Is China Going the Way of Brazil? China Needs to Address Problems of Inflation, Poor Corporate Governance and Better Regulation If It Is to Achieve Long-Term Economic Growth

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Ever since the Mao jacket went the way of the ozone layer, China has been the world's darling economy. 'Bigness' and very high rates of growth have persuaded otherwise canny investors to overlook some rather significant risks.

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Those risks were quantified in a study I carried out in 2001, which showed that China, while attractive, was a risky place to set up shop. Measured in basis points, a company doing business in China would have to earn its target rate-of-return plus as much as 1000 basis points to ensure its risks were covered. This figure, an indicator of potential costs, correlates highly with annual indices produced by Transparency International.

An update of the Opacity Index* indicates that not much has changed on the risk front. While the index was viewed by some as too tough on China (mostly by the Chinese!) recent developments suggest it may not have been far off the mark. Strong growth generally covers a host of economic and political sins, but in China's case, growth--9.7 per cent in the first quarter of 2004--may be doing the opposite.

Rapid growth--especially with regard to infrastructure improvements--has turned China into a major oil and commodity importer. With commodity prices rising, and its currency pegged to the low-flying dollar, China's import costs have soared. Overall, prices for raw materials and energy in China jumped 8.3 per cent in the first quarter of 2004, while overall input costs for China's manufacturing increased by 4.8 per cent. Other inflationary pressures facing China are its rapidly growing money supply and a new generation of hyperactive consumers whose spending drove up retail sales by 10.7 per cent in the first quarter of 2004.

Add to China's looming inflationary problems the weakness of its banks, which, despite a $45bn capital infusion from the government, continue to wheeze. As a result, the government's plans to privatise China's four largest banks have been put on hold.

The picture of China that is emerging is not pretty. Rather than resembling Japan in its heyday, China is beginning to look a little like Brazil, circa 1985, albeit without the massive foreign debt.

Why is China like Brazil?

Brazil was also a miracle economy that rose (with attitude) from abject poverty to become a world beater in steel, autos, chemicals, commuter airplanes and agricultural products. It grew its GDP at double-digit rates using a mix of exports and big infrastructure projects. Then, plagued by inflation and foreign debt, the Brazilian economy collapsed, only to languish for more than a decade.

In truth, China is no Brazil--at least not yet. China is rich with big foreign exchange earning businesses and it has little foreign debt. …