years before joining audit firm Pricewaterhouse Coopers in London, where he heads the China Business Centre.

He points out that Chinese officials focus on beefing up local growth rates because "you're more likely to be promoted".

"The central government is trying to cool down the economy, but that conflicts with local government officials who're keen to develop their economies," he explains.

"The local officials, basically they are paid by the local province....so the finance is not directly from the central coffers," he said. "Those local governments...have their own agenda".

Viewed this way, the bureaucracy needs reform as much as the economy.

A worker loading containers at Yantian Port, Shenzhen
A slowdown in China can hurt world trade

But there is little sign of a long-term rethink in the way Chinese officials are rewarded, says Mr Zhang.

To curb overheating, regulators have produced a blizzard of edicts in the last fortnight, and made a few high profile arrests.

Shocked banking executives were ordered to suspend all new lending for a week ahead of the May Day holiday, a move that unnerved foreign investors too.

The State Council has ordered firms wanting to build steel projects to find 40% of the cost. Banks have been warned they face inspections of their loans.

After years of chipping away price controls, the State Development and Reform Commission announced caps on utility prices. Local inflation will trigger a three month freeze on investment.

And officials behind the new Tieben steel project in Jiangsu province have been arrested, apparently for breaching land-use laws.

Banking on change

At the centre of these measures is an attempt to get banks to apply credit rules.

But banks face pressure from local officials who want to preserve jobs and social stability - another goal shared by Beijing.

China's banks are technically insolvent, with bad debts making up 45% of their loans, according to Standard & Poor's.

Better banks are central to China's future, and Beijing is trying to toughen them up and open them to international investment.

One much-touted solution among foreign economists - higher interest rates - would hurt firms that do pay their debts, while increasing levels of bad debt.

It could also slow down the growth in consumer credit - a novelty in China - and Beijing's plans for consumer-led growth.

China's new leadership has drawn up an ambitious agenda for economic reform, but reliance on state controls to make it work show how weak the market remains. Mr Wen's European tour has the feel of a political campaign.

The second industrial revolution
11 May 04  |  Asia-Pacific
China orders utility price freeze
10 May 04  |  Business

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