Mainland economic reforms put to the test

Inflationary factors pressure Beijing's policy resolve Beijing has long vowed to give the market a greater role in running the economy - but the threat of spiralling inflation and a collapse in the stock market are testing the government's resolve. In recent months, the central government has introduced a number of policies that smack of old-style state intervention in the economy, raising doubts about its commitment to economic reform when the going gets tough. Mainland officials have ordered coal producers in Shandong and Shaanxi to raise output and cut prices; demanded that banks rein in lending and raise reserve deposit ratios to unprecedented heights; instructed mutual fund managers not to sell into a falling market; and forced companies to pull share listings. Yet Beijing has also finally begun to lift price controls on domestic fuel, continued to let the yuan appreciate against the US dollar, and has so far declined to intervene to halt the sliding stock market - all half-hearted nods to market forces. 'We are not slipping back into Maoist planning. But when you're between being a planned and a market-driven economy, you get caught between two stools,' said Stephen Green, chief China economist at Standard Chartered. The problem facing policymakers is that the mainland's mixed economy makes it much harder for both the old and new methods of economic management to be used effectively. Old-style price-setting runs the risk of encouraging commodity producers to export goods out of the country rather than get a lower price for them at home, while shareholders can hardly be expected to invest in companies forced to sell at below market levels. Conversely, Beijing's attempts to use a market tool such as interest rates to stifle credit growth come unstuck in a country with an undeveloped money market and a nominal GDP growth of about 15 per cent. But crimping bank lending will not stop supposedly commercial lenders from trying to make money. Recent heavy-handed intervention in the economy reflects the fact that putting out today's inflationary fires naturally takes priority over pursuing the long-term economic goal of freer markets. Administrative measures, such as enforcing bank quotas, are tempting because they are more effective in the short term. 'It is clear that we are in a quasi-emergency setting, so they are reaching for the tools that used to work,' said Mr Green. 'But these measures are not ideological, they are pragmatic,' he said. Policymakers have not renounced their long-term goal of giving the market a greater role in setting prices. 'There is recognition that prices should be relaxed. This is not a structural shift but a temporary blip,' agreed RBS economist Ben Simpfendorfer. Beijing would need to fork out an annual US$65 billion - or 2 per cent of GDP - to compensate domestic refiners for importing oil priced at US$150 per barrel, according to RBS's calculations. Although the government has the fiscal strength to prop up domestic fuel for consumers in the medium-term, officials say they have no intention of subsidising fuel prices indefinitely. A gradualist approach to lifting prices in line with market levels is the only viable move both economically and politically. However, whether Beijing will ever expect its citizens to ride out the fluctuations of the world oil price is a moot point. Despite a consensus that energy prices should eventually move towards international norms, Communist Party leaders are unlikely ever to put the interests of economic reform ahead of social stability. 'There is an understanding that the market needs to set prices for goods but that the government ought to intervene actively to smooth out volatility in market-set prices. This concept was as true five or ten years ago as it is today,' said Arthur Kroeber, director of Beijing-based consultancy Dragonomics. The economic policymaking environment is less characterised by ideological turf wars than by different opinions on the speed of reform, with the central bank understandably keen to give a greater role to the market and to monetary policy in steering the economy. The National Development and Reform Commission, the former state planning department, is often accused of holding back reform. Yet the NDRC has been at the centre of plans to reform energy prices. In practice, tougher times will continue to provoke government intervention targeted at solving particular problems. Bank loan quotas will remain in place as long as the central bank thinks too much money is sloshing around the economy. Beijing may also cave in to pressure to boost sagging investor confidence in the stock market, possibly by setting up a 'stabilisation fund' to buy shares or by allowing investors to buy stocks with money borrowed from their brokers - so-called margin trading. April's stamp duty cut on share trading showed that policymakers will intervene in the stock markets once the Shanghai Composite Index drops below a certain level. April's floor of 3,000 is now rumoured to have shrunk to 2,000 - though this remains a subject to debate and to the reaction of investors. 'Although China is moving towards a market economy, administrative measures should remain a feature of the Chinese economic policymaking in the coming years,' said Citibank's chief China economist Huang Yiping. 'I think and hope that all these controls are blip on the road to reform, because they are not a substitute for market-based solutions,' warned Hong Liang at Goldman Sachs. 'At best they can buy some time for the authorities to undertake the market-based solutions gradually. Yet any such market solutions will almost certainly have their limits. The temptation to view the mainland's economic transition as a straight - albeit halting - trajectory from an absolute command economy to Hong Kong-style capitalism is to misread the beast. 'The purpose of Chinese economic reform was never to create an Anglo-Saxon free-market paradise. The aim was to create a high-growth mixed economy with a considerable degree of state involvement,' said Dragonomics' Mr Kroeber.