China Mongolia

COUNTRY REPORT

China Mongolia

4th quarter 1998

The Economist Intelligence Unit 15 Regent Street, London SW1Y 4LR United Kingdom The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The EIU delivers its information in four ways: through subscription products ranging from newsletters to annual reference works; through specific research reports, whether for general release or for particular clients; through electronic publishing; and by organising conferences and roundtables. The firm is a member of The Economist Group.

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Contents

3 Summary

China 5 Political structure 6 Economic structure 7 Outlook for 1999-2000 12 Review 12 The political scene 17 Economic policy 19 The economy 21 Industry 24 Agriculture 27 Infrastructure and the environment 29 Money and finance 34 Foreign trade and payments

Mongolia 42 Political structure 43 Economic structure 44 Outlook for 1999-2000 46 Review 46 The political scene 49 Economic policy and the economy 52 Agriculture 52 Industry and construction 53 Mining and energy 54 Transport and communications 54 Foreign trade, aid and payments

57 Quarterly indicators and trade data

List of tables 10 China: forecast summary 12 China: current-account forecasts 20 China: economic results 21 China: industrial value added, Jan-Sep 1998 29 China: financial statistics 35 China: trade, Jan-Sep 1998 35 China: direction by trade, Jan-Aug 1998 36 China: main exports and imports, Jan-Aug 1998 37 China: trade by type of enterprise, Jan-Jun 1998

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41 China: foreign debt, end-Jun 1998 51 Mongolia: inflation, 1998 52 Mongolia: money supply, 1998 55 Mongolia: foreign trade 57 China: quarterly indicators of economic activity 57 Mongolia: quarterly indicators of economic activity 58 China: foreign trade 60 China: trade with east European countries

List of figures 12 China: gross domestic product 12 China: renminbi real exchange rate 19 China: comparison of volume growth rates 20 China: inflation 25 China: grain output per person 27 China: urban and rural incomes 34 China: export value growth 45 Mongolia: gross domestic product

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November 25th 1998 Summary

4th quarter 1998

China Outlook for 1999-2000: Political and social stability require faster rates of economic growth, so the pump is being primed by capital investment. Bank lending has been increased in order to maintain production of state-owned enterprises (SOEs). GDP growth in 1998 will be higher than previously expected, although consumption and exports are sluggish and agriculture has been hit by floods. In 1999-2000 growth will slow as the heat goes out of the current investment drive and reform is resumed. There will be a modest devaluation in 2000. The current account will remain in surplus, and external debt will be kept under control.

The political scene: The government has been attempting to use the army’s involvement in the flood prevention efforts to bolster its own legitimacy. Political reform has resurfaced amid mixed signals on human rights. The October plenum of the Chinese Communist Party (CCP) stressed agriculture. The fourth generation of leaders is coming to the fore. Active diplomacy with the West has yet to pay dividends, but talks have resumed with Taiwan.

Economic policy: Policy is focused on boosting growth with looser monetary stance and fiscal expansion—financed by bond issues. Devaluation has been avoided, but more non-tariff barriers are in place. Progress on reform is taking second place to the maintenance of stability.

The economy: Data inconsistencies are worse than usual, but growth evi- dently slowed in the first two quarters of 1998 before picking up in the third quarter. Deflation has continued and flood repairs are likely to have stimulated growth.

Sectoral trends: Output growth has been maintained, as enterprise profits continue to decline. The coal industry remains depressed and listed companies reported a poor first half. Reform of SOEs has slowed. Agriculture’s role is once more being stressed and high hopes are pinned on the autumn harvest. The grain distribution network is in disarray and so is the cotton market. Rural incomes are barely growing. The floods were partly a man-made disaster. Con- struction of the Three Gorges project is continuing. Road-building and urban infrastructure are receiving greater attention. Construction of low-cost housing will boost growth.

Money and finance: Moves are under way to improve the regulatory environment and the two stockmarkets are in the doldrums. Curbing ITICs is a priority. M2 growth has accelerated as lending, especially for investment, has risen and savings rates are holding up. Foreign-invested enterprises are experiencing difficulties securing foreign exchange. Fears about the viability of debtors have led foreign lenders to cut credit, with serious implications for some projects.

Foreign trade and payments: Exports are losing momentum as a result of the Asian crisis, and import growth is sluggish. The share of SOEs in exports is

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falling. Smuggling is rampant, despite a major anti-smuggling campaign. A tightening trade regime makes entry to the World Trade Organisation more difficult. Inflows of foreign direct investment have held up. Counting foreign debt cannot rely solely on official data. Growth in tourism revenue is slowing.

Mongolia Outlook for 1999-2000: The political crisis that began in April 1998 will rumble on, partly owing to divided control of major political institutions. Mongolia’s constitutional arrangements may further delay a solution to the crisis. Neither side appears willing to compromise, but may feel pressured to do so by the 1999 Donors’ Group meeting. External finance will be needed to pay for another budget deficit, which is also likely to cause backtracking on tax reforms. The rate of economic growth may slow in 1999, partly because of falling external demand.

The political scene: Further prime ministerial candidates have been rejected. One possible candidate has been murdered, but instead of providing an impetus to a political solution, the killing highlighted tensions within the Democratic Coalition. The opposition Mongolian People’s Revolutionary Party (MPRP) has its own internal problems. The Constitutional Court has ruled that changes to the government law made in February were illegal, but parliament voted not to accept the ruling. The media is to be restructured. Mongolia has been engaged in diplomatic exchanges.

Economic policy and the economy: The budget balance remains in deficit. The government has increased taxes and has tried to improve compliance. The 1999 budget has been discussed, and may include some tax changes, as proceeds from privatisation may be disappointing. Cancelling a bank merger has been costly, although other banking sector reforms have been carried out. Inflation has slowed.

Sectoral trends: Early snows have destroyed crops, but vegetable production has improved slightly. An audit has revealed safety deficiencies in industry. Power supplies have been erratic. Oil will be imported from China, and transport costs for Russian oil may fall. The government hopes to increase gold production. Some MIAT planes are to be licensed to private operators. More roads are being constructed.

Foreign trade, aid and payments: Merchandise trade remains in deficit. The government has tried to increase meat exports, which may be boosted by preferential tariffs from Russia. Two new hotels have opened. Gambling may generate foreign-exchange earnings. The government aims to increase the use of foreign aid pledges. Foreign-exchange reserves have fallen.

Editors: Ken Davies; Paul Cavey All queries: Tel: (44.171) 830 1007 Fax: (44.171) 830 1023

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China

Political structure

Official name People’s Republic of China

Form of government One-party rule by the Chinese Communist Party (CCP)

The executive 15-member State Council elected by the National People’s Congress (NPC); State Council members, including the prime minister, may not serve more than two consecutive five-year terms

Head of state A president and vice-president are elected for a maximum of two consecutive five-year terms by the NPC

National legislature Unicameral National People’s Congress (NPC): 2,970 delegates elected by provinces, municipalities, autonomous regions and the armed forces; elects the president and members of the State Council and the members of the Standing Committee of the NPC, which meets when the NPC is not in session; all the arms of the legislature and executive sit for five-year terms

Regional assemblies & The 22 provinces, four special municipalities and five autonomous regions elect local administrations people’s congresses and are administered by people’s governments

National elections March 1998 (presidential and State Council); next elections due by March 2003 (presidential and State Council)

National government The Politburo (currently 20 members) of the Chinese Communist Party sets policy and controls all administrative, legal and executive appointments; its Standing Committee is the real focus of power

Main political organisation Chinese Communist Party (CCP) Jiang Zemin (general secretary) Politburo Standing Committee Li Peng; Li Ruihuan; Zhu Rongji; Hu Jintao; Wei Jianxing; Li Lanqing

Key members of government President Jiang Zemin Vice-president Hu Jintao Premier Zhu Rongji Vice-premiers Li Lanqing; Qian Qichen, Wu Bangguo; Wen Jiabao

Heads of selected state Ministry of Finance Xiang Huaicheng ministries & commissions Ministry of Foreign Affairs Tang Jiaxuan Ministry of Foreign Trade & Economic Co-operation Shi Guangsheng Ministry of National Defence Chi Haotian State development & planning commission Zeng Peiyan State economic & trade commission Sheng Huaren

Central bank governor Dai Xianglong

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Economic structure

Latest available figures

Economic indicators 1993 1994 1995 1996 1997 GDP at current market pricesa (Rmb bn) 3,450.1 4,711.1 5,940.5 6,936.6 7,607.7 Real GDP growth (%) 13.5 12.6 10.5 9.7 8.8 Consumer price inflation (av; %) 14.7 24.1 17.1 8.3 2.8 Population (m) 1,178 1,192 1,205 1,218 1,230 Merchandise exports fob ($ bn) 75.7 102.6 128.1 151.1 182.7 Merchandise imports fob ($ bn) 86.3 95.3 110.1 131.5 136.4 Current-account balance ($ bn) –11.6 6.9 1.6 7.2 29.7 Total debt incl undisbursed ($ bn) 86.3 103.7 130.2 141.5 150.9b Reserves excl gold (year-end; $ bn) 22.4 52.9 75.4 107.0 142.8 Exchange rate (av; Rmb:$) 5.8 8.6 8.4 8.3 8.3

November 20th 1998 Rmb8.28:$1

Origins of gross domestic product 1997 % of total Components of gross domestic product 1997 % of total Primary industry 18.7 Private consumption 47.5 Secondary industry 49.2 Government consumption 11.4 Tertiary industry 32.1 Gross fixed investment 33.8 Total 100.0 Exports of goods & services 24.5b Imports of goods & services –20.9b Total incl others 100.0

Principal exports 1997 $ bn Principal imports 1997 $ bn Textiles & clothing 45.6 Machinery & electrical equipment 46.7 Machinery & electrical equipment 38.3 Textiles & textile articles 17.2 Garments & clothing accessories 31.8 Chemicals & chemical products 10.3 Textiles yarn & fabrics 13.8 Mineral fuels 10.3 Foodstuffs, beverages & tobacco 12.1 Iron & steel 6.7 Footwear, headgear & umbrellas 10.2 Chemicals & chemical products 9.4 Mineral fuels & electricity 7.0

Main destinations of exports 1997 % of total Main origins of imports 1997 % of total Hong Kong 24.0 Japan 20.4 US 17.9 Taiwan 11.5 Japan 17.4 US 11.4 South Korea 5.0 South Korea 10.5 Germany 3.6 Hong Kong 4.9 Netherlands 2.4 Germany 4.4 Singapore 2.4 Singapore 3.2 Taiwan 1.9 Russia 2.9 a Expenditure-based. b EIU estimate.

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Outlook for 1999-2000

Political and social By the end of 1998 Jiang Zemin will be in an even stronger position at the apex stability— of China’s political system. This is because of his success in installing his supporters in positions of influence in the party, state and army, most recently at the 1997 15th Congress of the Chinese Communist Party (CCP, the sole ruling party), at the 1998 annual meeting of the National People’s Congress (NPC) and by dint of personnel changes in the army.

On the domestic front, Mr Jiang’s current concern is strengthening the CCP, particularly at the grass-roots. He realises that corruption and exploitation of the peasantry by rapacious and arbitrary local officials present a serious threat to the re-establishment of the party’s credibility. Building on the momentum established during the recent floods, when the party and army rode high on a voluntarist tide, Mr Jiang and his supporters are seeking to embed the party once more among the people. Moves to establish “democracy” and the rule of law should be seen in this context, not as embracing notions of pluralism.

Dealing with the political aspirations of an increasingly well-informed and so- phisticated urban elite is another long-term project, but one that Mr Jiang Zemin regards as fairly tractable compared with the need to retain the support of the rural population and at the same time prevent those who have lost out in the reform process from staging angry demonstrations. Movement towards a more open and tolerant political and cultural atmosphere is likely to continue.

Polishing the image of the army has been rendered easier by the media’s presentation of its heroic performance in the battle against the floods. But maintaining the military’s standing in the eyes of the population will be difficult. Although there has been no overt resistance to the order, at mid-year, that the army should cease its involvement in commercial activities, the complex process of disentangling military and civilian business activities, of employing the thousands of army personnel who are due to be laid off as part of a further downsizing of the military, and of putting military businesses into civilian hands is bound to be protracted. Mr Jiang’s reputation is closely associated with the success of this endeavour.

—requires a boost to If China’s social and political stability are to be maintained, the party must economic growth— continue delivering increases in the standard of living, especially to the areas— inland, rural, and now flood-damaged—where relative poverty is increasing. It must also support millions of workers employed in uneconomic enterprises or create an environment which will provide alternative employment as stream- lining and reform restart.

—and the pump is being A combination of deliberately induced slowdown, the spillover effects from the primed— Asian crisis, and the impact of reform of the state-owned enterprises (SOEs) caused a marked slowdown in economic growth in the first half of 1998. These effects were exacerbated by serious summer flooding. In the face of these events and the sporadic outbursts of protests by urban workers whose employers were unable to pay their wages, the government decided to slow reform and use all

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possible means to boost growth in 1998 so that it would approach the 8% target set by the premier, Zhu Rongji.

—mainly by investment in One plank of the government’s bid to boost growth is the investment pro- infrastructure— gramme. In May it was announced that $370bn is to be spent on infrastructure over a three-year period from 1998 to 2000; after the growth figures for the first half of 1998 were issued, it was announced that $1.2trn will be spent on infrastructure and construction over the same period. Clarifications of official pronouncements have made it clear that these large numbers clearly include all categories of fixed capital investment, not just infrastructure. The spending will be focused on central and western China and on urban infrastructure as well as flood repairs, and is in addition to several large-scale schemes that are already in progress, including the Three Gorges Dam.

The money for this spending will come chiefly from borrowing; large bond issues have already been made and others are in preparation. Issuing government debt will help to deepen the domestic debt market and will provide an alternative vehicle for personal savings to the banks.

—and by increased bank The boost to the economy from increased government spending has been lending— accompanied by an order to the state-owned banks that, rather than concen- trating on rebuilding their balance sheets and avoiding dubious credits, they should increase their lending to SOEs. They have done so, and the monetary stance of the government is likely to stay loose for the next 12 months. Interest rates have already been cut twice this year, and are likely to come down further.

—so that SOE production A major aim of credit loosening in 1998 has been to stimulate production by can resume SOEs. This represents a possibly temporary pause in the attempt to disentangle the SOE-state bank nexus. Many thousands of SOEs were forced to cut production as well as investment during the credit squeeze that was imposed, periodically, from mid-1993 to curb overheating, because they could not secure working capital. Data for industrial output in the first nine months (see Industry) show the beginnings of a recovery in growth. More credit is also being made available to small and medium-sized enterprises (SMEs) and also for exports.

Growth will be higher The stimulus provided by these measures, and the extra spending incurred in than previously expected response to the flooding, will lift GDP growth, as measured by official statistics. in 1998— While the government’s target of 8% growth will be hard to meet, a combination of faster investment growth on the demand side and more robust growth in industrial output will help to lift GDP growth to 7.8% in 1998, close to the official target.

—although consumption There are some signs that there has been an increased willingness by consum- and exports are sluggish— ers to spend, notably on smuggled imports, from mid-1998 onwards, but consumption is being held back by fears about job security in the cities and by the slow income growth in rural areas.

Exports, meanwhile, have been hit by depressed markets in Asia and are estimated to have grown by only 5.5% in national accounts terms in 1998. Import growth has also been sluggish, because the government-funded investment

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drive of 1998 is not high in import content and because exporters have been selling existing inventories.

—and agriculture has The floods that hit China in mid-1998 will certainly have cut the growth rate been hit by floods of agriculture; provided the autumn harvest is not affected, the damage will not be devastating on a national scale. Much of the output of the sector comes from sideline activities, not crop production. A growth rate of about 2.5% per year seems achievable, well below the 4% trend of recent years. But rural purchasing power will be seriously dented for several years in the flood-affected areas, where farmers have sustained large losses in property.

The world economy is Fears that the contagion from the Asian crisis, which has spread to Latin delicately poised— America as well as to Russia, could spark a world recession have intensified, prompting cuts in interest rates in the US. Japan, meanwhile, remains mired in recession, the causes of which are structural and not curable by mere counter- cyclical policy. Most of the countries in Asia affected by the crisis that started in mid-1997 are expected to remain in recession throughout 1999. Growth in the US will slow to 1.6% in 1996, before rising to 2% in 2000. The appetite of US consumers for Chinese exports is consequently likely to be less keen in the next two years than it has been previously. A similar picture will prevail in Europe, where growth is expected to be boosted by monetary union.

—but the EIU expects World GDP (measured in dollars at current exchange rates), after growing by world trade growth to 3.3% in 1997, is expected to reach only 1.7% in 1998, and is forecast to grow at recover— the same rate in 1999 as the initial recovery of some of the crisis-hit Asian economies is offset by slower growth in the US. We estimate that world trade growth has halved from 9.6% in 1997 to 4.8% in 1998, and will recover gradually, to 5.3% in 1999 and 6.5% in 2000.

—and WTO membership The prospects of an improvement in world trade growth, and of China’s own still seems a long way off exports in the longer run, would be enhanced by the admission of China to the World Trade Organisation (WTO). Time and again this has seemed a real prospect, only to fade because of US insistence that China must open its markets faster and further than is required of developing countries because of the sheer size of the economy and the share that it already commands in world exports.

The negotiations, which are due to gather momentum after an agreement to resume detailed talks between China and the US was reached in November, are complicated by the issue of devaluation. There is no doubt that China, which can point to a sharp slowdown in the growth of its exports in 1997-98, expects favourable consideration on the issue of WTO membership. In some ways WTO membership appears more desirable now that China faces a more difficult trading environment, and it is conceivable that China will be admitted to the WTO during 1999-2000. However, further market-opening gestures will have to be made if membership is to be secured, and the government will be reluctant to implement such changes in the context of slowing GDP growth and rising unemployment. Recent regulatory measures implemented by the government if anything take China further away from the criteria the US is seeking to impose for China to join the WTO.

