As unification with Hong Kong approaches, the "mainland" is cautiously preparing to further streamline the economy. At the recent annual session of the National People’s Congress, held in early March, state-owned enterprises emerged at the top of the country’s reform agenda. Moderate yet stable growth and reform of the agricultural and state industrial sectors were emphasized in Prime Minister Li Peng’s annual state- of-the-union work report, Finance Minister Liu Zhongli’s draft budget for fiscal 1997, and the economic plan for 1997, which was presented by State Planning Minister Chen Jinhua.

Liu announced a planned 1997 budget deficit of 57 billion renminbi (US$6.9 billion), down from 61 billion renminbi in 1996. Total government expenditures for the year were put at 896.7 billion renminbi, up 13 percent from last year, against revenues of 839.7 billion renminbi, up 14 percent. The deficit will be met by the issuing of a record 248.6 billion renminbi in domestic and foreign bonds this year, up from 196.7 billion last year. Of this, 57 billion renminbi will go to finance the deficit, and the remainder to service domestic and foreign debt. Despite the increase in revenue, Liu highlighted continued deficiencies in collection owing to widespread tax evasion, fraud, and arbitrary tax reductions and exemption. He also said that expenditures were "not effectively controlled," leading to serious waste and extravagance, notably among state-owned enterprises.

Two other key areas received promises of significant extra money:

• Agriculture. China had record grain harvests of 480 million tons in 1996, and average annual rural incomes rose 9 percent over 1995, to 1,926 renminbi. Further output increases could minimize import dependence as domestic demand rises. But local governments lack funds to pay farmers, who account for most of the workforce and are suffering from rising local taxes and fees. To support farmers and output, Liu proposed a 14.2 percent increase in agricultural expenditures in 1997, up from a 13.3 percent hike in 1996.

• Defense. Military spending is set to rise by 12.7 percent in 1997, to 80.6 billion renminbi, after an increase of 11.3
percent in 1996. (Some military sources claim that actual Chinese defense spending is at least 2.5 times that stated in the budget, as the military has access to other sources of revenue, for example, its industrial activities.) Nonetheless, as Beijing argues, the base figure is not excessive by international standards, especially given the People’s Liberation Army’s current technological deficiencies.

The economy grew by 9.7 percent last year, lifting total GNP to about 6.8 trillion renminbi (US$820 billion). And government economists have predicted that GDP growth will be as high as 10.5 percent this year. However, as happened last year, as much as two percentage points of this growth may go into expanding stockpiles of state-produced goods that no one wants. The growth of stockpiles to 530 billion renminbi (7.8 percent of GNP) last year highlights an inherent contradiction in China’s otherwise strong macroeconomic performance. In order to prevent a financial crisis in the state sector, authorities last year sharply increased loans to state-owned enterprises (SOEs). The way out of this dilemma is to accelerate the restructuring of SOEs, so as to allow a distribution of credit according to efficiency criteria.

Li’s report singled out SOE reform for the first time as the leading economic and political challenge (even though, owing to the rapid growth of private and foreign-invested sectors, the economy’s dependence on the state sector has fallen to around 40 percent). Such reform produces its own set of undesirable side effects, such as unemployment and elimination of wide-ranging social benefits for workers. According to Li the government’s immediate priorities are to standardize bankruptcy practices, encourage mergers and promote employment of people released from state enterprises. The State Council had set aside 30 billion renminbi to support these objectives. The government’s long-term objective is to concentrate state resources on building a core group of 1,000 companies that will dominate China’s major economic sectors and, it is hoped, compete on a global scale. Meanwhile, Li’s speech clearly implied that the country’s 240,000 smaller SOEs will be released to the private sector.

The government has succeeded in curbing price increases: retail prices rose by just 6.1 percent last year, down from 14.8 percent in 1995 and 21.4 percent in 1994. Inflation is expected to be less than 6 percent this year, despite 32 percent growth in fixed asset investments, to 2.53 trillion renminbi, down from 34.6 percent growth in 1996. Beijing’s financial position is respectable; its fiscal deficit is manageable and it has amassed record foreign reserves in excess of US$100 billion. The challenge for policymakers is to find a sustainable balance between the long-term economic need for SOE reform and the short-term political need for subsidies.