How to Turn the Asian Crisis to China’s Advantage
by Gao Shangquan

The extent, duration, and impact of Asia’s recent financial crisis caught everyone by surprise. This crisis will inevitably negatively affect China in many areas, including exports, foreign capital inflow, the cost of financing on the international markets, and tourism. While we should not underestimate this negative impact, we will be able to turn some disadvantages into advantages if we learn our lessons and take appropriate measures. Therefore, this crisis is not only a severe challenge but also an opportunity for implementing much needed reforms in China.

The Asian financial crisis erupted as globalization and financial liberalization accelerated and unrest on financial markets intensified. It was triggered by international speculation. The fundamental and deep-rooted causes were, however, the pervasive defects in the economic foundations and financial systems of the East Asia countries, including:

· The untimely economic adjustment after overexpansion.

· Banks burdened with large amounts of bad loans.

· The overdependence on foreign capital.

· Condonation of the irrational structure of foreign investment and ineffective supervision of capital inflow.

· The accumulation of large current account deficits and overdependence on capital influx to equalize the balance of payments.

· The increasing difficulty to readjust exchange rates as currencies became overvalued.

These miscalculations and policy failures, combined, led to the current crisis.

For China, the financial crisis in Asia is a vivid, invaluable, and free lesson. The key issue now facing China is to learn from the losses of other countries in order to offset the negative consequences of the Asian crisis and effectively maintain its economic development.

New Relationships

· In a government-dominated market economy relationships between the government, banks, and enterprises should be correctly handled. At the initial stage of their economic development countries like the Republic of Korea used administrative means to allocate resources and promote rapid economic growth. However, if the government overzealously intervenes in enterprise operations, then these enterprises, confident that the government and banks are behind them, will blindly expand, neglect cost and profitability, and fearlessly continue their loss-making operations. Enterprises and banks are bound together not by common interest but through government intervention. The result is soft budget constraints. Consequently, enterprises have low efficiency and banks are overburdened with bad debts. Then once the debt-credit chain between enterprises and banks deteriorates, a financial crisis will be a real possibility. To prevent that, both banks and enterprises should be free to choose each other, based on their individual circumstances.

· Large enterprise groups should operate in accordance with the market mechanism and not by administrative means. In some key industries, establishing large enterprise groups can promote efficiency and competitiveness. (However, attention should also be paid to small and medium-size enterprises.) Three important lessons can be learned from the Asian financial crisis:

1. Enterprises should be regarded as main players in establishing and developing enterprise groups.

2. The transformation of existing enterprise groups to stockholding companies should be accelerated, thereby substantially reducing government intervention in operations and management.

3. The government should adopt less patronizing financial policies toward large enterprise groups. Those groups should be encouraged to expand their financing channels through the capital market.

· Bad credits that state-owned commercial banks accumulated over time should be rapidly reduced and the efficiency of the financial sector improved. The enormous debt-credit chain between enterprises and banks was an important factor that led to the Asian financial crisis. In China bad loans that had accumulated over past years should be separated from the assets of state-owned commercial banks. Freed from the heavy debt burden, state-owned enterprises and banks could speed up the restructuring process. This is a key link in guarding against financial risks.

· Structural readjustment should be accelerated to prevent a bubble economy. In the past few years some banks in Southeast Asian countries have relaxed their requirements for obtaining real estate loans. Consequently, many of these loans became bad due to the oversupply of real properties. Thailand and the Philippines thereafter decided to limit the proportion of real estate loans to 20 percent of the total banking business and also to restrict borrowing for real estate investments: the loan amount should not exceed 60 percent of total funding requirements. China should consider these regulations. In drafting industrial policies, China should emphasize technological advancement, the upgrading of the industrial structure, and productivity improvement so as to strengthen the export-competitiveness of Chinese products.

Controlling Capital Flow

· A rational structure of foreign investment should be pursued. In order to achieve rapid economic growth, developing countries need foreign investment, but in a reasonable structure. In Thailand 70 percent of foreign capital is invested in securities. In Korea, out of a total of $245 billion in foreign capital investment, $180 billion is short-term capital. This has aggravated the current financial crisis. Therefore, within the total capital inflow, the ratio of direct to long- and medium-term investment should be increased, while short-term foreign capital and securities investment should be kept within reasonable limits.

· Financial supervision should be strengthened and the financial system should be protected against possible financial speculation. During the Asian financial crisis countries like Singapore didn’t suffer too much because of their policy of strict financial supervision. China should establish a financial supervisory system and strengthen their surveillance of derivative financial instruments and overseas financial operations in order to resist the impact of foreign investment capital.

· Peoples’ awareness of financial risks should be heightened in order to foster confidence. Not long ago Thailand’s vice premier admitted that, "When we publicized some data, the public thought that the real situation might have been much worse." Lack of confidence and unawareness of financial risks add fuel to the fire of the financial crisis. People should be prepared for national crises and their psychological capacity to bear risks should be strengthened. At the same time, the government should supply more information about developments on the financial market in order to maintain the general public’s trust.

Reviving Economic Growth

Right now exports and foreign investments, the main driving forces behind China’s economic growth, show signs of weakening. Domestic demand also keeps slowing down. In order to return to rapid economic growth in the coming years, a series of measures are necessary to stimulate domestic demand (both consumption and investment), bolster exports, and attract foreign direct investment.

· Nonstate economic actors should be able to invest in infrastructure, such as power production, power network, large water conservation projects, irrigation, and highways. Demand will be extremely high in future years for investment in infrastructure. These investments will become an increasingly important driving force behind economic growth.

· The transformation of public utilities to shareholding companies should be accelerated in order to eliminate government control and industrial monopoly and improve returns on investment in the public utilities sector.

· Reform of the housing system and real estate development should be accelerated in order to add more dynamism to economic growth.

· Market-oriented reform in the service sectors should be accelerated. This would entail improving service quality and satisfying consumer demand for various types of services, such as education, culture, electronic information, medical care, and travel and hospitality.

· A consumer credit system should boost domestic consumption. Expanding consumption credit, extending the maturity of mortgage loans, and reducing interest rates could stimulate consumption.

· Various types of export-promoting financial instruments should be applied, such as export credit, export credit guarantees, and export credit insurance.

· To attract foreign investment, a variety of methods should be adopted in order to exploit the comparative advantages of China. Though international capital still takes a wait-and-see attitude toward Asia, China is still an attractive destination. We can persuade investors to move in with a variety of methods, such as promoting foreign investment in Chinese stocks, initiating Buy, Operate, and Transfer arrangements, supporting a listing of Chinese companies at overseas stock exchanges, and utilizing the potential of Hong Kong as an international financial center.

The author is president of the China Institute for Reform and Development, (CIRD) Haikou, Hainan, and professor at Beijing University.