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China: forecast summary (% real change year on year unless otherwise indicated 1997a 1998b 1999c 2000c GDP 8.8 7.8 6.7 7.0 Fixed investment 9.0 13.0 8.9 9.0 Exports of goods & services 18.8 5.5 3.5 7.0 Imports of goods & services 3.6 4.0 4.0 6.0 Agricultureb 3.5 2.5 3.8 4.0 Industryb 11.1 9.0 7.5 7.7 Servicesb 8.2 8.0 7.5 7.8 Consumer prices (av) 2.8 –0.5 2.5 5.5 Exchange rate (av; Rmb:$) 8.30 8.30 8.30 9.30

a Actual. b EIU estimates. c EIU forecasts.

Growth will slow as the We expect the rate of economic growth to slow further in 1999-2000 to an heat goes out of average of 6%, once the current investment and lending campaign runs out of investment— steam.

On the demand side, investment growth will be curtailed by a probable fall in inflows of foreign direct investment (FDI) and a slowdown in investment by SOEs as well as township and village enterprises (TVEs) as a result of poor profits in 1998. The large amounts of government-financed infrastructure investment recorded this year will also be difficult to maintain. Nevertheless, fixed investment growth in 1999-2000 will continue to hold up mainly through continuing public-sector spending on infrastructure and housing.

—and reform starts once On the supply side, industrial output growth will slow over the next two years. more While the export-oriented foreign-invested enterprises (FIEs) which are con- centrated on the eastern seaboard will respond rapidly to a more favourable world market, SOEs will once more experience slower growth as enterprise reform regains momentum. By late 1999, with faster export growth in prospect and a recovery in agriculture well under way, the government will once again take up the cudgels of SOE reform, involving widespread closures and mergers of the constantly growing number of loss-making SOEs. The need for this will be felt more acutely because recapitalisation of the bad-debt-ridden state banks cannot proceed in isolation from enterprise reform.

The devaluation Arguments for and against devaluing the renminbi have been endlessly re- question— hearsed. Clearly a very large devaluation would be needed to boost competitiveness, but this would raise the price of imports, pushing up the costs of import-intensive FIEs. The cost of servicing foreign debt, which already exceeds official data, would also be increased by a devaluation. Political considerations, including the need to preserve stability in domestic financial markets, also weigh heavily against an early and steep devaluation.

—will be answered in 2000 The above considerations suggest that a promise made on November 21st by Mr Zhu not to devalue the renminbi in 1999 is one that he has every reason to keep. But we do expect a modest realignment at the beginning of 2000, partly because of the demonstration effect that such an assertion of control over the exchange rate would have, and partly because, as Asian currencies consolidate after sharp overcorrections against the US dollar, the 10.3% adjustment

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envisaged, to Rmb9.3:$1 at the beginning of 2000, will give China a genuine boost to competitiveness without being inflationary.

Inflation will be on the agenda once again by 2000. After the deflation of 1998, the boost to demand given by the extra spending on infrastructure, combined with the necessary removal of some recently imposed price controls, and further increases in key procurement prices, will stimulate wider price increases, and the annual average rate of inflation will return to 5.5% in 2000.

The current account will The discrepancy between export and import growth has been so large through- remain in surplus— out most of the past five years that it will take several years of imports out pacing exports by a wide margin to remove the trade surplus. Meanwhile a declining services deficit, as tourism revenue continues to rise and expenditure on trade-related services is cut back, will be more than offset by a rising deficit on the income account, caused by even larger outflows of interest, profit and dividends. But the magnitude of the trade surplus will ensure an overall current-account surplus for the next two years, falling from 3% of GDP in 1998 to 2.5% in 2000.

—and debt will stay under The sizeable current-account surplus will limit any increase in the overall level control of foreign debt. China’s stocks of outstanding external debt will, however, be recorded as rising more than they actually do as a result of a fairly vigorous effort now under way to count foreign assets not registered with the State Administration of Foreign Exchange (SAFE) as the debt which they truly repre- sent. Total debt is expected to rise to about $179bn in 2000, from around $162bn in 1998. Debt service will not be a cause for concern.

Foreign investors are Inflows of $30bn-40bn in actual FDI in recent years have not been all they losing heart— seem. An unknown but large share represents domestic funds that flowed out to Hong Kong and were then repatriated to seek the privileges accorded to “foreign” investment. However, even after discounting this “round tripping”, FDI flows have been large and are forecast to fall during 1999-2000 as a result of the weakness of investing economies and because China has lost some of its relative attractiveness as a location for FDI, at least in terms of cost.

—and policy needs to be Policy towards FDI is riddled with contradictions. The government still seeks a re-examined more restrictive regime to divert investment from areas which appear to bestow quick returns on foreign investors to areas which offer little immediate gain but the authorities feel would deliver greater benefits to China. The whole question of national treatment for foreign investors, which has been a matter for discussion and promise since 1995, needs to be clarified. Meanwhile there is every prospect of sharply diminished inflows and even disinvestment by companies in search of low-cost locations, especially if greater access to the domestic market is granted, as now, only grudgingly.

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China: current-account forecasts ($ bn unless otherwise indicated) 1995a 1996a 1997a 1998b 1999b 2000b Goods: exports 128.1 151.1 182.7 183.6 182.3 193.2 Goods: imports –110.1 –131.5 –136.4 –134.6 –134.5 –146.2 Trade balance 18.0 19.5 46.2 49.0 47.8 47.0 Services: credit 19.1 20.6 24.6 24.8 24.6 25.6 Services: debit –25.2 –22.6 –30.3 –30.2 –29.9 –30.7 Services balance –6.1 –2.0 –5.7 –5.3 –5.3 –5.2 Income: credit 5.2 7.3 3.2 3.1 3.1 3.1 Income: debit –17.0 –19.8 –19.1 –19.2 –18.9 –20.5 Income: balance –11.8 –12.4 –15.9 –16.1 –15.8 –17.3 Current transfers: credit 1.8 2.4 5.5 2.6 2.7 2.8 Current transfers: debit –0.4 –0.2 –0.3 –0.4 –0.5 –0.4 Current transfers balance 1.4 2.1 5.1 2.2 2.2 2.4 Current-account balance 1.6 7.2 29.7 29.8 29.0 27.0 % of GDP 0.2 0.9 3.2 3.0 2.7 2.5

a Actual. b EIU estimates. c EIU forecasts.

China: gross domestic product China: renminbi real exchange rate (c) % change, year on year 1990=100 10 120 China Asia (excl Japan) 110 8 Rmb:DM 100 6

90 4 Rmb:$ 80

2 70

Rmb:¥ 0 60 1996 97 98(a) 99(b) 2000(b) (a) EIU estimates. (b) EIU forecasts. (c) Nominal change rates adjusted for changes in relative consumer prices. Sources: EIU; IMF, International Financial Statistics. 90 91 92 93 94 95 9697 97 98(a) 98 99(b) 99 20002000(b)

Review

The political scene

Manning the barriers The floods that struck China in mid-1998 have proved to be the most devastating since 1954. Not only the mighty Yangtze which splits China between north and south but also the Sung and Nen rivers in northern China burst their banks. Floods are a perennial problem in China, but 1998 has been a particularly bad year. Figures released in mid-October stated that natural disasters of various kinds had “covered” (ie inundated) 44.2m ha and “affected” 17.3m ha —a vast swathe of China. There had been 4,610 deaths because of the floods and damage caused was estimated at $36.4bn.

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This year’s floods were not only more extensive than the last serious floods in 1991, but also lasted longer. The amount of rainfall recorded was not much greater than in 1954, but the Yangtze reached record heights. Thanks to the flood prevention works constructed during the rule of the former party chairman, Mao Zedong, only one dike burst, at Jiujiang in Jiangxi province. As the flood waters mounted during July, the vice-premier, Wen Jiabao, manned the Flood Control Headquarters. In early August the Politburo Standing Committee decided to send in the army and declared that flood fighting, chiefly by protecting the dikes, was the top priority.

The whole battle against the floods became a mass mobilisation effort reminis- cent of the Mao years, in which the People’s Liberation Army (PLA) and People’s Armed Police (PAP) were portrayed as performing acts of heroism. The role of the Chinese Communist Party (CCP) as the guiding force in flood fighting was emphasised. “The relationship between party and people is like blood and flesh, and the relationship between people and army is like fish and water,” said the president, Jiang Zemin, using phrases borrowed directly from Mao. At the end of September the floods has been brought under control. A total of 100m people had been involved in the campaign, which did much to restore the image of the army, tarnished by the 1989 Tiananmen Square mas- sacre in Beijing and by the active involvement of the military in commerce and graft in the heady years of rapid growth.

Mr Zemin’s triumph The flood campaign presented Mr Jiang with another opportunity to strengthen his grip on power. Rumour has it that he will, in the near future, adopt the appellation “leader”—lingxiu—in place of his current position as the “core” of the leadership. There can be no doubt that the flooding has, in the short term at least, fortified his already strong position. As head of the Central Military Commission (CMC), Mr Jiang ordered the army to cease its business activities in July (3rd quarter 1998, page 16). Although compliance may well be patchy, his ability to issue such an order testifies to his confidence.

Meanwhile, Mr Jiang remains above the immediate political fray. The handling of the economy, a task that increasingly demands running as fast as possible in order to stand still, is in the hands of the premier, Zhu Rongji. The task of overseeing the legislation for and implementation of the limited degree of political loosening envisaged by the election of local leaders falls to the former premier and current chairman of the National People’s Congress (NPC), Li Peng. Mr Li is also the self-appointed champion of the vast Three Gorges Dam project in Hubei province. The extensive flooding this year has made this project even more controversial; it has long been criticised by environmentalists, and many are now questioning whether the $11bn that the dam is expected to require in fixed costs could not have been better spent restoring the environmental damage that made the flooding so serious, as well as improving less glamorous flood defences nation-wide.

Political reform While leaving day-to-day management of domestic affairs to his subordinates, reappears— Mr Jiang remains preoccupied with the task of restoring the image of the CCP in the eyes of an increasingly sceptical, and even cynical, public. Stamping out corruption and improving governance at the local level are central to this

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project. It is in this context that the notion of political reform resonates for Mr Jiang.

The contours of political reform as envisaged by Mr Jiang were outlined in his speech at the 15th CCP National Congress in September 1997 (4th quarter 1997, pages 10-12). While the “people’s democratic dictatorship” and the leading role of the CCP remain sacrosanct, a more consultative political system is to be built, starting from the grass-roots. Rule by law is to be reinforced. The NPC Standing Committee has begun to discuss the draft legislation providing for local elections to village committees and to discuss the relationship between the committees and the township and town governments. It has been stressed that grass-roots CCP organisations should continue to play a “leading core position in rural grass-roots organisations”.

—but any action will be Debate on political reform higher up the hierarchy is generally not accessible, limited— although it certainly happens. Mr Jiang is reported to have accepted the need to start building a more genuinely open and accountable political system some time in the early part of the next century. A more open atmosphere now pre- vails, with democracy and pluralism the subject of discussion and notions about the need to circumscribe the powers of government openly aired. Protests about specific grievances are increasingly tolerated, providing a pressure valve in times of greater social and economic disruption. At the same time, the authorities do not hesitate to arrest and muzzle those whose calls for reform go too far, especially if they go so far as to set up any form of opposition party. Thus when the UK prime minister, Tony Blair, visited China in October, known dissidents and advocates of political pluralism were detained, albeit briefly.

—and “splittists” will be Meanwhile, the harshest punishment would be meted out to “splittists”, if harshly dealt with they could be caught. One of the Chinese leadership’s nightmares is the prospect of Uygur Muslim separatists from Xinjiang province receiving aid and succour from beyond China’s borders. But that is now happening in Afghanistan, where the Taliban are reported to be training Uygur terrorists and the Chinese government is bracing itself for an escalation in the hitherto sporadic acts of violence. An influx of Han Chinese displaced by the Three Gorges project to the neighbourhood of the city of Kashgar, in Xinjiang province, has sparked resentment and attacks on policemen.

Some developments on Chinese officials are becoming more confident about the way in which they human rights— engage with the West on the subject of human rights. An international symposium on human rights was held in Beijing in October at which Chinese speakers affirmed the government’s view of human rights: that the issue includes more than the simple guarantees of freedom for individuals which Western countries insist upon and that developing countries’ human rights records must be judged by broader criteria.

After the conference, China established its own website on human rights (www.humanrights-China.org). Beforehand, China signed the International Covenant on Civil and Political Rights and its ambassador to the UN in new York, Qin Huasun, affirmed China’s willingness to conduct dialogue on the

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subject of human rights in the wake of the visit by the UN high commissioner for human rights, Mary Robinson.

—but the UN convention China has also signed, but not ratified, the International Covenant on has not been ratified Economic, Social and Cultural Rights. If and when the NPC does ratify the two covenants, reservations could be attached which allow China leeway to continue to suppress dissidents.

The October plenum Although the reform of the state-owned enterprises (SOEs) is a daunting task, stresses agriculture but one which must be accomplished if China is to achieve its developmental goals, raising agricultural productivity is equally necessary and no less complex. The man-made environmental damage that this summer’s flooding has laid so bare (see Infrastructure and the environment) adds another dimension to the issue of rural modernisation. The primacy of agriculture, already stressed at the 15th CCP Congress, was reinforced at the October plenum. Expectations that there would be high-level personnel changes at this meeting were not fulfilled. The theme of the meeting dealt with the results of 20 years of rural reform. Mr Jiang made two inspection tours—to Anhui and Jiangsu—before the meeting.

The plenum communiqué made an explicit link between rural development and local democracy. “To achieve balanced development in the rural economy and society and maintain rural social stability”, it asserted, “is imperative to effectively strengthen rural grass-roots democracy and legal system, socialist spiritual civilisation, grass-roots party organisations, and contingents of cadres.” It continued: “Villagers’ self-government is a great creation of the party which leads peasants in their hundreds of millions to build socialist democratic politics with Chinese characteristics. We must carry it out in an orderly manner according to established steps and under the unified leadership of the party, establish and improve various systems, and combine this closely with the endeavour to improve the legal system. The key to building prosperous, democratic, and civilised socialist new countryside lies in strengthening and improving party leadership.” Clearly, democracy Chinese-style will be carefully guided.

The fourth-generation In late August rumours started to gather that the vice-president appointed at leadership the NPC meeting in March, Hu Jintao, would be crowned as heir-apparent to Mr Jiang by being appointed a vice-chair of the CMC at the plenum. This did not happen. But Mr Hu remains the most likely person to succeed Mr Jiang. Other rising stars in the CCP’s firmament include the newly appointed party leader of Guangdong province, Li Changchun. Elected to the Politburo at the 15th Congress, while serving as party secretary of Henan province, he was transferred to Guangdong province in May this year to enforce greater compliance from the province, which has displayed a tendency to ignore or flout orders from the centre. Wen Jiabao, who also joined the Politburo at the 15th Congress, was appointed this year to head the State Flood Control and Drought Relief Headquarters. His reputation as an able economic manager (he is head of the Central Finance and Economic Leading Group) has been enhanced by his work on flood control.

Active diplomacy— Mr Jiang has been very active on the diplomatic front in 1998. The flood crisis prompted the postponement of visits to Japan and Russia, which were planned

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for early September. The visit of the US president, Bill Clinton, in June was followed by visits from the French prime minister, Lionel Jospin, the UK prime minister, Tony Blair, and the president of the European Commission, Jacques Santer. There have also been high-level exchanges with Vietnam and Russia, and China participated in the four-way talks—with the US, South Korea and North Korea—about the Korean peninsula in Geneva in October.

—has yet to pay Thus far, the benefits accruing from all this diplomatic activity are largely dividends— intangible. China has received plaudits for not devaluing the renminbi, despite the harm that the Asian crisis is doing to its export competitiveness and to its Asian markets. In fact, the government believes that devaluation is not in the country’s best economic interests (see Economic policy).

—particularly on the But on the long-standing issue of entry to the World Trade Organisation trade front— (WTO), virtually no progress has been made, although China regards early entry on acceptable terms as the ideal quid pro quo for its restraint on devaluation and its generally responsible stance on the Asian crisis and other matters of concern to the West in general and the US in particular.

In fact, trade relations with the US are under the usual sort of strain that arises when China’s bilateral surplus rises sharply, as it has done again this year. The US administration estimates that the surplus will reach a “politically unsustain- able” $60bn in 1998 and accuses China of erecting various new barriers to imports in order to protect its domestic markets.

Among the grievances listed by the US under-secretary of commerce, David Aaron, on a visit to China in September were:

• China’s plan to block the only avenue used by foreign companies to invest in the rapidly growing telecommunications services market;

• restrictions on imports of power plant equipment: the list of projects not allowed to import equipment has been cut from 11 to 4—the US wants the ban lifted;

• price and profit controls being considered or already implemented which would discriminate against imports of pharmaceuticals;

• import quotas and licensing requirements imposed by the State Machine Building Bureau;

• lack of an adequate response to US proposals that could form the basis of WTO membership; and

• rebates on value-added tax (VAT) to exporters of certain goods which have been raised to levels that amount to subsidy.

—and China criticises US China, meanwhile, has said that it is “strongly dissatisfied with and firmly legislation against” legislation in the Omnibus Appropriation Act and the 1999 Fiscal Year Department of Defence Authorisation Act which the US Congress has recently passed. According to the Chinese side, the acts “contain anti-China contents that interfere in China’s internal affairs, support Tibet’s separatist forces, ob- struct the normal Sino-US co-operation in economic, trade and other fields,

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and demand the inclusion of Taiwan into the Theatre Missile Defence [TAD] system and the arms sales to Taiwan be continued”.

The strong showing by the Democrats in the recent congressional elections in the US may make for a Congress that is less apt to pass legislation that disrupts the bilateral relationship. But the issue of bilateral trade—and increasingly of China’s entire foreign trade and investment regime—is likely to become more difficult in the immediate future because economic policy in China is becoming less friendly to trade and investment and barriers are rising in an effort to protect domestic growth.

Talks with Taiwan resume In October the chairman of Taiwan’s Strait Exchange Foundation (SEF) and an important figure in the ruling Kuomintang, Koo Chen-fu, arrived in China. The visit marked the resumption of high-level contacts between the two sides, which had been broken off by China in 1995, when the president of Taiwan, Lee Teng-hui, paid a visit to the US.

