But government deficits of the sort that Xiang and Zhu fret about aren't what should keep Chinese officials awake at night. In fact, the flap over the budget steals attention from China's real financial difficulties. The world's most important developing economy is dogged by a pair of hidden deficits: bad bank loans and unfunded pension liabilities. These are the problems that China must keep from snowballing.
INFRASTRUCTURE INVESTMENTS. The big budget overruns are tolerable because they have gone toward building much-needed infrastructure -- roads, bridges, ports, and power grids -- that help spur growth and attract foreign investment. Despite five years of aggressive pump-priming, the cumulative deficits only total about 17% of GDP. By international standards, that's a comfortable level: By comparison, most analysts peg Japan's total deficit at 130% of GDP. Moreover, the Chinese government's revenues are growing in line with the economy. And there's plenty of room to improve tax collection, right now a paltry 16% of GDP, compared with 30% to 50% in most developed economies.
But when pensions and bad bank debt are figured in, the math gets scary. On that basis, Goldman, Sachs & Co. economist Fred Hu estimates that the real deficit is 100% to 150% of GDP. Given China's high growth and savings rates, the pensions and dud loans haven't caused a problem. But they could if growth stalls. "The government can pay for it right now," says Andy Xie, chief economist at Morgan Stanley Dean Witter & Co. in Hong Kong. "What's important is to stop the bad debts from growing."
The numbers aren't pretty. Bad bank loans, mostly by state-controlled banks to state-owned enterprises, total $400 billion to $600 billion, or up to half of annual GDP. True, China set up a quartet of asset-management companies in 1999 to address the problem. But they have taken over only $170 billion of the loans and sold off just $15 billion.
DEADBEAT CORPORATIONS. If the debt is ignored, it could eventually crush the economy. "Everywhere in the world, the lesson is that the longer you wait to deal with bad loans, the higher the bill," says Hu. Although keeping bankrupt companies operating ameliorates a troubling unemployment situation -- unofficial estimates put the rate at up to 30% -- there are better ways to deal with redundant workers. One is to create jobs in new small companies. The more quickly China can do away with deadbeat corporations and fund, instead, the companies of tomorrow, the more certain its growth prospects will be.
Unfunded pension liabilities from defunct state companies are China's second hidden problem. Salomon Smith Barney economist Yiping Huang estimates that these obligations total up to $600 billion. Last year, authorities embraced a policy of selling shares in state-owned outfits to fund the pensions. But policymakers pulled back after investors dumped stocks on worries that a wave of share sales would depress prices.
Because the government won't take the short-term pain of a sagging stock market, it is setting itself up for trouble. The recent demonstrations by discontented PetroChina Co. workers, who feared a loss of pensions, are a harbinger of what is to come if China doesn't deal with workers forced into early retirement. Selling down state shares would hasten privatization of the Chinese economy and help break the vicious circle of banks making loans to companies that can't compete.
DAUNTING CHALLENGE. If China moves more quickly to eliminate bad debts and uses share sales or bonds to pay off redundant workers, it could jump-start a new cycle of growth. That's no easy task, but the alternative could be Japan-style stagnation.
For now, China has momentum on its side. Reported growth hit a snappy 7.6% annual rate in the first quarter, beating analyst estimates. But China has to use these good times to deal with looming challenges. As they prepare to step down, President Jiang Zemin and Premier Zhu Rongji could leave no better legacy. Asia Regional Editor Clifford has tracked the continent's numerous banking crises over the past decade.