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Between Reform And A Hard Line


International Business

BETWEEN REFORM AND A HARD LINE

Zhu Rongji, China's economic czar, has made a lot of enemies in the past two months. Since launching his plan to rein in China's overheating economy, Vice-Premier Zhu has forced bankers to call in unauthorized loans, cast a chill over the highly speculative real estate market, and publicly humiliated local officials who dared question him. With Zhu antagonizing so many of China's elite, skeptics in the West are questioning whether he can survive.

But instead of backing down, Zhu is calling for even more radical change. His aides are developing sweeping proposals to modernize China's archaic banking and tax systems and cut loose money-losing state enterprises. Sources say an outline emerged at high-level economic planning meetings in August. This new wave of reform is the key to accelerating China's transition from a centralized system to a market economy.

Zhu is pushing ahead with all this change just as the Clinton Administration is stepping up pressure on Beijing (page 39). With the U.S. slapping sanctions on China for exporting missile technology to Pakistan, Beijing will be forced to respond in kind. While Zhu has little influence over foreign or military affairs, his conservative rivals will use the U.S. move as a way to gain clout. Imposition of U.S. sanctions, says one Western diplomat in Hong Kong, "will give the hard-liners a way to sound off on nationalist pride and enhance their position."

Zhu's job is hard enough, though the first phase of his reforms has already shown some success. The goal was to use some blunt instruments of state power to regain some control of the economy and to prop up the teetering banking system. The economy, which grew at an annual rate of 13.9% in the first half of 1993, is now cooling. Industrial production in July was off by 5.1% from June. "He's off to a good start," says Geoff Lewis, regional economist for Smith New Court Securities Ltd. in Hong Kong.

DEBT AND TAXES. Now Zhu is looking to change China's institutions themselves. Chinese officials call the goal "macro-control." The reforms would create an economy that can be guided and even controlled by Beijing but managed by provincial officials. Teams of experts are working up a program for making major changes in four key areas: banking, finance, investment, and managing state properties. If they get their way, the People's Bank of China will be modeled on the U.S. Federal Reserve system, the country will have a radically new tax code, and the state-run enterprises will be converted into free-market companies within five years. While many of these proposals have been debated for at least a decade, analysts in Hong Kong say Zhu is determined to submit them for approval at a Communist Party plenum in October.

The first target will be banking reform. Under the proposed scheme, the People's Bank would regulate monetary policy and spin off its commercial-lending operations. Beijing would also create new commercial banks, including an import-export bank. "A Federal Reserve bank would be much more effective" than the current system, says Du Yan, director of the China Market Research Institute in Beijing.

Also under consideration is a massive revamping of the tax system to ensure the central government gets a steady flow of funds from the provinces. Local authorities now contribute "contracted quotas" to Beijing and keep the restfor themselves. The new system, if itis approved, defines central-government taxes, local taxes, and those shared by the two. That way, Beijing can make sure it gets its fair share. Since reforms started in the late 1970s, provincial leaders have become increasingly adept at preventing taxes from flowing to Beijing. According to the official People's Daily, taxes collected by the central government dropped to 14.7% of gross national product in 1992--down from 31.2% in 1978.

But even before the tax reform, Chinese officials are expected to review eight draft laws ranging from consumer-protection to accounting and securities laws. The consumer legislation, the first of its kind in China, would confer legal status on consumer groups that are cropping up across the country.

BALANCING ACT. Enacting these ambitious plans won't be easy. Local leaders are resisting the creation of regional branches of the People's Bank of China. They view the new proposals as a backdoor means of increasing central-government power. Even Zhu's relatively modest credit-crunching measures are running into resistance. Bank officials tried to call in many loans to speculators by an Aug. 15 deadline set by Zhu. But so far, the officials have only managed to rein in half the loans they had targeted. Zhu himself has expressed frustration at the government's inability to wipe out property speculation.

As he charges ahead, Zhu continues to walk a political tightrope. While Deng Xiaoping lives, Zhu will likely have a mandate for long-term reforms. But Zhu needs to do more than prevent the economy from deteriorating. If he can, Zhu may silence his critics and become the leader in the race to replace Deng.ZHU'S NEXT TARGETS

BANKING Replace the central bank with a decentralized Fed-style

system

TAXES Create new system to clearly separate national and

provincial revenues

STATE CORPORATIONS Cut loose central-government enterprises over five years

LEGAL SYSTEM Adopt new laws on consumer protection, securities

regulation, and accounting procedures

DATA: BUSINESS WEEK

GREG GIRARD/CONTACT

Joyce Barnathan in Hong Kong, with Matt Forney in Beijing


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