When in Beijing Mr Koo met Mr Jiang, in the highest level contact between the two sides since 1949. It was also agreed that Mr Koo’s mainland counterpart, the chairman of the Association for Relations Across the Taiwan Strait (ARATS), Wang Daohan, would visit Taiwan probably in early 1999.

Other than agreeing to continue talking, little progress was made. Both sides are unable to budge from entrenched positions on reunification, which China is pressing ever more forcefully now that it has successfully resumed sovereignty over Hong Kong. China was also given a boost by Mr Clinton’s public pronouncement in June that the US would not support a Taiwan declaration of independence. Taiwan still seeks to confine talks with the mainland to matters of a practical nature, insisting that political talks could only follow China’s acceptance of Taiwan as a political equal.

Economic policy

Boosting the economy— The government has been seeking to boost growth during 1998. The marked slowdown in the first half of this year, when both domestic and external demand were constrained, caused serious concern. The government, worried that GDP growth would fall below the official target of 8%, embarked on a programme of accelerated spending. It has also relied on its remaining administrative mechanisms to order the resumption of active lending by the state banks to the sectors which the state wants supported—selected large SOEs, small and medium-sized enterprises (SMEs) and exporters.

—with looser monetary Interest rates have been lowered on several occasions over the past year. Fur- policy— ther reductions will only be made if the government believes such cuts will not undermine public confidence in the ability of the government to maintain the exchange rate at Rmb8.3:$1. Looser monetary policy has therefore also taken the form of allowing and encouraging greater volumes of lending by the state- owned banks.

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—and a fiscal expansion— At the same time there has been a large increase in central government spending, directed mainly at infrastructure projects and targeted in particular towards the central and western areas that have experienced slower growth in the 1990s. Spending was also stimulated by the massive resource-deployment effort that has been necessary in response to the flood emergencies in mid-1998. In the first nine months government expenditure rose by 17.5%, compared with a budgeted target of 10.3% for the year as a whole (2nd quarter 1998, page 19), while revenue rose by 10.4% compared with a budgeted rise of 12.1%.

—financed by bond issues The additional spending, and the increased budget deficit as a result, is being financed by additional debt, mainly domestic debt owing to the difficulty of raising funds abroad. By mid-October Rmb220bn ($26.5bn) had been issued in state bonds, over and above the Rmb100bn bonds issued to finance infrastructure spending. The state is also monetising its broader deficit—which includes policy lending by the People’s Bank of China (PBC, the central bank) to SOEs— by expanding the money supply in order for the state banks to support state- owned industries.

Staving off devaluation— Pressure to boost export competitiveness lost as a result of the large-scale devaluation of the currencies of many other emerging markets has been exerted by some industry sectors, but has been resisted by the government. The official calculus still reckons that the gains would outweigh the costs of devaluation— political loss of face, more expensive imports for swathes of export-oriented and import-intensive industry, the risk of higher inflation at a time of economic stimulus, more expensive debt-service costs for some shaky Chinese borrowers, and a generally heightened sense of instability as a result of the government’s reversal of policy on an issue on which it has previously been adamant. The gains would include an enhanced ability to compete on price without denting margins or being accused of dumping as well as deterring cheap imports. But many export markets, especially in Asia, are regarded as being too severely depressed to respond to a devaluation of the renminbi on any scale that has occurred previously.

—but erecting more Meanwhile China is acting to deter imports by administrative means, includ- non-tariff barriers ing what may be a rather liberal interpretation of the concept of smuggling. Exports are being supported by increased tax rebates on VAT and increased export credits. Western trade partners regard current Chinese moves as lessening the country’s eligibility for WTO membership and it must be concluded that the Chinese government has decided that WTO membership is not at the top of the policy agenda, at least not while the current weakness and instability of the world economy persists.

Reform is secondary— Although a certain amount of restructuring of the SOE sector has continued this year (see Industry), the process of enterprise reform is not proceeding at the pace envisaged by Mr Zhu, when he made bold commitments to accelerated reforms at the beginning of 1998. The recapitalisation of the state-owned banks, in particular, has been set back by their deployment, once more, as channels of working capital to allow SOEs to continue to produce during the current economic downturn.

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—to the maintenance of The overriding goal of economic policy is now the maintenance of stability. stability This, the government believes, means that growth must accelerate. However, the longer-term problems of industrial enterprise and financial-sector reform and the urgent need to raise the productivity of agriculture and combat environmental degradation have not disappeared, and will need to be tackled sooner rather than later.

The economy

Data difficulties are worse In the early and mid-1990s, at a time of comparatively high inflation, discrep- than usual ancies between the stated growth rate of constant-price GDP and the physical data for output of industries such as electricity, power and rail freight led many to the conclusion that the deflators being used to calculate growth rates for GDP, and especially industrial output, were unusually unreliable.

During 1998, a period of deflation, the discrepancies between growth and China: comparison of volume growth rates physical output have remained wide. For example, in the first eight months of Average 1992-97; % change, year on year the year, according to official statistics, industrial value added rose by 7.8% year on year. This is unusual, as it represents even faster growth in real terms, Industrial output (a) since the producer price index actually fell by around 5%. In the same period, electricity generation rose by only 1.6%, total energy output declined by 5.5% and the total freight volume by 5.9%. There is also anecdotal evidence (see Energy consumption (b) Foreign trade and payments) of an increased incidence of smuggling and of over-reporting of exports. Although there may be sound economic arguments Freight traffic (c) for some of the discrepancies—increased efficiency in the use of electricity may explain some of the gap between energy and GDP growth, for example—the 0 2 4 6 81012141618 data discussed below are more-than-usually questionable. There is evidence (a) Constant-price index in GDP figures. (b) Measured in tonnes of standard coal equivalent. (c) Tonnes. that data are being misstated for political reasons. Although the central govern- Source: State Statistical Bureau, China Statistical Yearbook 1998. ment has issued stern injunctions to the contrary, and has gone to the lengths of legislating to make false reporting of data an offence before the law, local officials may still be tempted to overstate growth rates.

Some areas of the In the first three quarters of 1998 retail sales were up by a nominal 6.3%—more economy grow strongly— in real terms in the context of deflation—boosted by purchases of food and medicine needed to combat the effects of the flood. Although the value of overall savings deposits rose, the real annual rate of growth of urban income per head was 6%, while that for rural incomes was only 1%, suggesting that the savings rate fell slightly.

Investment, which grew by 20% year on year in the first nine months of 1998, compared with 11.2% in the same period of 1997, has been boosted sharply by government-directed spending on infrastructure and by the simultaneous resumption of lending to SOEs since mid-1998. Inflows of utilised FDI have remained large (see Foreign trade and payments), which has boosted total fixed investment.

Also contributing to growth in the first nine months of the year was a rise in industrial stocks. Many thousands of SOEs were able to resume or increase production during the third quarter, following government pressure on state banks to re-start lending. In August, according to the State Statistical Bureau

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(SSB), industrial inventories were up by 8.9% year on year, a rate of growth that doubtless exceeded that of nominal GDP.

—but although GDP Although imports grew hardly at all in value (and very little in volume) in the growth slows in the first first nine months of 1998, export growth slowed markedly, held back by com- nine months— petitiveness losses and weak demand in Asian markets. This contributed to a slowdown in overall GDP growth. The economy grew by just 7.2% year on year in the first nine months of 1998, compared with 9% in the same period of 1997.

China: economic results (% real change year on year unless otherwise indicated) China: inflation % change, year on year Jan-Sep 1996 1997 1998 Consumer prices Retail prices GDP 9.6 9.0 7.2 6 of which: gross fixed investmenta 19.3 11.2 20.0 4 exports of goods & servicesb –2.7 24.0 3.9 b 2 imports of goods & services 5.8 2.5 0.4 industryc 12.9 10.7 8.0 0 Consumer price index (CPI) 8.8 3.4 –0.7 Retail price index (RPI) 6.6 1.3 –2.5 -2 Money supply (M2)d 27 17.1 16.0 -4 Jan . .Apr. . Jul . .Oct. . Jan . .Apr. . Jul . .Oct a b 1997 98 Nominal rise in completed investment in fixed assets by the state sector. Percentage change in current dollars. c Real growth in industrial value added. d Nominal rise, end-period. Sources: State Statistical Bureau, China Statistics; press reports. Source: New China News Agency.

—the economy picked up Efforts to stimulate the economy by means of lower interest rates, more bank in the third quarter lending to industry and government investment spending have started to show through in the data. One of the government’s targets was to slow down economic growth from 12.6% in 1994 to around 8% in 1998. However, growth below 7-8% a year over a protracted period is seen as unacceptably low, in light of the millions of new jobs that the economy needs to create to keep pace with workforce growth and compensate for lay-offs in the state-owned sector.

According to the SSB, in the third quarter of 1998 GDP growth rose to 7.6% year on year, up from 7.2% in the first quarter and 7.3% in the first six months. Fixed asset investment in the third quarter increased sharply by 28.2% year on year. In order achieve the annual target of 8% for 1998, which government spokespeople are saying is within reach, fourth-quarter growth will need to reach 10.4%.

Deflation continues In the first nine months of 1998 the consumer price index fell by 0.7% and the retail price index was down by 2.5%. The fall in prices reflected a combination of abundant food supplies, weak domestic demand exacerbated by several years of overproduction, and abundant imports of cheap inputs and consumer goods. In September a fall of 1.5% year on year in consumer prices and 3.3% in retail prices marked the 11th successive month of falling prices. The producer price index (first published in June 1998) for 31 major cities fell by 5.1% year on year in September. The deflation has prompted the government to place a floor under the price of several products, in an attempt to end cut-throat competition both between domestic companies, and from imports. Some relief from the deflationary trend has been provided by the floods, which have

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pushed up food prices. The prices of vegetables in Guangdong in September were 20.7% higher than in August, while the grain price was up by 2.1%.

Flood repairs may have Estimates of the damage caused by the floods quoted in the Chinese press in stimulated growth mid-October put the total at $36.4bn. There was severe damage to crops, as well as to property and livestock. But although the floods have dented the size of the Chinese economy, they may actually provide a stimulus to growth. Investment in flood recovery construction and in infrastructure has been boosted in response. Expenditure on certain consumer goods and medicines has also risen.

Industry

Output growth is As a result of the economic stimulus measures implemented at mid-year, indus- maintained trial value added growth had ceased to decelerate in the first nine months of 1998, when it grew by 8% overall in annual terms. In the third quarter, the year-on-year growth rate of industrial value added rose to 8.6%. During the first nine months of the year the value added growth rate of SOEs, at 2.6%, lagged behind that of total value added, but still accounted for almost 46% of the total. The industrial value added by joint-stock enterprises (which include the growing number of SOEs that have sold shares to the public) grew by 10%. Value added by FIEs continued to record the highest growth of 12.3% year on year in the first nine months.

China: industrial value added, Jan-Sep 1998 (1990 prices) % change, Rmb bn % of total year on year Light industry 642.8 44.7 8.5 Heavy industry 796.4 55.3 7.7 Total 1,439.2 100.0 8.0 of which: SOEs 656.8 45.6 2.6 collectives 359.4 25.0 8.0 joint-stock enterprises 94.1 6.5 10.0 foreign-invested enterprises (FIEs) 276.4 19.2 12.3 Source: China Economic News.

Enterprise profits The total profits of SOEs fell by 36% year on year to Rmb63.9bn ($7.7bn) in the continue to fall first nine months of this year, according to the SSB. But the SSB also announced, not for the first time, that the rate of decline was slowing, from a fall of 58% in the first quarter to 43.2% in the first nine months. The profits of SOEs have been dented by deflation, which has depressed prices, and in some cases by cheap imports. Profits from exports have also been hit by weak demand and by the need to cut prices to compete with goods made in other countries which have experienced large currency depreciations. But the main problem has been the weakness of domestic demand.

The coal industry remains Coal production, sales and profits fell in the nine months to end-September, depressed according to the specialist journal China Coal Industry News. Large state-owned coal mines—which total about 2,500 and produce more than one-third of national output—posted cumulative losses of Rmb3.75bn ($451m); total output

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shrank by 7.4% year on year, to 816m tonnes. Sales fell by 13.2% to 771m tonnes. Stockpiles were 200m tonnes. Another report put the losses of the 94 main state-owned coal companies at Rmb1.8m ($217,439), compared with a profit of Rmb200m for the whole of 1997. According to China Coal Industry News, the poor performance is the result of slowing economic growth, structural adjustments and the Asian crisis. The unpaid bills of large state-owned coal mines rose by Rmb6.3bn between January and September, to Rmb34.4bn; the mines laid off 422,000 workers in the first nine months, but provided subsidies to only 58% of those laid-off. By 2000, about 22,000 of the 75,000-odd pits run by township and village enterprises (TVEs) are earmarked for closure.

Listed companies report a More than half of the 810 Chinese companies listed on exchanges in Shanghai, poor first half Shenzhen and Hong Kong reported that their first-half earnings were down on the first half of 1997, according to the Asian Wall Street Journal. Nearly 10% of the 810 firms reported losses, nearly twice as many as the previous year. Many firms reported that profit, revenue and sales volume had fallen and attributed the poor results to cheap, smuggled imports. Despite the difficulties, many firms also said they were planning to expand capacity.

The biggest drag on earnings remains slack domestic demand caused largely by the huge lay-offs resulting from SOE reform. Increased job insecurity of those remaining in work, and the difficulties that some SOEs are having in paying wages, have further contributed to weak demand. Only a handful of companies said they expect the situation to change soon, despite government plans for heavy spending on infrastructure projects in the next three years. Instead, these companies will be pinning their hopes on improved export prospects and will be pressing the government to take the necessary steps—devaluation or the equivalent to help them achieve better export growth.

Steel and petrochemicals Performance in steel and petrochemicals was particularly disappointing. are in difficulties Yizheng Chemical Fibre Co, which is listed in both Shanghai and Hong Kong, posted a first-half net loss of Rmb183.6m ($22.1m) compared with a net profit of Rmb113.2m in the year-earlier period. Shanghai Petrochemical Co reported that net profit was down by 91% to Rmb27.3m. Ma’anshan Iron & Steel Co in China, listed in Hong Kong, did poorly, with a net profit downturn of 44% to just over Rmb9m.

The property market is Property companies are also performing badly. Gintian Industry (Group) Co, a poor major land developer in Shenzhen, lost Rmb35.9m ($4.3m) in the first half of 1998 after making Rmb13.8m in the first half of 1997. Shanghai Lujiazui Finance & Trade Zone Co reported a 25% fall in net profit to Rmb133.5m ($16.1m) and failed to sign any new contracts in the first six months of this year. Despite government plans to reform the housing market, a combination of massive oversupply and unaffordable prices mean that a revival in the property market is a distant prospect.

The automobile and air transport sectors are also in the doldrums. Jiangling Motors Corp, which has a joint venture with Ford Motors of the US, reported a net profit dip of 87% to Rmb3.7m ($445,783). FAW Car Co, the second-largest auto company, said core revenue fell by 30% to Rmb2bn. FAW produced only

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7,429 cars in the first half of this year, even though proceeds from its stock offering are being used to expand capacity to 90,000 units per year, from 30,000 units. Meanwhile, China Eastern Airlines reported a loss of Rmb360m as passenger volumes declined sharply.

Consumer goods record Industries that have been profitable in recent years, including alcohol and mixed results colour televisions, suffered reverses in the first half of 1998, according to a report in the Asian Wall Street Journal. Sichuan Changhong Electric Co, China’s largest television producer, said net profit fell by 32% to Rmb634m ($76.4m), while Anhui Gujing Distillery Co, a liquor producer, reported that its earnings had slipped by 44% to Rmb78m.

There are, of course, companies that are still performing well. One example is the refrigerator producer, Guangdong Kelon Electrical Holdings, a township venture, listed in Hong Kong, which posted a 20.4% increase in first-half profits to Rmb407m. The market for refrigerators in large cities is now saturated and is being dented by concerns about job security. Strong marketing efforts in small cities, aimed also at rural markets, are partly responsible for the first-half success.

Another local concern that is proving very successful is Huawei Technologies, a privately owned company that now has 8,000 workers and makes switches and other components for fixed and mobile phone networks. Profit is expected to be $25m in 1998 on sales of $1.5bn and the company is expanding. Such home-grown concerns present an increasingly powerful challenge to the large foreign multinationals such as Motorola that are trying to capture a share of the huge and rapidly growing telecoms market in China.

Shipyards are in trouble Among the strongest callers for devaluation, or some other emergency action, and aircraft disappoint is the shipbuilding industry, which has been hit hard by currency devaluation in Asia. Some of the largest shipyards have not had a single export order this year and domestic ship purchasers are now turning to overseas suppliers. Japan and South Korea are especially competitive. The tax rebate for ship exports has been raised to 14% from 9%, a concession which the sector sees as far too little. Plans have been announced to allow two comprehensive shipping licences to European companies. However, the terms offered to the European companies—P&O, Nedlloyd and Maersk—are regarded as less favourable than those granted to the two US lines that already have licences.

Weak demand from the domestic commercial airline sector lay behind a decision in August to abandon most of a plan to build 20 McDonnell Douglas MD-90 jets in China. Plans to build a jet in collaboration with Airbus Industries and Singapore Technologies have also run into difficulties. Aviation Industries of China (Avic), which is already planning to shed 150,000 or one-third of its workforce over the period to 2000, was to have been the Chinese partner in these ventures. In October it looked as though the planned co-operation with Airbus had been partly salvaged by an agreement that Avic would make wing parts for Airbus.

Reform of SOEs has Closure of moribund SOEs has slowed markedly since mid-1998, and the slowed but not completely government has ordered the banks—and local governments—to keep prod- stopped— uction going (even if the pools are only destined for the stockpile), for fear of the

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consequences of a rapid rise in unemployment. But the process of restructuring has not completely ceased. In October it was announced that the State Economic and Trade Commission plans to add 150 SOEs to those offering shares to the public in the next three years. Shares in some 200 of the 500 large SOEs have already been offered and the state spent close to Rmb200bn ($24.1bn) in restructuring SOEs in 1997. To restructure the SOEs in accordance with the ambitious plan of Mr Zhu would need a further Rmb600bn-800bn, according to official estimates. A report in the China Daily Business News had said that 6,000 large and medium-sized state enterprises were now reporting losses and that two-thirds would be merged or closed.

