Courtesy Reuters

China and the Asian Contagion

SO FAR, SO GOOD

The Asian financial contagion has so far left China largely unaffected. Unlike the plummeting currencies elsewhere in the region, the renminbi has appreciated against the U.S. dollar since the onset of the crisis. In real terms the Chinese economy has also fared well. In 1997 the growth of GDP, while slower than the blistering pace of the immediately preceding years, was almost 9 percent. Inflation was at a 5-year low. Exports grew over 20 percent in 1997, contributing to an unprecedented $40.3 billion trade surplus. Foreign direct investment rose for the seventh consecutive year, reaching $45.3 billion, and China raised an additional $16 billion through debt and equity offerings on international markets. Foreign exchange reserves rose sharply, reaching $139.9 billion by the end of the year, second only to Japan's.

The official outlook for 1998 is also bright. The government is predicting eight percent growth, which would make China far and away the most rapidly expanding economy in the region. It is also forecasting positive growth of imports and expects the renminbi to maintain its value. Achievement of these goals should be warmly welcomed for their contribution to Asia's financial and economic recovery.

Nonetheless, Chinese policymakers are genuinely concerned that they may contract the Asian financial contagion and have taken a number of bold steps to bolster their resistance. Unfortunately, China has many of the same structural problems that South Korea, Thailand, and Indonesia had, most notably, bank-dominated financial systems, weak central bank regulation and supervision of commercial banks, excessive lending, and a large buildup of nonperforming loans. It is too soon to say whether China's reforms will succeed.

CHINA'S VULNERABILITIES

Even in a region in which banks dominate financial systems, China stands out. Banks account for nine-tenths of all financial intermediation between savers and investors, exceeding the ratio in almost all other Asian countries. Bank-dominated financial systems, where markets for equity and debt are small, tend to share several closely related problems. First, the lack of well-developed capital markets creates a high potential for

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