China Begins to Feel Economic Shock Waves

Though optimists predict China could surpass the US as the world's largest economy within decades, doomsayers point out that many state-run companies and banks here could go quickly bankrupt without huge injections of cash from government coffers.

More than half of the government-run companies chalked up losses last year, and many are kept afloat with state-ordered loans from Chinese banks. "China can't really reform its banks until it reforms their major customers, the state firms," Hong Kong banker Overholt says.

Already, "up to 20 percent of the credit issued by Chinese banks consists of nonperforming loans to state companies," says Wu Jinglian, an economist at a think tank run by China's State Council, or premier's office.

"The net worth of these banks is probably negative," says a recent report issued by the World Bank.

"Bad debts in China may be larger than those in [South] Korea and Southeast Asia," adds Huang Yasheng, an expert on the Chinese economy at the Harvard Business School in Cambridge, Mass. But because Chinese banks have not used short-term foreign credit to finance risky domestic loans, as many Asian counterparts have, China will not need an international bailout, he says.

Instability has also affected the nation's nascent stock market.

State-owned trading houses often pump money into the market to reverse dips caused by poor company earnings reports, which has created a stock market bubble. While exchanges from Bangkok to Tokyo have suffered double-digit drops in recent months, Chinese shares have risen.

China's state-run press exerts little pressure on managers of state firms to release information about losses to shareholders.

China has been willing to work with international agencies like the World Bank to painstakingly reform its system and "pop economic bubbles before they explode," Mr. Overholt says.

Chinese Vice Premier "Zhu Rongji is a superb economist, and the reforms he has started are unmatched" in Asia, adds Overholt, who is author of "China: The Next Economic Superpower."

While currency drops by Asian competitors could cut into China's foreign trade, Mr Zhu said recently that Beijing will not lower the value of its currency. The yuan has been stable since 1994, and Beijing has an estimated foreign reserve of $130 billion with which to back it.

Yet the problems still are enormous: China aims to transform its top 1,000 companies into giant conglomerates that can compete on the global market while simultaneously remaking shaky banks into profitmaking enterprises.

The result, if successful, is likely to refashion China's economy into a cross between the free-market American model and the Japanese system of close government-business cooperation.

"China is still on track to become the world's next economic superpower" if it carries through with the painful economic reforms that lie ahead, Overholt says.

Opening its financial system too quickly "would expose it to the same ... currency speculators who wreaked havoc in other parts of Asia," Wu says. While China's leaders can no longer afford to stop state-run firms from sinking by providing bailouts, they also seem to fear privatization will erode their political power.

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