—including some The troubles that many Chinese enterprises are encountering may be fostering takeovers by foreign a flexible attitude towards foreign investors, at least in those areas where profits concerns are thin. Several deals announced in the last few months, involving foreign takeovers of Chinese concerns, have been notable for the speed with which they were concluded. In June the municipal government of Shanghai licensed an SOE to offer consulting services covering mergers and acquisitions and the company, Shanghai East Best International Assets and Equity Co, has many Western clients.

Privatisation and The Ministry of Railway, a powerful and inward-looking bureaucracy that has competition come to the been resistant to market-oriented change, is facing a shake-out that will lead to railways the shedding of 300,000 of its vast 3.4m workforce and a reorganisation of its operations into five companies. The ambitious target is to turn losses of Rmb4bn ($481.9m) in 1997 into break-even by 2000. The network is to be selectively opened to private operators; private freight delivery services are already allowed access to the network.

Agriculture

The role of agriculture is After the October CCP plenum, a document was released entitled Decision of the once more stressed Central Committee of the Chinese Communist Party (CCP) on Several Major Issues in Agriculture and Rural Work. Ten main conclusions were reached, as follows:

• the primacy of agriculture in the national economy was restated (“agriculture is the foundation of national economy”); investment in the sector should therefore be increased;

• the “basic economic system in which the major form of public ownership and other forms of ownership develop simultaneously” was reaffirmed, allowing for a considerable degree of state influence over agriculture;

• China should “grasp firm grain production” and develop “a diversified economy”;

• China should develop agriculture through science and education;

• China should facilitate construction of water conservation projects, speed up afforestation, protect farmland, forests and water resources, and control soil erosion, desertification and environmental pollution;

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 China 25

• township-run enterprises (or township and village enterprises—TVEs) should be further developed to absorb surplus rural labourers;

• practical measures should be taken to reduce farmers’ burdens; that is, local officials should refrain from excessive depredations of the rural economy— "more should be given and less taken from farmers";

• birth control should be “advocated in rural areas”, to raise the productivity of agriculture in the long term and ease pressure on resources;

• development of democratic politics at grass-roots levels in rural areas should be advanced, but with the leadership of party organisations; this measure is aimed at achieving a measure of local-level decision-making; and

• “equal attention should be paid to material civilisation and cultural and ethical progress in rural areas”.

This prescription for rural development contains nothing innovative. How- ever, its publication does indicate that the government is concerned about the slowdown of growth in food production in recent years. Output of grain per head rose from 316.6 kg in 1978, at the onset of economic reform, to 390.3 kg in 1984 as a result of the restoration of family farming in the early 1980s. Thereafter, the pace of improvement in agricultural output has slowed, while the rate of population has continued to increase; output of grain per head now fluctuates at around 400 kg.

High hopes are pinned on The summer grain harvest this year was affected by the severe flooding of the the autumn harvest Yangtze and other rivers and consequently fell by 11%, to only 98.5m tonnes. This promoted fears that the harvest for the whole year would be below the 492.5m tonnes collected in 1997, the second highest on record.

China: grain output per person (a) The autumn harvest typically makes up 70% of the national annual harvest, kg and efforts are being made to ensure that this year’s later crops are gathered in. 420 Work teams have been sent to Hunan, Hubei, Anhui, Jiangsu, Jiangxi, Sichuan

410 and Chongqing provinces. Around 182,000 tonnes of chemical fertilisers and 9.2m tonnes of seeds had been sent to the flood affected areas by the end of 400 August. This has helped to raise the area sown to autumn grain crops by 33,300 390 ha compared with the area sown 1997. 380 Even if the bigger autumn harvest does not make up the shortfall, Chinese 370 commentators are looking on the bright side. Pointing out that there are large 360 stockpiles of grain left over from previous bumper harvests which are expensive to maintain, they argued that releasing grain from the granaries would be 1991 92 93 94 95 96 97 beneficial. Such a move would also avert the need for large-scale grain imports. (a) Total grain output divided by year-end population. Source: State Statistical Bureau, China Statistical Yearbook. Meanwhile, world wheat prices were at their lowest for five years in September 1998, and it looked as though this would be a good time for China to secure imports at reasonable prices. There were rumours in October that China had bought at least 200,000 tonnes of wheat, possibly from the EU, and estimates of China’s imports of wheat in 1998/99 range from 3m tonnes to 7m tonnes. Total grain imports in 1997 were 4.2m tonnes, of which wheat imports accounted for 1.9m tonnes.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 26 China

The grain distribution In mid-October it was reported that $25.8bn had disappeared from state grain- network is in disarray purchase funds in the past six years. Between April 1992 and the end of March this year, state loans advanced to buy grain totalled Rmb543.1bn ($65.4bn), but grain agencies can only account for purchases and stocks valued at Rmb329.1bn. An audit conducted by the Ministry of Finance and the PBC discovered that more than Rmb80bn allocated for grain purchases had been diverted to hotel and luxury housing projects, stocks and futures trading or to purchases of cars and mobile phones.

Under the grain distribution system as currently configured, only state agencies have the right to buy and sell rice, corn, wheat and other grains. But for the last ten years, when state-set prices were artificially low, the state has turned a blind eye as farmers sold to private dealers who paid market prices. When market prices fell below state-set prices, owing to a run of bumper harvests in recent years, state purchase agencies sustained large losses, paying state-set prices for grain that they could not sell. Meanwhile, state grain officials used state funds for a host of other money-making schemes—or for their own enrichment.

Mr Zhu has tried to put a stop to the capital drain with sweeping reforms of the state-run grain system (2nd quarter 1998, pages 26-27). Key among the reforms announced in April 1998 is the removal of central government subsidies from provincial grain companies, making the companies responsible for their own costs. They also envisage the removal of private dealers and seek to reinforce the state monopoly and its control over pricing.

Cotton chaos The government plans to abolish purchasing price controls over cotton in 1999 and this is expected to reduce cotton prices sharply, encouraging domestic sourcing by the beleaguered textiles industry, which lost about Rmb8bn ($963.9m) in 1997.

The price control system has kept the domestic price at 10-20% above the international price and has encouraged imports, which reached a total of 800,000 tonnes last year. Bumper harvests at home have led to the accumula- tion of large stocks of around 3.4m tonnes. As a first step, state purchase prices were cut by 5-7% in April.

The floods of 1998 are not expected to make a large dent in the cotton harvest, which is estimated at around 4m tonnes. About 30% of Chinese cotton production comes from Xinjiang, which was not affected. Exports of 500,000 tonnes are targeted for 1998, compared with officially sanctioned imports of 200,000 tonnes, which will tend to depress world prices and exacerbate the gap between the domestic and international price.

Rural incomes are barely The dilemma posed by low domestic prices, or indeed low import prices, exac- growing erbates the difficulty of balancing the interests of urban industry and consumers, which require low input and food prices, with those of rural farmers. Traditionally, the Chinese state has squeezed the rural sector to provide cheap food and inputs for the privileged urban elite. The gap between rural and urban incomes narrowed in 1994-96 as a result of government policy, but has since remained static and has started to widen again this year: the average per head cumulative net income of urban residents for the first nine months of this year

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China: urban and rural incomes (a)

Urban, Rmb '000; left scale Rural, Rmb '000; left scale Disparity between urban and rural incomes (b); right scale 6 3.0

5 2.8

4 2.6

3 2.4

2 2.2

1 2.0

0 1990 91 92 93 94 95 96 97

(a) Annual net income per head of rural households and annual disposable income per head of urban households. (b) Urban income divided by rural income. Source: State Statistical Bureau, China Statistical Yearbook.

reached Rmb4,063 ($489.5), up by 6% year on year in real terms, while the average per head cash income of rural residents was Rmb1,427, up by only 1%. Although farmers’ ire is regarded as less threatening than the fury of the urban workforce, the government is worried about rural discontent, which is becoming more manifest. As well as population pressure on the land, China’s agricultural system suffers from a lack of competitiveness because of poor technology, absence of scale economies, environmental degradation and distortional signals from state pricing, among other problems.

Infrastructure and the environment

A nan-made disaster The Chinese government has admitted that the severe flooding that took place in the Yangtze valley and in the north-east of China in mid-1998 was at least partly man-made, being made much more severe by the effects of silting.

In the aftermath of the floods the authorities have decided to allow land reclaimed from Dongting Lake in Hunan province to return to the lake. In 1825 the lake covered an area of 6,000 sq km, but reclamation, particularly after 1958 under the influence of the Maoist policy of “priority to grain production”, has reduced the lake’s area to only 2,700 sq km. It has now been decided to return it to its 1949 size. Afforestation efforts are being stepped up and attempts will be made to curb the destruction of forest in Sichuan province in the upper reaches of the Yangtze river.

In 1996 the concept of “sustainable development” was enshrined in the policy goals to be met by 2010. Investment in the environment was targeted to rise to 1.6% of GDP from 0.7%. A white paper on the environment was issued and numerous laws were passed. In 1997 the law on water pollution was revised and a new law on noise pollution was tabled. The State Environmental Protec- tion Administration (SEPA) became a ministerial-level body and a Ministry of Land and Natural Resources was set up, merging the former Ministry of Geol- ogy and Natural Resources with other bodies responsible for land administration and surveying and mapping. In November 1997 the SEPA announced that Rmb180bn ($21.7bn) would be invested in the environment up to 2000.

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The Three Gorges goes on The disasters of this year have thrown into focus the neo-Maoist boldness of the enormous Three Gorges Dam project at Sandouping in Hubei province. This involves physical and human displacement on a huge scale—a modern equivalent of the hydraulic feats achieved by early Chinese emperors.

Questions about the environmental impact of the project have now become more pressing. The issue of silt levels is one of these; critics of the project argue that the dam and the river below it will become heavily silted soon after construction of the dam. There is also the massive human displacement and loss of cultural heritage. In addition, the more difficult international environment will make securing finance for the foreign-exchange part of the project a tall challenge for the government.

Infrastructure spending is As of the end of September, only about one-third of the Rmb100bn bond issue protracted— for infrastructure and flood rebuilding had been invested. Complicated procedures, rushed planning of projects and lack of land for construction have been given as reasons, which obliged the Ministry of Finance to cancel some of the funds originally allocated to these projects. The increased government spending was part of overall plans to invest $1.2trn over the next three years.

—as road-building speeds The Ministry of Communications has announced an accelerated programme of up road-building for the period from early October until the end of the year because only half of the targeted spending of Rmb180bn earmarked for road construction in 1998 has been spent. China aims to add 33,000 km of high- ways in 1998, including 1,560 km of expressways and 7,947 km of high-grade roads. The State Council recently added another Rmb20bn to road construction investment, which had already been increased to Rmb160bn from an initial figure of Rmb120bn.

The government plans to spend Rmb200bn on 601 existing and new urban infrastructure projects over the next two years to improve city facilities. The projects—two-thirds of which are already under construction—mainly cover waste-water treatment, solid waste treatment, water supply and drainage, roads, heating and coal-gas piping systems. The central government will subsi- dise the projects so that three-quarters are complete by the end of 1999. Of the recently issued Rmb100bn in bonds, about 35% will be spent on city infrastructure construction.

Low-cost housing will The official target of building 212m sq metres of lower-cost residential housing boost growth this year is regarded as being within reach. New completions are reported to have risen by 44.3% in the first seven months of 1998, with over 80% accounted for by residential housing. In late August it was decided that more than Rmb170bn should be deployed to construct the 212m sq metres of low- cost housing. The move is expected to boost GDP growth and to increase urban living space per head to 9 sq metres by the end of this year, up from 8.8 sq metres at the end of 1997. A total of 3.93 sq metres of new housing were completed in January-July, while another 11.23m sq metres were sold, 55% more than in the same period of 1997. Ministry of Construction data indicate that total investment in commercial housing rose by 15% in the first seven months of this year, with investment in residential housing surging by 22.2%.

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But the property market is severely depressed at the upper end of the cost spectrum, both for residential and commercial use.

Rural power projects A total of Rmb136.8bn ($16.5bn) is slated to be spent on the building and upgrading of rural power grids in the next three years, as part of a project to cut rural power prices to the same level as urban prices over the next five years. In one north-eastern village, for example, power cost Rmb5/kwh in late 1998, more than ten times the average price in urban areas. The rural power management system is to be improved as well; county-level power firms will be turned into shareholding companies affiliated to provincial power firms. Township power stations will be reformed as integral units of county-level companies.

Money and finance

M2 growth accelerates— Monetary policy is being loosened as part of the current attempt to boost growth. The broad measure of money supply, M2, rose to Rmb10trn ($1.2trn) at the end of September 1998, up by 16% year on year. M1 increased by only 13%, to Rmb3.65trn, and M0, cash in circulation, grew by 12% to Rmb1trn, according to press reports. M2 growth was only 14% year on year at the end of June (3rd quarter 1998, page 21).

—as lending rises— The value of loans extended by all financial institutions rose by 17.1% year on year in September, to Rmb8.3trn ($1trn). This growth rate, identical in nominal terms with that recorded in September 1997 (4th quarter 1997, page 20), reflects the instructions issued in mid-1998 that banks were to increase their overall lending to the state sector, to SMEs for infrastructure, and for exporters.

China: financial statistics (Rmb bn) Sep 1997 1998 % change Personal savings 4,414 5,181 17.4 Enterprise deposits 2,688 3,086 14.8 Loans 7,056 8,264 17.1 Source: Press reports.

—especially for investment Investment, in particular fixed investment, has accelerated (see The economy). In September the State Development Bank (SDB) announced a second increase in its planned lending for 1998, to more than Rmb150bn ($18.1bn). The increased loans will be used mainly as matching funds for infrastructure projects financed by money raised through bond issues by the Ministry of Finance. The SDB will issue a further Rmb20bn-30bn in bonds in the remaining months of this year, in addition to the Rmb71bn issued in the first half, to help finance its lending.

Meanwhile, under instruction from the PBC, the four major state-owned commercial banks have set up offices exclusively for the arranging of loans to SMEs. The largest of the four, the Industrial and Commercial Bank of China (ICBC), has announced that it has lent Rmb30bn this year to such enterprises. Accord- ing to the New China News Agency, Xinhua, there are more than 10m registered SMEs, accounting for 60% industrial output and 40% of profit.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 30 China

In late October it was reported that the ICBC’s total loans had reached Rmb2.01trn ($252bn) at the end of September, up by Rmb183.8bn from the beginning of the year. Its lending has been focused on selected large-sized state enterprises and infrastructure projects financed by the government’s recent Rmb100bn bond issue. The second-largest bank, China Construction Bank, has reported that it lent Rmb528.3bn in the nine months to September, taking outstanding loans to Rmb114.1bn since the beginning of the year.

Savings rates are also Personal savings have accounted for a large share—around two-thirds—of gross holding up— domestic savings during the reform era. The fundamental stability of the financial system therefore depends on the continued willingness of the public to place their savings in the banks, which account for around 75% of personal savings.

By some measures the state-owned banks are technically insolvent. In reality, they are little more than conduits for policy lending and repositories of savings. Conservative estimates of their non-performing loans (NPLs) in 1997 put them at around 20%. The true figure is doubtless much higher, not least because of the lending splurge which began in mid-1998. Policy must therefore concentrate on maintaining the faith of the public in the banking sector. This has been done successfully during the reform era, generally by ensuring that the banks pay positive interest rates, even when interest payments have been made by the state. The Chinese banking system could not withstand a serious loss of confidence in one or more of the large state banks, which would not be able to fund a serious run on deposits. This is one reason why the government is so anxious to plug the leakage of foreign currency and to underpin the stability of the renminbi. Thus far, helped by the extreme volatility of most other forms of saving, especially on the stockmarket, public faith in the banking sector has been maintained.

Improving financial sector regulation

Steps have also been taken to improve regulation in other areas of the financial sector.

• It has been confirmed that the streamlined subnational branches of the People’s Bank of China (PBC, the central bank—3rd quarter 1998, page 26 and 1st quarter 1998, page 27) will be located in nine cities: Shenyang, Tianjin, Jinan, Nanjing, Shanghai, Guangzhou, Wuhan, Chengdu and Xi’an. The streamlined central bank will be less susceptible to pressure from provincial and local governments in its implementation of monetary policy and supervision of the commercial banking sector.

• Supervision of the insurance and securities markets, previously the responsibility of the PBC, is to be undertaken by separate bodies. The China Securities Regulatory Commission has authority over stock trading, and the recently established China Insurance Regulatory Commission will manage the country’s insurance companies.

• A draft securities law, aimed at harmonising the practices of the two stock exchanges and providing a more transparent regulatory framework, has been drawn up, but not yet published.

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—but renminbi interest The need to maintain public confidence in the banks means that although rates cannot come down another cut in interest rates would be of immediate assistance to beleaguered yet SOEs and would also help to stimulate the economy, lower rates are not a realistic prospect at the moment. Lower rates would diminish public confidence in the renminbi exchange rate. In late October the PBC told commercial banks to cut dollar interest rates by half a percentage point to bring the rate on one-year fixed deposits of individuals to 3.75% and two-year deposits to 4.25%. The rate for financial institutions and FIEs on a one-year dollar deposit has been cut from 4.625% to 4.125%, compared with 4.77% on a one-year renminbi deposit. Dollar rates were last cut in China on October 27th.

There are moves to Along with other reforms of the financial sector (see box on page 30), the improve the regulatory government is attempting to overhaul the commodities futures trading ind- environment ustry and also to rationalise and stiffen the criteria that companies seeking to list on the country’s two stock exchanges must meet.

