China-creditworthiness

The divergence between official statistics on one hand, and the reality of Chinese productive capacity and living standards on the other, results from the suppression of prices by the socialist system and from the great disparity between the valuation of various products (rice in China at a fraction of world market prices versus rice in Japan at 8 times world market prices) in developing and developed societies. 

Problems of China's economic reform

Any reforming communist state must face a variety of serious problems. These include:

1) potential shortage of foreign exchange as liberalization promotes imports and permits movement of capital out of the country,

2) inflation as prices are freed,

3) budget deficit due to state enterprises losses,

4) unrest stemming from the different impact of reforms on different social groups,

5) reaction by political leader who are ideologically opposed to reform or fear loss of control.

Creditworthiness .

Liberalization of trade invites a flood of imports, and liberalization of capital movements create the possibility of capital flight.

For most of their post-1949 history, the leadership simply refused to take on debt because they saw it as potentially endangering the country's independence.

Since the reform of 1979, they have gradually added debt, but in a very conservative way.

China's debt at the end of 1991 was $67 billion.

Of this, $13.9 billions was trade finance of less than one year duration. This trade finance is just a set of guarantees that traded goods will reach their destinations, and it liquidate itself automatically when the goods do so. As a result, bankers do not counts this short term-trade debts when analyzing a country's creditworthiness.

That leaves real debt of $53.1 billion.

Against this $53.1 billion debt, China had $43.7 billion of foreign exchange reserves and $4.5 billion of gold.

In short, its net debt was $4.9 billion, a very small figure for a fast-growing country as large as China.

A more direct measure of the ability of a country to pay is how much of its annual export revenues a country must pay to service its debt.

Most bankers consider a country creditworthy if it has not committed more than 20% of its export revenue to pay its debt. By this standard (called the debt service ratio), China is extremely creditworthy because it can pay its debt service with only 12.4%of its export receipts.

Another key standard of creditworthiness asks whether a country has sufficient reserves of foreign exchange and gold to weather a crisis.

(The crisis could, for instance, be a downturn in the world economy, economic sanctions, or loss of export markets due to a political crisis at home or abroad.) China reserves are extraordinary large. Only five countries in the world (Taiwan, japan, Germany, the United States and Spain) have larger reserves than China. The general bankers' standard of creditworthiness is that a country's reserves should cover at least three months of average imports; China's cover nine months.

The third and the forth standards have to do with the size of a country's debt and net debt. Bankers get worried if a country's total debt (excluding trade finance) exceed the size of its economy (GNP) or if its net debt exceed the size of its export revenues. By these criteria, China's figures (7.1% and 18%, respectively) seem diminutive indeed.

China-Financial-Practices

The conservative financial practices of Beijing's leadership, like their counterparts in Taiwan, have deep historical roots. China's debt and inflation trauma from the 1930s and 1940s was worse than Germany's and had an even more intense impact on the mentality of Chinese decision makers. The generation for whom that trauma was a central experience is still in power. All factions manage the country's finances conservatively; and they do this even when under severe political pressure. During the Tiananmen Square incident, Beijing never relaxed its anti inflation austerity program. In most country an election is sufficient excuse to abandon sound financial management. Chinese economic management remained sound, without the economically deleterious political games that would have occurred in most countries.

There is a great deal more to be learned by comparing China's situation with the financial disasters of Vietnam, the former Soviet Union and Eastern Europe. Vietnam's bankruptcy stemmed from military overcommitments and the failure to initiate reform. In contrast, China severely cut its military budgets and was the first communist regime other than Hungary to liberalize and at the same time to avoid general political or economic crisis. Nor is fragmentation an issue in China. China's situation also differs radically from that of Poland, where the political opposition deliberately shut down much of the economic as a (successful) political tactic. 

In China, sabotage of the economy has been unattractive strategy for opponents of the regime. The Polish strategy of economic sabotage derived from a view of the government as a Russian imposition, and for all its political faults the Chinese government is a domestic phenomenon.

Nor China is in the position of Yugoslavia, which could not control cross-border trade and capital flows and therefore experienced a foreign exchange crisis as a result of financial  hemorrhage long before the country disintegration. 

InflationThe single most obvious risk of any reforming socialist state is that the removal of price controls will translate into catastrophic inflation.

China has not been immune to this problem, and did not identify the basic solution until the end of the first decade of reform. Its initial strategy was the sensible one of simply liberalizing prices very gradually. By the late 1980s, price liberalization plus excessive credit (at heavily subsidized interest rates) and other factors had created both excessive demand and psychology of inflation. Prices rose by 18.5% in 1988 and 17.8% in 1989, and at twice that rate of more in major cities. Anger at this inflation was a prime cause of the Tiananmen crisis. Since that time, the government has sought to borrow western market methods of inflation control. If one can control money supply, the thesis goes, then one can control the overall price level. Inflation requires monetary fuel, and the secret of defeating it is not to abandon price reform, but to take away the fuel. The government therefore moved to curtail its own budget, to control credit growth directly, to change bank loans from grants to western-style interest-bearing loans, and to stimulate the emergence of a bond market.

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