By the end of January 1999 it is intended that the number of official commodity exchanges will be reduced from 14 to 3: Dalian; Shanghai and Zhengzhou. They will be regulated by the China Securities Regulatory Commission (CSRC) under the State Council and all but 12 of the 25 commodities now traded will have been removed. This move is part of the effort to reduce risk and volatility in the markets, of which hapless private investors often fall foul. Margin

Tightening foreign-exchange regulations

Fears on the part of the Chinese authorities that foreign • A national review will take place, item by item, of all exchange is escaping the country, thereby adding to potential foreign-exchange purchase and loan approvals issued in pressure on the renminbi exchange rate, have caused a flurry 1998. of regulations aimed at stemming the outflows. • Strict prohibition of commodity trade, financial • Chinese companies were ordered to cease hoarding derivatives or guaranteed rates of return to foreign investors foreign exchange abroad and to comply, by October 1st, of any kind as a disguised form of foreign borrowing. with regulations stipulating that foreign-exchange earnings be remitted through the Chinese banking system. The • Local branches of the designated foreign-exchange banks deadline was extended twice, to October 7th and then to are prohibited from settling, selling or paying out foreign the end of the month. exchange for capital-account transactions. All business of that kind previously handled by them was to be passed over • Early repayment of foreign debt by Chinese concerns has to higher level branches of the banks by the end of been forbidden unless the loan agreement provides for it and September. the State Administration for Foreign Exchange (SAFE) has granted permission—a most unlikely eventuality. • All banks to conduct an internal review of their procedures for handling foreign-exchange debt payments • Circular No 50, issued by SAFE, has forbidden before July 31st and to have reported to SAFE on them by foreign-invested enterprises (FIEs) from selling renminbi for the end of September. dollars to prepay dollar debt. It also prohibits the acceptance by domestic banks of foreign bank guarantees or renminbi • The use of swap centres by FIEs to buy and sell foreign loans to FIEs. exchange, permitted since 1980, is to cease from December 1st 1998. According to the Chinese authorities, this reflects • Extensive documentation must be submitted to SAFE by the greater maturity of the banking system, which has been all borrowers, including legal verification of the purpose of handling most domestic foreign-exchange business since short-term borrowings, including by FIEs. 1996.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 32 China

requirements for most commodities will be raised and the remaining 11 exchanges will either be closed or restricted to acting as satellite trading centres for the three officially recognised centres.

In a further move aimed at strengthening regulation, new rules governing listing requirements have taken effect. All entities wishing to list on the stock exchanges must be registered as shareholding concerns with no more than ten legal shareholders and management must by shared evenly by state-owned parent companies and their listed units. All non-profit operations must be spun off before listing. About 40 of the 800 companies listed in 1997 posted losses and loss-making companies are now given special-treatment status which put tighter limits on daily price movements.

The two stockmarkets are Class A shares, which are only available to domestic investors, have been hit by in the doldrums general economic gloom and by early October had fallen by about 7%. B shares, which only foreigners are allowed to buy but which are sought by domestic investors because they tend to be cheaper, are a casualty of the new restrictions on foreign exchange (see box on page 30). There are 106 B shares and by mid-October the Shanghai and Shenzhan B share markets had fallen by around 40%.

Curbing the activities In November it was announced that rules are being drafted to curb the securities of ITICs operations of International Trust and Investment Corporations (ITICs). The new regulatory framework is intended to reduce the exposure of the heavily indebted and undercapitalised trust and investment firms, to domestic stockmarkets. It comes as part of a broader crackdown on the speculative investment practices of ITICs in general and underlines fears that problems with ITICs could threaten the economy. This follows the closure in October of the Guangdong ITIC (GITIC), when it could not pay foreign debts of some $2bn. This was the third ITIC closure in the last 18 months. The overseas liabilities of ITICs are estimated at around $10bn, but thousands of SOEs and government departments have ITIC deposit accounts.

Sponsored by government agencies and state banks, ITICs were established in the mid-1980s to make commercial investments. Many are managed by former government officials and have had to offer interest rates above levels mandated by the PBC to pull in corporate deposits, which are the only ones they can accept. ITICs invested heavily in property. The slump in the property market is encouraging them to depend on securities, in which they speculate, and the authorities are worried that this speculation distorts the markets and increases their volatility.

Regulators are stressing that ITICs have only a fraction of the total deposits in China, but auditors are trying to establish their current status. One banker, quoted in the press, has suggested that they have about Rmb300bn ($36.1bn) in assets, of which a large part are not recoverable. The CSRC is reported to be arguing that they should be dealt with swiftly and that they should immed- iately be banned from lead underwriting Class A-share offerings. It is intended that ITICs will be gradually rationalised, with their number falling from 240 to around 40 through mergers and closures.

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Corruption, takeovers and A review of all the country’s 90 lawful securities companies started in mid- new funds 1998, when the CSRC took over. In November it was revealed that three former senior officials at a small securities brokerage firm in Liaoning had been accused of misusing some Rmb500m ($60.2m) in company funds. They have all confessed and face court proceedings. This is one of the largest cases of securities-market corruption ever made public in China and the decision to announce the arrest is part of an attempt to reassure the Chinese public that the authorities are moving to clean up malpractice on the stockmarkets.

Two privately held Chinese firms have bought controlling stakes in SOEs listed on the Shenzhen Stock Exchange. This is one of the first occasions on which private companies have been allowed to take over listed SOEs. In one trans- action, Sichuan Santong Enterprise Co has paid Rmb69m for a 15% stake in Sichuan Jinlu Group Co, a maker of chemical products, becoming its largest single shareholder. In the second, Guangcai Industrial Investment Co bought a 53% stake in a real-estate concern, Shenzhen Nanyou Property Development Co, for Rmb216m. Both Sichuan Santong, a building-materials concern, and Guangcai Industrial, an investment company, are privately held.

Calls are being made for the creation of open-end investment funds to develop the fund industry. The existing closed-end funds are regarded by some as too limited in size and investment scope. Small closed-end funds have been in existence for several years and five were established in early 1998. Five more are expected to be launched this year, all for domestic investors. Heavy index declines earlier this year led four of the five funds to announce that they had lost some of their initial capitalisation of Rmb2bn each.

Day-to-day problems with Foreign-invested enterprises (FIEs), whose revenue is primarily in renmimbi, foreign exchange are now faced with funding difficulties; they are fearful of borrowing in dollars lest the renminbi should devalue, but their access to renminbi loans is now problematic. There is, as often, a great deal of confusion about which rules apply: Circular No 50 (see box on page 31) was issued in August, but was only sent to Chinese banks.

Meanwhile, FIEs face mounting difficulties. Local banks are forbidden from lending to Chinese companies on the basis of foreign bank guarantees or letters of credit and FIEs are now finding that the foreign bank letters of credit that they present as security for working capital in borrowing from Chinese banks are subject to close scrutiny. They are also finding it hard to be allowed to pay in advance for imports in foreign exchange and foreign companies are not generally allowed to accept payment for their exports to China in renminbi.

Concerns about the The sudden closure of GITIC by the PBC because of its inability to meet its viability of debtors— debts in early October sent a shockwave through the foreign lending commu- nity. GITIC’s outstanding foreign liabilities and guarantees are estimated at $2bn. Because of its size, GITIC’s closure was not seen just as a matter of good housekeeping, as has been the case with previous closures of financial institutions in China, notably Hainan Development Bank. Rather, it was seen as indicative of the over-indebted and illiquid state of ITICs in general—including the other five regional ITICs—and of lax supervision by the financial authorities, especially local government-level authorities.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 34 China

The subsequent default by a Guangzhou ITIC (GZITIC) on payments due on a $30m loan only served to heighten anxieties about the ability of Chinese financial institutions to service their foreign debts. GZITIC’s missed payment was followed by another Guangdong ITIC defaulting and by the an- nouncement by the Fujian ITIC (FITIC) that it was considering selling its stake in the local airline in order to raise cash.

—lead foreigners’ credit to Although the amounts involved in the defaulting loans are not large, foreign dry up banks have been rattled by the PBC’s pledge that it would give priority to honouring those foreign obligations of GITIC that were backed by the appro- priate official documentation. The PBC has also said that creditors should approach the Guangdong provincial government, rather than the centre. Much of the short-term lending to ITICs, and other borrowers, was not registered, as regulations stipulate that it should be, with the State Administration for Foreign Exchange (SAFE).

Banks are concerned that millions of loans which were extended without due diligence in times of plenty may now turn sour, and have stopped new lending and are calling in loans to ITICs, compounding their liquidity problems. The PBC has been trying to curb unofficial and unregistered foreign borrowing, which is common at the level of local governments, for some time and has turned the tables rather neatly with this move, with the burden of regulation and prudential investigation being put firmly on the lenders.

—with serious But China needs foreign funds to pay for imported components for huge infra- implications for some structure projects, both now and in the future, and it needs to be able to roll over projects its official short-term debt without undue difficulty or expense. The China Three Gorges Corporation, for example, is looking for ways of raising several billion dollars overseas. Previously, it has borrowed only to fund imports of China: export value growth % change, year on year equipment, but it is now considering an international bond issue or even a share 40 listing in New York and Hong Kong. Such plans would have been difficult to fulfil in the current international economic climate, without the extra problems 30 thrown up by ITICs and other non-bank financial institutions in China. 20 Realising this, the governor of the PBC, Dai Xianglong, made reassuring noises 10 about ITICs in early November, saying that only a “tiny few” would be closed

0 down. He also mentioned the possibility of recapitalising some of them, a process that is proceeding with the state banks. China is presenting the prob- -10 lem loans, foreign and domestic, of the non-bank financial sector as an issue -20 that is well under control, but is warning lenders to take due care and not to Jan . .Apr. . Jul . .Oct. . Jan . .Apr. . Jul . .Oct 1997 98 depend on government bail-outs. Sources: General Administration of Customs of the People's Republic of China, China Customs Statistics; press reports. Foreign trade and payments

Exports are losing In dollar value terms, the growth of exports has slowed markedly, recording momentum only 3.9% in the first nine months of 1998 year on year, compared with 24% in the same period of 1997. In September alone, the year-on-year value of exports fell by 6.7%; in October exports fell by 17.3%. The month-by-month trend in export value suggests that exports for the year as a whole may well be less than in 1997. Import growth, meanwhile, remains sluggish, growing by

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only 0.4% in dollar terms in the first nine months. The terms of trade appear to have been moving against China, with fairly steep cuts in export prices being made to retain market share in a number of areas.

China: trade, Jan-Sep 1998 % change, $ bn year on year Exports 134.1 3.9 Imports –98.8 0.4 Balance 35.3 13.9 Source: State Statistical Bureau.

—thanks to the Asian crisis Data are available for the destination of trade in the first eight months of 1998. They show clearly that the Asian crisis has eaten deeply into China’s export markets. Exports to most Asian markets were severely curtailed; those to Europe, by contrast, were buoyant, while the all-important US market continued to be strong. A particular effort is being made to increase trade with Africa and Latin America, and exports to each of these regions rose strongly, but made up an insignificant share of the total.

China: direction by trade, Jan-Aug 1998

Exports Imports $ bn % changea % of total $ bn % changea % of total Balance Hong Kong 27.2 –0.2 22.9 4.2 –3.1 4.8 23.0 Taiwan 2.4 20.5 2.0 10.6 5.4 12.1 –8.2 Singapore 2.4 –9.2 2.0 2.7 –3.5 3.1 –0.3 Indonesia 0.6 –44.4 0.5 1.6 –6.7 1.8 –1.0 Malaysia 1.0 –15.4 0.8 1.6 4.9 1.8 –0.6 South Korea 3.9 –32.7 3.3 9.6 5.9 11.0 –5.7 Japan 18.6 –5.8 15.7 17.5 –1.2 20.0 1.1 UK 2.9 29.5 2.4 1.2 2.0 1.4 1.7 Germany 4.7 17.8 4.0 4.1 16.1 4.7 0.6 France 1.8 28.9 1.5 1.4 –8.2 1.6 0.4 Italy 1.7 19.5 1.4 1.4 –4.9 1.6 0.3 Netherlands 3.3 22.9 2.8 0.5 –15.3 0.6 2.8 Russia 1.3 29.5 1.1 2.4 –13.6 2.7 –1.1 Canada 1.3 12.3 1.1 1.4 10.4 1.6 –0.1 US 23.6 17.4 19.9 10.3 2.3 11.8 13.3 Australia 1.4 16.6 1.2 1.6 –18.4 1.8 –0.2 Latin America 3.5 28.4 3.0 1.7 –22.4 1.9 1.8 Africa 2.7 41.6 2.3 1.0 –35.4 1.1 1.7 Total 118.6 8.6 100.0 87.3 1.5 100.0 31.3 a Year on year.

Source: Economic Information & Agency, Hong Kong, China’s Customs Statistics.

The dollar value of imports was restrained by volume growth of virtually zero in many categories, but also by a large inflow of some goods from countries where depreciation has conferred large competitiveness gains, such as South Korea, and also Japan. Imports from Europe and the US were generally sluggish, with the exception of Germany.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 36 China

Exports of garments are During the eight months to August, exports of the mainstay sector, garments still robust and clothing accessories, were rather sluggish, growing by 6.2% in value terms, but still accounting for 17.3% of total exports. Exports of consumer electronics and data-processing products were fairly buoyant. Exports of raw materials— coal, crude oil and of steel products—were down in volume terms.

China: main exports and imports, Jan-Aug 1998

Value Volume $ m % changea % of total % changea Exports Aquatic products 1,023 –7.1 0.9 6.2 Vegetables 882 –3.8 0.7 10.4 Coal 608 –12.7 0.5 –3.2 Crude oil 1,120 –39.8 0.9 –15.6 Petroleum 525 –32.9 0.4 –13.5 Medical & pharmaceutical products 1,094 13.0 0.9 8.1 Textiles & yarn 8,538 –4.3 7.2 n/a Garments & clothing accessories 20,545 6.2 17.3 n/a Steel products 1,118 –4.8 0.9 –20.4 Sound recording apparatus 1,714 7.3 1.4 5.0 Parts of telecommunications equipments 799 15.5 7.3 8.1 Switching apparatus 748 15.5 0.6 n/a Furniture 1,403 25.1 1.2 n/a Travel goods, handbags, etc 2,172 2.6 1.8 n/a Footwear & parts 5,716 2.6 4.8 n/a Plastic articles 2,562 20.8 2.2 18.8 Toys 3,117 10.9 2.6 n/a Total 118,646 5.5 100.0 n/a Imports Cereals & flour 496 –12.0 0.6 –3.7 Edible oils 626 –36.9 0.7 –43.8 Cotton 288 –72.2 0.3 –71 Iron ore 933 –2.6 1.1 0.4 Crude oil 2,665 –21.4 3.1 1.1 Fertilisers 1,676 –24.2 1.9 –21.7 Polymers of styrene 1,495 3.3 11.6 1.1 Paper & paperboard 1,960 7.7 2.2 3.0 Synthetic textiles 1,488 –10.8 1.7 –3.9 Steel products 4,013 –2 4.6 –11.6 Copper 1,211 18.2 1.4 26.8 Aluminium 814 8.4 0.9 4.4 Textile machinery 821 –9.2 0.9 n/a Automatic data-processing machines 794 29.8 0.9 41.2 Machine tools 917 8 1.1 –8.4 Parts of automatic data-processing machines 2,190 33.9 2.5 –6.8 Diodes, transistors, etc 821 29.1 0.9 20.2 Mechanical handling equipment 689 –10.3 0.8 n/a Telecommunications parts 1,227 10.8 1.4 –13.2 Switching apparatus 1,107 2.6 1.3 n/a Vehicles & chassis 495 25.9 0.6 –10.3 Auto parts 459 –18.8 0.5 n/a Aircraft 1,072 –9.3 1.2 –23.6 Electronic integrated circuits 2,605 23.7 3.0 22.8 Total 87,265 0.4 100.0 – a Year on year.

Source: Economic Information & Agency, Hong Kong, China’s Customs Statistics.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 China 37

Imports growth slows Import growth has, meanwhile, slowed further. In value terms almost all major further categories registered falls in the first eight months of 1998, year on year. The exceptions were copper, automatic data-processing machines, diodes and transistors, all inputs to the export trade.

Prices for most imports were down in dollar terms, reflecting currency movements as well as demand factors. But, as noted, the terms of trade deteriorated as Chinese exporters reduced their prices to keep markets.

The share of SOEs is falling In 1997 SOEs accounted for 56.2% of China’s exports and 42.8% of its imports. In the first six months of 1998, as the problems of SOEs worsened, their share had fallen to 52.4% of exports and 40.7% of imports. Among FIEs, those which are wholly foreign-owned are still experiencing rapid growth, registering a strong surplus in the first half of the year, while the whole FIE sector, which is normally in deficit as a result of the imports associated with strong inflows of investment goods, registered a very small surplus.

China: trade by type of enterprise, Jan-Jun 1998

ExportsImports $ m % changea % of total $ m % changea % of total SOEs 47,114 3.1 52.4 26,228 –3.2 40.7 FIEs 36,888 12.0 41.0 36,474 6.4 56.6 of which: contractual joint ventures 4,144 2.4 4.6 4,203 7.0 6.5 equity joint ventures 16,305 6.4 18.1 17,623 –2.1 27.4 Foreign owned 16,438 21.0 18.3 14,647 19.0 22.7 Collective 2,643 38.1 2.9 1,132 13.9 1.8 Total incl others 89,975 7.6 100.0 64,424 2.2 100.0 a Year on year.

Source: Economic Information & Agency, Hong Kong, China’s Customs Statistics.

Smuggling is rampant Smuggling has always played a role in Chinese trade flows and is difficult to police, given the relatively porous border between Guangdong province and Hong Kong. In mid-1998 the government started to mount a crackdown on smuggling activities, including by the army, which have been depressing domestic prices. Cheap consumer goods, and inputs such as steel and oil, have been competing with Chinese products and further denting the profits of SOEs.

No dependable estimate of the value of smuggling has been made, but anecdotal evidence suggests that it is a widespread phenomenon. There is good reason to believe that official trade data understate trade flows. Chinese exports, especially the exports of FIEs along the eastern seaboard, have a fairly high import content. It is questionable whether export growth can be sustained with import growth so sluggish. There is evidence that exports are being over-reported in order to claim higher VAT rebates. It is also highly likely that imports are being under-recorded, to avoid duties and to evade foreign-exchange controls (an argument which might also apply to exports), and to avoid other trade barriers. One sign of an increase in illegal importation in 1998 is the fact that foreign-exchange reserves have not risen much above $143bn, despite the large official trade surplus.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 38 China

Tightening the trade Those who argue that China should devalue, or at least those who believe that regime— Western trade partners are mistaken in their praise for its restraint on this front, can point to changes in the trade regime that are pushing China further away from compliance with World Trade Organisation (WTO) norms.

Meanwhile, China is seeking to boost exports in various ways. Rates of value- added tax (VAT) rebate on 12 items—seven machinery and electronics products and five light industry products—were raised to 11% from 9% in the first half of the year and the rebate on base metals has also been raised by the same amount, with effect from September. These moves are regarded as unacceptable subsidies by the US government. Funds available for export credits have been increased, and the banks are being enjoined to support the exports of SMEs. Private companies with registered capital and net assets both exceeding Rmb8.5m ($1m) are to be allowed to engage in foreign trade.

Those SOEs whose domestic markets have been hit by cheap imports are the most prominent advocates of devaluation. The government’s response has been indirect. It has cracked down on smuggling and put a floor under prices for various industrial products, including passenger cars. It has also made it difficult, through the strict enforcement of a raft of previously ignored regulations covering foreign-exchange transactions (see box on page 31), for companies, foreign invested as well as domestic, in China to access the foreign exchange needed to pay for imports. This move is not intended to block imports per se, but is part of a campaign aimed at preventing the illegal acquis- ition and hoarding of foreign exchange that has been putting pressure on the exchange rate, as companies have sought to hold foreign currency in anticip- ation of a devaluation of the renminbi.

—makes WTO The effect of these manoeuvres, in the context of a rising trade surplus, espe- membership a more cially with the US, is to make China’s foreign trade and investment regime less distant prospect compatible with entry into the WTO. China still takes the public position that it is ready for WTO membership, although it must be clear that this stance has become increasingly problematic. Friction with trading partners—the EU and the US—continues; China is furious at emergency US restrictions on its exports packed in untreated wooden crate, announced in mid-September and due to take effect within 90 days, which would affect between one-third and one-half of Chinese shipments to the US. The US and the EU regard China’s market opening in the services sectors as less than adequate.

Trade relations with the EU are usually less prickly and the EU has shown a more flexible attitude. In May this year, the EU decided to adjust its anti-dumping policy and removed China from its list of non-market economy nations. The Council of Ministers’ meeting in June endorsed a document calling for the establishment of a fully fledged partnership with China, and in early October the EU announced a decision not to levy anti-dumping duties on unbleached cotton imported from five countries, including China.

Inflows of FDI hold up— In the first nine months of 1998 actual inflows of foreign direct investment (FDI) totalled $31.4bn, almost the same level as in the first nine months of 1997. Contracted FDI rose by 2.5%, to $35.8bn. The continued strength of FDI is unusual, in view of the Asian crisis. Hong Kong, Japan and South Korea

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 China 39

accounted for 68.5% of actual cumulative FDI inflows in 1985-96, the US for 7.9%, and no European country for more than 2%. Data on the origin of the FDI for the first nine months of this year are not available, but it must be presumed that China’s dependence on the US and European markets for exports was duplicated in inflows of foreign investment.

—despite a more Once again, China seems to be operating a contradictory attitude towards the restrictive attitude— issue of foreign investment. Among recent decisions and initiatives are the following.

• New restrictions on investment in China by foreign retail companies. In early November it was announced that retail sector FIEs must comply with 1992 regulations that stipulate that Chinese partners must hold at least half of any retailing joint venture (JV). This means that to increase investment the Chinese partner will need to put up more equity. In practice, local-level governments have allowed 100% foreign ownership. There are 277 such ventures and some foreign retailers are expected to pull out. Influenced in part by the difficulties that such inconsistencies herald, Marks and Spencer, the UK retailer, has decided not to go ahead with plans to open its first store on the mainland and has closed its Shanghai office. Foreign life insurance companies are also limited to a 50% stake in any JV.

• Telecommunications companies have been ordered to discriminate, where possible, in favour of locally made mobile telephony equipment. It is not clear whether products locally made by foreign manufacturers will be discriminated against. Nokia, Motorola, Alcatel, Nortel and Ericsson are among the 46 companies that have invested in China, which is the fastest growing telecoms market in the world. The newly appointed minister responsible for the Ministry of Information Industry, Wu Jichuan, has also charged that some of the foreign companies involved in ventures with China Unicom have broken the law by profiting from installation fees rather than operation of services.

—but not everywhere By contrast, it was announced in September that more foreign investment will be actively sought in the construction sector and in shipping, especially port construction. The Ministry of Construction recently announced that 39,000 projects with foreign funding had been agreed up to the end of 1997, with pledged investment of over $160bn. According to the Ministry of Communi- cations, 125 Sino-foreign shipping companies and 13 solely foreign-funded shipping firms had been set up in China by the end of June this year, while overseas shippers had opened 324 offices in the country and China had signed ocean-going shipping agreements with 52 foreign countries, and river shipping pacts with four. Loans from the World Bank, the Asian Development Bank and foreign governments have been used on port projects.

China allows foreign companies to lease local ports, build their own berths and facilities on leased industrial land, and operate international liner business between China’s open ports and foreign ports. Foreign consortiums have invested in port projects in Shanghai, Shenzhen, Dalian, Tianjin and Zhuhai.

Agriculture is another area for which foreign investment will be actively sought, especially in central and western China; preferential policies are being

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 40 China

drawn up. Agricultural projects were stressed at a seminar promoting central and western China held in Changsha, Hunan province in October. Also at the fair, a vice-minister of foreign trade and economic co-operation, Sui Guangxiang, said that FIEs will gradually receive national treatment, a remark that flies in the face of recent moves in the retail and telecoms sectors. A vice-president of the PBC, Liu Mingkang, has also held out the prospect of greater access to renminbi business for foreign financial sector companies and equal tax treatment.

Counting foreign debt Official data for foreign debt as of the end of June 1998 have now been published. As the table below shows, the official measure of foreign debt was $138bn at the end of June, representing only 14.4% of GDP. Of this total, short-term debt was only 13%. The foreign debt of FIEs, at $43bn, was larger than the debt of SOEs, and of debt borrowed by enterprises and projects with State Council approval. FIE external debt also exceeded that of the foreign debt of financial institutions, which, following the financial difficulties of ITICs (see Money and finance), is presently causing concern.

It is widely believed that the official figures understate China’s real external obligations. The debt of so-called shell companies in Hong Kong, which are owned by Chinese entities and are used as a conduit for foreign capital inflows, is excluded. An unknown proportion of the large inflows of FDI is also believed to be disguised debt. Local governments have been forbidden from borrowing abroad for several years and it is suspected, not least by the SAFE, that local governments have been evading controls by recording as FDI inflows of foreign currency that are in fact debt. Guaranteed toll-road projects are regarded as more properly belonging to debt because they are structures so that interest, profits and capital are all recovered by the foreign investor. There are also significant amounts of lending, much of which are short-term, that have not been registered with the SAFE and therefore do not appear in the official data.

While the shell companies’ debt is measurable, calculating the debt compo- nent of FDI would be a complicated task. An estimate of around $200bn for total external liabilities including the shell companies’ debt is current and seems reasonable.

The fact that foreign debt is substantially larger than official figures suggest would help to explain why the minister of finance, Xiang Huaicheng, cited debt-service considerations as a reason why China wished to avoid devaluation at the IMF meeting in Washington in October this year.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 China 41

China: foreign debt, end-Jun 1998 % change $ bn on end 1997 State council 37.99 5.6 SOEs 14.53 9.3 FIEs 43.24 15.7 Financial institutions 40.46 –4.9 Others 1.74 –2.8 Total 137.96 5.3 Medium & long term 120.00 6.3 Short term 17.96 –0.9 Source: New China News Agency.

Growth in tourism In 1997 revenue from the tourism industry rose by 18%, to $12bn, but so far revenue is slowing this year the Asian crisis has curbed the growth of tourism. In the first nine months revenue from tourism was up by only 3.2%, at $9.2bn.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 42 Mongolia

Mongolia

Political structure

Official name Mongolia

Form of state Republic

The executive Cabinet made up of members of the ruling Democratic Coalition, comprising the Mongolian National Democratic Party (MNDP) and the Mongolian Social Democratic Party (MSDP)

Head of state The president, Natsagiin Bagabandi

National legislature A single-chamber parliament, the State Great Khural, which has 76 members, of whom 50 are members of the Democratic Coalition

National elections June 30th 1996 (parliament) and May 18th 1997 (presidential); next elections due by June 2000 (parliamentary) and June 2001 (presidential)

Main political organisations Democratic Coalition: Mongolian National Democratic Party (MNDP) and Mongolian Social Democratic Party (MSDP); opposition: Mongolian People’s Revolutionary Party (MPRP)

Chief members of the cabinet Prime minister Janlaviin Narantsatsralt

Key ministersa Agriculture & industry Norovyn Altankhuyag Defence Rinchensanbuugiin Odonbaatar Education Chimediin Saikhanbileg Finance Bat-Erdeniin Batbayar Foreign relations Rinchinnyamyn Amarjargal Health & social security Sharavjamtsyn Batbayar Infrastructure development vacant Law Sarigiin Batchuluun Nature & the environment Sangajavyn Bayartsogt

Central bank governor Jigjidiin Unenbat

a Members of the outgoing cabinet of the former prime minister, Tsakhiagiin Elbegdorj. At the time of writing, the cabinet of the new prime minister, Janlaviin Narantsatsralt had still to be appointed.

Economic structure

Latest available figures

Economic indicators 1993 1994 1995 1996 1997 GDP at current prices (Tg bn) 166,219 283,263 429,207 586,529 737,039 Real GDP growth (%) –3.0 2.3 6.3 2.4 3.3 Consumer price inflation (av; %) 268.4 87.6 60.5 45.8 44.6 Population (av; m) 2.22 2.23 2.29 2.33 2.37a Exports fob ($ m) 382.6 356.1 473.3 424.3 418.0 Imports cif ($ m) 379.0 258.4 415.3 450.9 443.4 Current-account balance ($ m) 31.1 37.3 27.0 –38.3 –59.5 Reserves excl gold ($ m) 59.7 81.4 117.0 107.4 175.7 Total external debt ($ m) 373.6 447.2 512.4 524.4 n/a Exchange rate (av; Tg:$) 396.5 412.7 448.6 548.4 790.0

November 16th 1998 Tg875b:$1

% of % of Origins of gross domestic product 1997 total Components of gross domestic expenditure 1997 total Agriculture 34.6 Private consumption 64.9 Industry 23.9 Government consumption 15.8 Mining, manufacturing & electricity, gas & water 20.4 Gross fixed capital formation 23.0 Construction 3.4 Increase in stocks 0.0 Trade 21.8 Net exports of goods & services 0.9 Transport & communications 5.4 Statistical discrepancy –4.6 Finance, public administration & others 14.3 Total 100.0 GDP 100.0

Principal exports 1997a $ m Principal imports 1997a $ m Fuels, minerals & metals 233.8 Machinery & electrical equipment 118.5 Textiles & garments 94.2 Oil & petroleum products 90.8 Live animals & animal products 17

Main destinations of exports 1997 % of total Main origins of imports 1997 % of total Switzerland 31.5 Russia 36.2 China 21.7 China 14.3 South Korea 10.5 Japan 7.6 Russian Federation 9.5 US 6.6 Japan 8.8 South Korea 4.5 a EIU estimate. b Central bank figure quoted in press report.

Outlook for 1999-2000

The political crisis The political crisis that began in April 1998 with the resignation of the prime rumbles on— minister, Mendsaikhany Enkhsaikhan, and his government, continues to rumble on. Mr Enkhsaikhan was replaced by Tsakhiagiin Elbegdorj and a cabinet composed of members of parliament. However, a controversial bank merger led to the fall of Mr Elbegdorj’s government in July and since then the country has been without a proper government.

—and divided control of The crisis has persisted partly because of the division of control of Mongolia’s institutions has hindered political institutions between different political parties. The president, agreement Natsagiin Bagabandi, formerly a member of the opposition Mongolian People’s Revolutionary Party (MPRP), has rejected all but one of the prime ministerial candidates put forward by the Democratic Coalition, which holds a majority in the State Great Khural (parliament). The situation is exacerbated by divisions within both the MPRP and the Democratic Coalition. Mr Bagabandi, although a former member of the MPRP (he had to resign his party membership upon becoming president), has not supported calls by the parliamentary party for the dissolution of parliament. The president appears to have an agenda all of his own, and one that is different from that of the parliamentary MPRP.

Constitutional The crisis has also exposed the weaknesses of Mongolia’s constitutional ar- arrangements have also rangements. Initially, it was expected that after failing to agree on a new prime prolonged the crisis— minister, the president would dissolve parliament, and call fresh elections. When it came to the crunch, however, it was not clear that Mr Bagabandi had the right to take such a step. In view of this, Mr Bagabandi proved unwilling to take the risk. If the president had gone ahead and dissolved parliament, and was later found by the Constitutional Court to have acted illegally, his reputation would have been severely damaged, and Mr Bagabandi would have been left in a very difficult position.

—and may further delay a The October decision of the Constitutional Court, that a change in February to solution being found the government law allowing serving MPs also to hold government posts was illegal, may add to the political stalemate. The passing of this amendment in February was the change that allowed Mr Elbegdorj to replace Mr Enkhsaikhan in the first place. Parliament voted not to accept the decision, so the issue is still not resolved.

Neither side appears All sides are now realising that these constitutional arrangements have pro- willing to compromise— longed the crisis, and are therefore talking about the need to change the laws. However, although a dissolution of parliament now seems unlikely, getting out of the current crisis will still be difficult, as neither the ruling Democratic Coalition nor the MPRP is expected to make significant compromises. Al- though the MPRP has only 34% of the seats in the State Great Khural, the presence of the MPRP is needed for there to be a quorum in parliament. The willingness of the opposition to boycott parliament and paralyse the parliamentary process, a tactic used frequently since October 1997, means that the agreement of the parliamentary MPRP will be needed if any solution is not quickly to become untenable.

—but may feel pressured One issue that could force the parties to work out a solution to the current to do so by the 1999 impasse is the seventh meeting of the Mongolian Donors’ Group, which is due Donors’ Group meeting in Paris in early 1999. Aid flows have been extremely important to Mongolia since 1990. The current poor global economic outlook, which has undermined the price of Mongolia’s most important exports, has made external financial support even more important. The present political instability will not inspire confidence among potential donors. The president and Democratic Coalition, not wanting to see domestic economic growth deteriorate further, may therefore feel pressured into agreeing on a prime minister, thereby perhaps avoiding a potential fall in pledges of external aid.

External support will be Such aid will allow the government to finance another budget deficit expected needed to finance another in 1999. Initial proposals suggest that the budget deficit will be Tg101.5bn budget deficit— ($118.7m) next year (the budget deficit in the first nine months of 1998 alone was Tg50.2bn). The outturn may be greater than this as there will be demands for greater welfare expenditure. The 1998 harvest has been poor, causing hard- ship for farmers, most of whom had not insured their crops.

—which is also likely to The government will react by trying to increase revenue. However, one area cause backtracking on tax that is likely to be targeted—revenue from privatisation—may be disappoint- reforms ing. Given the poor global investor climate, privatisation proceeds are likely to be below official expectations. The government is therefore likely to backtrack on some previously implemented reforms of the tax regime to try and close the deficit. One area that may be targeted is import duties. Import duty was abol- ished on all but a few items in May 1997. In 1998 parliament passed a bill allowing the introduction of some seasonal duties on flour and vegetables, and preliminary proposals for the 1999 budget suggest a wider reintroduction of such duties.

The rate of economic The rate of economic growth is likely to slow in 1999 compared with 1998. growth may slow in 1999 There may be some upturn in the agricultural sector following the poor harvests of 1998. No sharp improvement is expected in industrial production, which will be hit by government efforts to restructure the sector, and output growth will be held back by power shortages and outdated machinery.

External demand is also likely to fall in 1998 compared with 1998 levels. Mongolia: gross domestic product % change, year on year Economic growth in China, which was Mongolia’s largest export market in the

10 first nine months of 1998, is expected to slow from an estimated 7.8% in 1998 to 6.7% in 1999. The economies of other important export markets, such as 8 Russia, South Korea and Japan, after contracting in 1998, are expected to shrink 6 further in 1999. Mongolia’s export performance will be further damaged by the

4 (a) continued weak world commodity prices forecast for 1999. The price of copper is forecast by the EIU to fall by a further 3.7% in 1999, after falling by an 2 estimated 26.8% in 1998 (copper accounted for around one-third of Mongolia’s 0 exports in the first nine months of 1998). The price of cashmere, another

-2 Mongolia important export, will also remain soft. Asia (excl Japan) -4 1993 94 95 96 97 Although growth in the value of merchandise imports—which grew by 11.7%

(a) Official estimate. in the first nine months of 1998—is likely to slow, the trade balance will Sources: IMF, International Financial Statistics; Ardyn Erk. remain in deficit. Owing to a fall in reserves to just $73m at the end of October

1998, equivalent to under two months of merchandise imports, the currency, the togrog, is expected to weaken further in 1999.

Late note On December 9th the State Great Khural approved the nomination for prime minister of the current mayor of Ulaanbaatar, Janlaviin Narantsatsralt. This appointment follows the Constitutional Court’s decision to reaffirm its Octo- ber ruling that members of parliament could not also hold posts in the government. Although at the time of writing Mr Narantsatsralt had still to appoint a cabinet, Mongolia’s prolonged political crisis did appear to be coming to an end.

Review

The political scene

More prime ministerial Mongolia has been in state of political flux since the resignation of the govern- candidates have been ment of Tsakhiagiin Elbegdorj in July (3rd quarter 1998, page 39). The different rejected players involved—the president, Natsagiin Bagabandi; the majority party in the State Great Khural (parliament); the Democratic Coalition; and the opposition, the Mongolian People’s Revolutionary Party (MPRP)—have been unable to agree on a replacement for Mr Elbegdorj. The president has rejected all except one of the four candidates put forward by the Democratic Coalition since July. The politician most favoured by the governing party, Davaadorjiin Ganbold, has now been rejected seven times by the president. Mr Bagabandi claims that Mr Ganbold, as chairman of the parliamentary Committee on Economic Policy, had not acted to cancel the bank merger which had brought down the previous government.

On August 31st the president had accepted the coalition’s nomination of a second prime ministerial candidate, the acting foreign minister, Rinchinnyamyn Amarjargal. However, Mr Amarjargal’s candidature was nar- rowly rejected by parliament on September 2nd, partly because Mr Amarjargal himself did not exercise his casting vote.

One possible candidate is It was reported that, on October 2nd, a leading figure in Mongolia’s peaceful murdered— transition to democracy in 1990, Sanjaasurengiin Zorig, had a meeting with the president, and agreed to be nominated as prime minister. Mr Zorig had been minister of infrastructure development in the outgoing government. However, Mr Zorig never had the opportunity to become prime minister. On the very day that his nomination was reportedly accepted, Mr Zorig was axed to death in his home.

—but instead of providing The murder shocked the entire country. However, instead of providing the the impetus for a political impetus needed to encourage all parties to find a rapid solution to the govern- solution— ment crisis, Mr Zorig’s death merely increased the sense of political crisis in Mongolia. One problem is that the motive behind Mr Zorig’s killing is not clear. It could have been a simple burglary. However, newspaper reports suggested that as the murderers were leaving Mr Zorig’s house, they said to his wife

that “there will be others”. These warnings led to other leading democratic politicians being placed under police protection.

—the killing highlighted Mr Zorig’s death also served to highlight tensions within Mongolia’s pro- tensions within the democracy parties. In a speech made at the memorial service for the murdered Democratic Coalition politician, the chairman of the Mongolian Democratic Union and director of Mongolian Radio and Television, B Bilegt, lashed out at the former prime minister, Mendsaikhany Enkhsaikhan (Mr Enkhsaikhan had been replaced in April by Mr Elbegdorj) and Dogsomyn Ganbold, calling them traitors. Mr Bilegt also criticised other prominent figures, such as the Mongolian United Traditional Party MP, Ochirbatyn Dashbalbar, and the leader of the Mongolian United Movement (MUM), G Boshigt. (The MUM is a non-governmental organisation, and has mounted a number of anti-government demonstrations over the past year.)

The opposition MPRP has The opposition MPRP has had its own problems. It has been calling for a its own problems national referendum to allow the people to decide whether parliament should be dissolved. Such a dissolution would be to the MPRP’s advantage, as, given the current economic situation, the party would be expected to make gains in a subsequent parliamentary election. However, even though Mr Bagabandi was the MPRP’s candidate at the presidential election in 1997, there is no sign that the president is seeking to dissolve parliament.

Changes to the To complicate matters further, on October 23rd the Constitutional Court ruled government law may be that a change to the government law passed in February was illegal. This reversed amendment, which permitted MPs to serve concurrently as members of the government, had allowed the administration of Mr Enkhsaikhan to be replaced with a cabinet of MPs led by Mr Elbegdorj. The State Great Khural voted not to accept the court’s decision, and so the court will need to readdress the issue.

Mongolia’s media is to be The government crisis has meant that only about one-quarter of the legislation restructured scheduled for the spring session had actually been dealt with. However, there has been some progress. On August 28th, the last day of the spring session, a law was passed on the freedom of the press and information. The law provides for a fundamental restructuring of the media in Mongolia. From January 1st 1999, the date when the law will come into effect, the two main central government-owned papers, Ardyn Erkh (People’s Rule) and Zasgiin Gazryn Medee (Government News), along with other official newspapers and maga- zines, will be dismantled. The state television and radio services, and the national news agency, Montsame, are to be reorganised, probably as a public broadcasting service. A working party has been established to examine how the privatisation process is to be carried out.

Public-sector workers Public-sector workers, in particular teachers and health service staff, continue demonstrate— to be dissatisfied: many have not been paid for two or three months, making public-sector pay increases, due to be implemented in October, largely mean- ingless. On November 2nd an estimated 10,000-20,000 people took part in a demonstration in Ulaanbaatar. The Mongolian Association of Trades Unions delivered an ultimatum to the acting government, demanding implementation

of a Tg20,000 ($23.4) per month minimum wage, a 10% increase on pensions and salaries, and payment of overdue salaries and benefits. The union stated that if the government failed to meet the demands by December 4th, a general strike would be called from December 10th.

—but the government is The immediate response of the Ministry of Health and Social Security was to short of funds reject the demands, saying that in some cases it was local government and not central government that was to blame for the overdue payments. The ministry also pointed to the shortage of government funds. The government’s balloon- ing budget deficit (see Economic policy and the economy) means that the authorities will be under some pressure to cut spending further in the 1999 budget, due to be debated in the autumn parliamentary session.

The former director of Sh Otgonbilig, who was dismissed from his post in July as general director of Erdenet appeals against Erdenet, the Mongolian-Russian copper joint venture (3rd quarter 1998, his dismissal— page 42), has appealed to the district court of Chingeltei in Ulaanbaatar, claiming that his dismissal by the State Property Committee (SPC) was illegal. On September 21st the court ruled in Mr Otgonbilig’s favour. The judgment was then overturned by the City Court, which ordered the Chingeltei court to reopen the case, but it again supported Mr Otgonbileg.

—but the authorities do To complicate matters further, on November 9th the SPC itself annulled its not back down resolution against Mr Otgonbileg. The reason for this is unclear but the SPC may have been influenced by the strong reaction of Erdenet’s Russian partners to the whole affair. The Russians disapproved of the Mongolian side imposing the emergency regime, partly because they had not been consulted over the changes. The Russians also claimed that the action violated the terms of the intergovernmental agreement on Erdenet of 1991. However, when the Erdenet board of directors met on November 16th, they backed the decision to termi- nate Mr Otgonbileg’s employment.

Germany’s president visits On September 19th the German president, Roman Herzog, accompanied by a Mongolia— 70-strong delegation, paid a four-day state visit to Mongolia. Mr Herzog signed agreements on such issues as the establishment of a Mongol-German school, and German government credit for Mongolia. The president also expressed approval of the development of Mongolia’s democracy and market economy, and gave assurances that Germany would sustain aid at the present level— Germany has granted DM25m ($14.8m) for 1998-99.

—as does a delegation In mid-August a delegation from the Chinese Communist Party (CCP), led by from China the head of the CCP’s International Liaison Department, Dai Bingguo, visited Mongolia, at the joint invitation of all the parliamentary parties. The delegation donated $20,000 worth of office equipment to the MSDP, and Mr Dai expressed the hope of future co-operation between the CCP and MSDP. During a meeting with Mongolia’s president, Natsagiin Bagabandi, Mr Dai reaffirmed the CCP’s respect for Mongolia’s independence, sovereignty and territorial integrity. Mr Bagabandi said he hoped that trade between the two countries would be expanded. The president is due to make an official visit to China on December 7th-12th.

Mongolia’s foreign Mongolia’s acting foreign minister, Rinchinnyamyn Amarjargal, arrived in minister visits the US— New York at the end of September to attend the 53rd session of the UN. During his visit, Mr Amarjargal had talks with the secretary-general of the UN, Kofi Annan. Mr Annan said that he would probably accept a standing invitation to visit Mongolia in 1999.

—and Canada— Mr Amarjargal went on to visit Canada, where he signed a communiqué on friendly relations and co-operation, covering such areas as mining, agriculture, and education and training.

—and seeks support for The acting foreign minister has also been pursuing Mongolia’s aim of achiev- APEC ambitions during a ing greater economic strategic involvement in Asia. On his way back from trip to Japan— Canada, Mr Amarjargal made a brief stopover in Japan. The acting foreign minister held talks with Japan’s foreign minister, Masahiko Komura, about the possibility of Mongolia being admitted to observer status in the Asia-Pacific Economic Cooperation (APEC) forum.

—and to South Korea Mr Amarjargal further pressed Mongolia’s APEC case on a visit to South Korea, when he met foreign ambassadors who are also accredited to Mongolia (including the ambassadors of Mexico, Singapore, the Vatican, Greece and Malaysia). Mr Amarjargal was in Seoul to attend a UN Development Programme (UNDP) meeting on “Asia-Pacific countries in the next century”. Mr Amarjargal also met South Korea’s foreign affairs and trade minister, Hoong Soon-young, and signed an agreement with the South Korean government on co-operation in the investigation of crime and the extradition of criminals.

Mongolia helps a On November 10th a parliamentary delegation led by the acting finance min- 50-year-old friend ister, Bat-Erdeniin Batbayar, visited North Korea, taking with them 8 tonnes of meat and meat products, worth Tg10m ($11,700). The visit marked the 50th anniversary of the establishment of diplomatic relations with North Korea.

Economic policy and the economy

The budget balance There has been no improvement in the government’s finances so far in 1998, remains in deficit— following the Tg68bn ($86.2m) deficit recorded in 1997. According to newspaper reports, government revenue totalled Tg151.6bn in the first nine months of 1998, compared with expenditure of Tg201.8bn, resulting in a deficit of Tg50.2bn.

—and the government In an attempt to make up some of the budget shortfall the government at- increases taxes— tempted to impose a 13% export tax on gold in August. The new tax had IMF approval but foreign mining companies reacted by threatening to close down operations. Fearing that the tax would have a detrimental affect on foreign investment inflows, the president, Natsagiin Bagabandi, vetoed the levy. The government did not give up however, and on November 6th parliament approved the introduction of a 10% gold tax, to be levied both on gold sold to the Central Bank and on exports. The tax resulted in lay-offs and shutdowns in the industry, threatening government plans to increase gold production from 9 tonnes in 1998 to 20-25 tonnes by 2003 (see Mining and energy).

—and tries to improve Apart from introducing new taxes, the government has also tried to ensure compliance stricter compliance with the taxes already levied. It is widely believed that tax evasion is a problem in Mongolia. However, the government’s latest attempt to crack down on this, a six-week campaign called Debt-45, launched on September 25th, boosted government revenue by only Tg1.8bn ($2.1m).

The 1999 budget is At the end of October parliament began to discuss the 1999 budget. Preliminary discussed— figures suggest that expenditure will be Tg355.4bn ($415.7m), up from Tg294bn in the 1998 budget. Power and heating will account for approximately 33% of expenditure, the public service for around 9%, education, health and public works 18%, defence and policing 7%, and other equipment 11%. The government has proposed only around Tg10bn, or 3% of total expenditure, for construction and the repair of roads and bridges. Preliminary figures put revenue at Tg253.9bn, up from a budgeted Tg215bn in 1998, leaving a budget deficit of Tg101.5bn.

—which may include some As part of these proposals, the government is considering several changes to tax changes— the tax regime, including:

• increasing the new gold tax by 1 percentage point to 11%;

• extending the recently imposed import duty on food to other items; and

• introducing a state monopoly on the production of alcohol.

The government will also try to limit spending on healthcare. From January 1st 1999 herdsmen and students will be required to pay their own health insurance. Only those who live below the poverty line will have health insurance paid for by the state.

—as proceeds from The government will continue to place importance on the proceeds from privatisation may be privatisation in 1999. However, privatisation revenue may not be as high as the disappointing government hopes. The government is unlikely to receive the Tg16bn ($18.7m), or 7%, of government revenue targeted to be generated by the privatisation process in 1998. One problem is increased foreign investor scepticism about emerging markets generally, which is unlikely to change in 1999. The inability of the parliamentary parties to agree on how larger concerns are to be privatised is a further obstacle to the planned sell-offs.

Cancelling a bank merger On July 17th parliament withdrew the controversial resolution calling for the is costly— merger of the state-owned Reconstruction Bank and the private Golomt Bank (3rd quarter 1998, page 44), the issue that had led to the fall of the government of Tsakhiagiin Elbegdorj. The two banks therefore had to be separated once more. The failed merger proved costly to both banks. Golomt Bank claimed to have lost both cash and goodwill. Furthermore, the failed merger did not improve the financial health of Reconstruction Bank, which was the reason given by the government to justify the merger in the first place. The failure of the merger, by encouraging large depositors to take their business elsewhere, may if anything have exacerbated Reconstruction Bank’s financial difficulties.

—as external aid The failure of the bank merger, and the political crisis, has also been costly for payments are delayed— the government. In October the IMF suspended a $45m payment to the

government, partly blaming the annulment of the bank merger. This followed a government request for extra financial assistance from the IMF and the World Bank made at the beginning of October, which was also refused. Apart from the failed merger, the political instability in the country is also likely to have influenced the decision of the two multilateral institutions to refuse greater assistance.

—although other bank Despite the government’s back-tracking on the merger, other bank reforms, reforms have occurred supported by the IMF, continue. A number of commercial banks have under- gone audits, and Shuudan Bank, Bayanbogd Bank and Investment and Tech- nological Innovation (ITI) Bank were reported to the police after irregularities were discovered. Both Shuudan and ITI were found to have insufficient reserve funds. In addition, Shuudan was found to be engaging in business outside banking, and the processing of transactions was being delayed at ITI. Bayan- bogd had exceeded the credit ceiling set by the Mongol Bank (the central bank). The licences of two insolvent banks, Ediin Tenger and Mongol Business, were revoked in October.

There have also been some reforms to the regulation of the banking sector, as follows:

• the central bank has increased the authority fund of commercial banks to Tg1bn ($1.2m); small banks have been given a year in which to comply;

• according to an amendment to the banking law, banks making false state- ments about their finances can be fined up to Tg10m ($11,700); and

• under amendments to the criminal law, individual debtors risk both a jail sentence of up to five years and confiscation of assets; reoffenders and members of financial crime syndicates can be imprisoned for up to eight years.

Inflation has slowed The increase in value-added tax (VAT) to 13% from September (3rd quarter 1998, page 43) exerted upward pressure on many domestic prices. Further inflationary pressure was generated by a decision by the local telecommunications company, Mongol Telecom, to raise the prices of domestic telephone calls in September. However, other factors, such as weak domestic demand and falling retail prices in China, Mongolia’s largest trading partner in 1998, seem to have more than offset this increase. The year-on-year rate of inflation in Mongolia has continued to fall, with prices rising by just 5.3% year on year in October, compared with an annual inflation rate of 21% in January.

Mongolia: inflation, 1998 (% change, year on year) Jan-Jun 9.2 Aug 7.4 Sep 5.7 Oct 5.3 Source: Press reports.

Money supply growth has also continued to slow. In October M1 (cash in circulation plus deposits) increased by 1.1% year on year, compared with 4.6%

in September and 23.7% in January. Broad money supply, M2, rose by 4.4% in October year on year, compared with 34.9% in January.

Mongolia: money supply, 1998 M1 M2 Tg bn Apr 70.9 156.1 May 79.7 166.5 Jun 78.7 160.2 Jul 84.2 168.5 Aug 80.1 165.2 Sep 79.2 166.0 Oct 76.8 162.6 % change, year on year Apr 19.5 26.5 May 23.5 25.1 Jun 16.66 16.2 Jul 11.6 10.2 Aug 8.1 9.7 Sep 4.6 9.5 Oct 1.1 4.4 Source: Press reports.

Agriculture

Early snows destroy Hopes that the 1998 grain harvest would be greater than the 240,000 tonnes crops— collected in 1997 are unlikely to be fulfilled, following early falls of snow in many areas. By November 5th only 188,327 tonnes had been harvested. The fodder crop has also suffered.

—but vegetable However, there have been improvements in other crops. By November 5th, production improves 64,450 tonnes of potatoes and 40,910 tonnes of vegetables had been harvested, slightly compared with 54,600 tonnes and 34,000 tonnes respectively in 1997.

Promising results from Results of crops produced under the “Green Revolution” project backed by the the “Green Revolution”— UN Development Programme (UNDP) have shown some promising results. Around 70,000 families and 920 small businesses are reported to have taken part in the project to cultivate 10,000 ha of land.

—and from seed trials Results of the trials of Saratov-29 wheat, a hardy seed bred in Kazakhstan (2nd quarter 1998, page 51), have been encouraging. After cultivating 200 tonnes of the seed over 1,200 ha, 1,300 tonnes of grain was produced. A total of 930 tonnes of the grain will be used in a further trial in 1999.

Industry and construction

An audit reveals safety A government audit of safety standards in Mongolian industry revealed that deficiencies in industry over 10,000 toxic chemicals were being used. The audit found that:

• in 39.5% of workplaces where such chemicals are used emission levels ex- ceed safety standards;

• in 37.5% of the factories flammable and explosive substances are not stored properly; and

• in 22.4% of the plants employees have not had adequate training in the use of such substances.

Ulaanbaatar Sports Centre Construction of a 10,000-seat sports stadium, which began in 1989 with back- will be completed ing from the Soviet Union but stalled in 1990, is now to be finished. The mayor of Ulaanbaatar, Janlaviin Narantsatsralt, recently reached an agreement with the mayor of Moscow, Yuri Luzhkov, in which the two cities will share the costs of finishing the work. The work is to be carried out by the Russian construction company Mosstroi.

Mining and energy

Unpaid power bills result Power supplies in parts of Mongolia continue to be affected by blackouts. After in cuts in supply by both storms in April damaged power lines, supplies to the western power grid, which Russian— uses imported electricity from Russia, were only restored in August. They were cut again on September 15th, with the Russian suppliers claiming they were owed Tg700m ($818,700) by Mongolian customers. Bayankhongor aimag in the south-west was blacked out in November for a similar reason.

—and Mongolian In September local power companies, in an effort to force the payment of an producers estimated Tg10bn ($11.7m) worth of unpaid bills, carried out threats to cut supplies. As a result, Tg2bn of the outstanding debt was paid. The Russian- Mongolian copper joint venture, Erdenet, paid Tg1bn.

Erratic fuel supplies also There are also problems with the coal mines, particularly the two largest, cause problems Sharyn Gol and Baganuur, which supply most of the fuel for the power stations of the central grid. This year the mines have missed production targets by a wide margin, deliveries have been erratic and power stations have often been left with no more than one or two days worth of stocks. The government is hoping to improve the situation, partly through a Tg2bn ($2.3m) aid package from the Japanese government, which will be used mainly to purchase spares and fuel for Sharyn Gol and Baganuur. In addition, the government plans to sell Tg2bn of bonds to support the power industry.

Oil will be imported from The largest fuel importer in Mongolia, Neftimport Concern (NIC), has con- China— cluded an agreement to purchase oil from China. The first consignment is due to arrive by rail in November. This may allow greater flexibility of oil prices in Mongolia, by breaking the country’s reliance on imports from Russia.

—and imports from Russia Transport costs on oil imports are expected to be reduced after the opening of could also increase a new depot on the Mongolian-Russian border. To date, Russian oil has been delivered by rail to Ulaanbaatar and to other parts of Mongolia from there.

Foreign companies explore The Mongolian petroleum authority and a US company, Desert Oil, are discuss- for oil ing a product-sharing agreement. If approved, the agreement will allow exploration of a 650-km area over a five-year period beginning in March 1999.

A Chinese oil company is to undertake test drilling in the west of Mongolia. The work aims to identify oil and natural gas deposits in the Great Lakes region.

The government hopes to The 1998 production target of 9 tonnes of gold is close to being met: 8.8 tonnes increase gold production has already been produced (of which the central bank purchased 6.6 tonnes). The government has a production target of 11 tonnes for 1999, 14 tonnes for 2000, with output rising to 20-25 tonnes by 2003.

Estimates of Mongolia’s gold reserves continue to be upgraded. According to sources in the Ministry of Agriculture and Industry, deposits containing 20 tonnes were identified in 1998, and a further 50 tonnes is expected to be added to the reserves as a result of planned exploration work.

Transport and communications

Some MIA aircraft are to The Ministry of Infrastructure is planning the privatisation of the state airline, be licensed to private MIAT. In the run-up to the sell-off, eight AN-24 and three AN-26 aircraft operators presently used by MIAT on domestic routes are to be licensed to private operators. MIAT is keen to divest itself of its domestic routes, which operate at a loss of approximately Tg1bn ($1.2m) per year. However, the plan to license the planes is highly unpopular with domestic crews who expect to be made redun- dant. Pilots have threatened to go on strike if the licensing of the aircraft goes ahead.

Mongolia will return After two recent fatal crashes involving Chinese-built Yu-12 passenger planes, Chinese planes MIAT grounded the remaining three planes of the fleet. It has now been agreed that MIAT will return the remaining aircraft. As the aircraft have not yet been paid for in full, the date of return will be decided when the question of the outstanding payments is resolved.

More roads are constructed Work recently began on a gravel road between the provincial centres of Kharkhorin, Tsetserleg and Tosontsengel, at a cost of $58m. The road will be financed with a loan from the World Bank. Work is also continuing on the 500-km Ulaanbaatar-Altanbulag road, which is 80% financed by the Asian Development Bank, and on the Erdenet-Darkhan road, being built with funds from Kuwait.

Foreign trade, aid and payments

Trade remains in deficit In the first nine months of 1998 Mongolia’s trade deficit reached $128.4m, compared with just $9.1m in the first nine months of 1997. In the same period, exports fell by 23.7%, from $334.2m to $255.1m, and imports rose by 11.7%, from $343.3m to $383.5m. The decline in exports is largely attributable to the poor performance of the copper and textiles sectors. In the first nine months of 1998 the value of copper exports fell by 38.5% year on year, from $143.8m to $88.4m, and the value of textile and garment exports fell by 29.9% year on year, from $71.3m to $50m.

Mongolia: foreign trade ($ m) 1997 1998 % change Imports Jan-Mar 70.7 95.2 34.7 Apr 36.9 51.4 39.3 May 18.7 39.6 111.8 Jun 53.8 44.5 –17.3 Jul 40.6 31.6 –22.2 Aug 44.7 37.2 –16.8 Sep 38.3 37.9 –1.0 Oct 39.6 46.1 16.4 Jan-Oct 343.3 383.5 11.7 Exports Jan-Mar 79.0 64.7 –18.1 Apr 36.3 22.0 –39.4 May 39.3 27.6 –29.8 Jun 45.1 26.6 –41.0 Jul 33.5 26.3 –21.5 Aug 33.3 27.3 –18.0 Sep 31.3 23.7 –24.3 Oct 36.4 36.9 1.4 Jan-Oct 334.2 255.1 –23.7 Trade balance Jan-Mar 8.3 –30.5 –467.5 Apr –0.6 –29.4 4,800.0 May 20.6 –12.0 –158.3 Jun –8.7 –17.9 105.7 Jul –7.1 –5.3 –25.4 Aug –11.4 –9.9 –13.2 Sep –7.0 –14.2 102.9 Oct –3.2 –9.2 –24.3 Jan-Oct –9.1 –128.4 1,311.0 Source: Press reports.

The government aims to Faced with this situation, the government has been trying to promote the increase meat exports— export of alternative goods, particularly meat and meat products. It has set a target for meat and meat product exports in 1999 of 20,000 tonnes, partly by the establishment of a meat marketing project. In addition to lessening the trade deficit, it is hoped that increases in meat exports will increase incomes and employment in both the meat and skin industries. Both sectors have been depressed for several years.

—which may be boosted The meat industry received a further boost at the end of October, when the by preferential Russian governor of the Russian region of Irkutsk, Boris Govorin, visited Ulaanbaatar, tariffs— along with a delegation of businessmen. Mr Govorin announced that Russia would levy preferential tariffs on Mongolian exports of meat and meat products, which account for 65% of Mongolian exports to the region. The delegation also expressed interest in taking fluorspar from the joint venture Mongolrostsvetmet for processing in Irkutsk.

—but deer exports are Parliament has passed an amendment to the hunting law banning the export banned of deer products. There is a huge demand in China for such products and an estimated 720.8 tonnes of antlers alone were exported between 1994 and 1997.

Environmentalists claim that, as a result of the trade, the deer population has fallen from 130,000 to 40,000 since 1995. Moreover, illegal hunting is blamed for forest and steppe fires which have caused further environmental and economic damage.

There are also hopes for In 1997, 16,000 tourists visited the country, compared with an average of only the tourism industry— around 4,000 per year at the beginning of the decade. The government is keen to increase revenue from tourism. In June representatives from 30 foreign tourist companies attended an investment conference (3rd quarter 1998, page 45). In October the Mongolian embassy in Washington hosted a meeting for US tour operators. In November Mongolian tour companies participated in an international tourist exhibition in London.

—as new two hotels open New attractions for tourists are beginning to appear as accommodation becomes available. Two new hotels have recently been established in the Khovsgol region, in the north-west of Mongolia. The Gobi cashmere company has opened a 30-bed hotel in Moron. In the small centre of Khatgal near Lake Khovsgol, which is set in a national park, a more modest 18-bed hotel has been completed with the help of the US Peace Corps.

Gambling may generate The Mon-Macao joint venture, which won a tender to operate a casino in foreign-exchange Ulaanbaatar’s Chingis Khan hotel, has great hopes for gambling in Mongolia. earnings— Mon-Macao believes that up to two plane loads of gamblers could fly into Mongolia per day. The company has promised that 1% of all profits will go to humanitarian projects and 2% to the Ulaanbaatar Fund, which has been set up to develop the Mongolian capital.

—and the government The utilisation of foreign aid continues to be criticised: so far in 1998 only wants to increase use of $108.9m of the $205.4m aid allocated for the year has been utilised. In an foreign aid attempt to rectify this situation, and establish a better climate for foreign investment, the government has undertaken some institutional reforms. The Ministry of External Relations has set up a new foreign investment and loan co-ordination council to replace the foreign loan and aid co-ordination board, and the foreign investment board has become the foreign investment and trade agency.

Foreign-exchange reserves Mongolia’s trade deficit contributed to a fall in international reserves. By the fall end of October reserves totalled just $73m, compared with $129.8m at the beginning of the year. The currency has also continued to depreciate. At the end of October the exchange rate was Tg863:$1, compared with Tg813:$1 at the end of 1997. According to central bank figures, the exchange rate had fallen to Tg875:$1 by November 16th.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 Quarterly indicators and trade data 57

Quarterly indicators and trade data

China: quarterly indicators of economic activity

1996 1997 1998 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Prices Monthly av Consumer prices: change year on year % 9.1 7.9 7.0 5.2 2.9 2.1 1.0 0.0 –0.9 –1.4a Moneyb End-Qtr M1, seasonally adj: Rmb bn 2,700.3 2,834.7 2,997.3 3,304.5 3,496.4 3,573.4 3,748.1 3,734.0 3,857.6 n/a change year on year % 17.3 18.6 19.8 27.4 29.5 26.1 25.0 13.0 10.3 n/a Foreign trade Qtrly totals Exports fob $ m 35,803 39,979 47,166 35,585 45,360 48,173 53,759 40,072 46,488 31,714c Imports cif “ 33,843 32,737 42,959 28,804 33,998 35,370 44,017 29,453 34,834 22,843c Exchange holdings End-Qtr Goldd $ m 3,716 3,664 3,583 3,346 3,267 3,083 2,920 2,803 2,857 2,747e Foreign exchangef “ 86,616 95,363 105,029 112,055 120,941 134,074 139,890 140,617 140,510 140,738e Exchange rate Market rate Rmb:$ 8.322 8.302 8.298 8.296 8.291 8.285 8.280 8.279 8.280 8.278g

Note. Annual figures for most of the series shown above will be found in the Country Profile. a Average for July-August. b Consolidated accounts of the People’s Bank of China, domestic branches of the Bank of China and the Bank of Agriculture. c Total for July-August. d End-quarter holdings at quarter’s average of London daily price less 25%. e End-August. f Excluding foreign-exchange holdings of the Bank of China. g Source: FT.

Source: IMF, International Financial Statistics; FT.

Mongolia: quarterly indicators of economic activity

1996 1997 1998 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Prices Monthly av Consumer prices Jan 1991=100 5,336 5,952 7,201 7,841 8,860 8,690 8,631 9,035 n/a n/a change year on year % 45.7 35.9 53.8 55.6 66.0 46.0 19.9 15.2 n/a n/a Money End-Qtr M1, seasonally adj: Tg m 50,066 56,848 61,266 58,347 68,052 73,349 76,109 70,938 79,174 76,498 change year on year % 25.5 37.5 41.1 21.5 35.9 29.0 24.2 21.6 16.3 4.3 Foreign trade Qtrly totals Exports fob $ m 124.0 98.6 100.5 79.0 75.6a n/a n/a n/a n/a n/a Imports cif “ 121.4 105.8 119.9 70.7 55.6a n/a n/a n/a n/a n/a Exchange holdings End-Qtr Foreign exchange $ m 75.60 84.50 107.00 99.90 100.40 128.20 175.00 111.40 95.20 98.90 Exchange rate Market rate Tg:$ 531.15 601.70 693.51 830.00 797.99 804.3 813.16 817.61 838.63 855.00 a Total for April-May.

Source: IMF, International Financial Statistics.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 58 Quarterly indicators and trade data

China: foreign trade ($ m) Total Japan Taiwan US South Korea Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Imports cif 1997 1998 1997 1998 1997 1998 1997 1998 1997 1998 Food, beverages & tobacco 2,613 2,217 99 101 14 17 353 376 32 38 of which: cereals & preparations 566 495 4 3 1 0 21 57 2 1 Metalliferous ores & scrap 1,289 1,296 2 2 1 1 8 9 1 1 Mineral fuels 5,719 5,895 209 134 17 19 138 129 587 569 Chemicals 11,100 11,778 2,006 2,033 1,865 1,938 1,669 1,777 1,617 2,181 of which: organic 1,593 1,722 391 406 62 64 189 166 335 467 dyeing & tanning materials 543 605 103 111 118 139 52 51 69 80 fertilisers 1,973 1,441 0 0 12 7 706 663 5 6 plastics & manufactures 5,360 5,997 1,227 1,180 1,392 1,426 490 455 1,116 1,517 Rubber & manufactures 736 592 135 122 114 110 25 25 56 55 Hides, skins & leather 1,441 1,342 48 38 334 304 167 219 496 418 Wood & manufactures 1,006 1,092 7 4 29 23 69 80 25 32 Paper & manufactures 1,927 2,048 231 241 266 235 369 365 356 458 Textile fibres & mnfrsa 9,856 8,664 1,765 1,566 1,929 1,992 712 311 1,833 1,651 of which: synthetic fibres & mnfrs 4,110 3,842 899 783 1,017 1,095 119 94 1,198 1,077 Base metals & manufactures 6,801 7,057 2,012 2,100 1,021 1,155 408 405 793 1,089 of which: iron & steel & mnfrs 4,359 4,309 1,532 1,558 576 654 132 183 557 758 copper & manufactures 1,152 1,272 259 286 255 282 122 88 95 206 aluminium & manufactures 834 884 133 160 97 118 118 89 90 81 Machinery excl electric 12,360 13,150 3,353 3,437 1,287 1,162 1,708 1,728 709 610 Electric machinery 11,410 13,196 3,857 3,832 1,315 1,734 1,030 1,362 1,064 1,135 Transport equipment 2,516 2,447 299 379 77 71 1,010 923 48 37 of which: road vehicles & tractors 974 942 281 358 76 71 86 71 35 29 aircraft 1,420 1,304 0 1 0 0 914 845 13 1 Scientific instruments etc 2,468 2,769 1,031 1,078 174 178 397 483 78 59 Total incl others 75,834 76,387 15,398 15,429 8,776 9,261 9,036 9,000 7,932 8,563

EU Hong Kong Singapore Russia Indonesia Imports from other Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul main suppliers 1997 1998 1997 1998 1997 1998 1997 1998 1997 1998 Total 9,560 10,116 3,804 3,697 2,400 2,359 2,464 2,084 1,521 1,465 continued

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 Quarterly indicators and trade data 59

Total Hong Kong US Japan South Korea Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Exports fob 1997 1998 1997 1998 1997 1998 1997 1998 1997 1998 Food, beverages & tobacco 6,443 6,162 1,116 1,053 328 337 2,391 2,138 514 408 of which: meat & fish & preparations 2,349 2,081 284 262 126 126 1,414 1,153 144 71 fruit & vegetables & preps 1,606 1,532 149 126 104 110 678 716 75 33 Oilseeds 497 429 69 48 21 24 170 148 50 19 Mineral fuels 3,989 2,953 580 393 301 212 1,209 819 649 446 Chemicals 7,641 8,549 1,447 1,606 1,261 1,488 896 927 359 278 of which: organic & inorganic 3,237 3,337 283 250 328 472 474 468 242 176 plastics & manufactures 2,520 3,090 822 861 628 770 219 261 39 34 Leather mnfrs, handbags, travel goods 2,910 2,991 564 529 738 697 330 304 36 22 Textile fibres & manufactures 22,982 24,339 9,286 9,480 1,979 2,149 4,543 4,471 974 759 of which: cotton & manufactures 1,845 1,554 966 817 87 56 142 83 71 48 synthetic fibres & mnfrs 1,981 2,039 745 681 35 46 89 81 358 260 clothing 14,771 16,511 6,067 6,586 1,490 1,595 3,541 3,645 329 304 Footwear 4,770 5,028 298 462 2,456 2,547 417 393 96 54 Non-metallic mineral mnfrs 1,734 1,811 217 244 333 382 391 353 54 18 Precious stones, metals & jewellery 915 1,126 545 754 131 158 21 17 11 8 Base metals & manufactures 7,062 7,042 1,202 1,172 910 1,229 985 845 900 406 of which: iron & steel & manufactures 4,037 3,773 491 443 462 632 582 499 733 264 Machinery excl electric 7,261 8,977 1,356 1,431 1,861 2,495 720 866 150 92 Electric machinery 12,513 14,379 3,227 3,296 2,337 2,913 2,244 2,416 560 502 Transport equipment 2,675 3,407 569 558 414 623 186 202 128 149 of which: road vehicles & tractors 1,200 1,275 132 74 351 463 150 161 18 6 Scientific instruments etc 3,234 3,589 798 861 704 791 726 745 38 28 Furniture etc 1,969 2,281 319 326 784 987 249 233 22 9 Toys etc 3,480 3,995 665 656 1,559 1,915 265 281 43 34 Total incl others 96,360 103,100 23,637 24,115 17,066 20,191 16,818 16,098 4,900 3,415

EU Taiwan Singapore Australia Russia Exports to other Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul Jan-Jul main markets 1997 1998 1997 1998 1997 1998 1997 1998 1997 1998 Total 12,373 15,569 1,751 2,114 2,241 2,022 1,022 1,232 840 1,171 a Including clothing.

Source: Economic Information & Agency, Hong Kong, China’s Customs Statistics.

EIU Country Report 4th quarter 1998 © The Economist Intelligence Unit Limited 1998 60 Quarterly indicators and trade data

China: trade with east European countries ($ m) Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Dec Jan-Jul Jan-Jul 1992 1993 1994 1995 1996 1997 1997 1998 Chinese imports cif Russia 3,889a 4,987 3,496 3,799 5,153 4,086 2,464 2,084 Poland 90 224 105 84 47 32 16 25 Czech Republic 176b 243c 125 88 66 29 17 17 Romania 211 379 286 194 73 72 45 10 Hungary 19 62 20 31 40 26 18 7 Bulgaria 58 137 73 20 34 17 11 2 Slovak Republic n/a 24c 14 36 52 6 6 1 Total listed 4,443 6,055 4,119 4,252 5,465 4,268 2,577 2,146 Chinese exports fob Russia 2,690a 2,692 1,581 1,665 1,693 2,033 840 1,171 Poland 119 248 294 472 569 673 338 427 Hungary 45 165 390 325 219 296 147 200 Romania 78 120 110 157 151 176 100 148 Czech Republic 38b 59c 85 140 166 250 119 144 Bulgaria 20 36 37 32 27 31 15 27 Slovak Republic n/a 9c 10 32 26 28 14 19 Total listed 2,990 3,329 2,507 2,823 2,851 3,487 1,573 2,136 a Former Soviet Union. b Czechoslovakia. c April-December.

Source: Economic Information & Agency, Hong Kong, China’s Customs Statistics.