BACKGROUND

China is rich and the world's most populous nation, and covers an area larger than the United States. Yet the China market is small and concentrated in a few areas along the eastern seaboard. China is one of the world's oldest civilizations, with thousands of years of history, literature and culture. Yet the People's Republic is a mere 50 years old and most of the laws and regulations governing business and trade have been written in the past twenty years. Courtesy toward guests is a virtue in Chinese culture, and Chinese people can be extraordinarily hospitable and kind. Yet everyday discourse in China is rude and confrontational and the China market is full of cheats and swindlers. China is a communist country; the first article of the Chinese constitution states that China is a socialist country under the leadership of proletariat. Yet, over the past twenty years China has moved from a planned to market economy and is now in many ways more capitalist than communist.

The stunning contradictions in China have been nurtured by the unprecedented changes of the past twenty years. Since the beginning of the policy of "reform and opening-up" in 1979, China's economy has grown more than tenfold. Previously rationed goods such as bicycles, textiles and grains are now in over-supply. Foreign invested firms, practically none existent in the 1970s, now number over 300,000 and account for almost 50% of China's exports. Foreign trade has grown from $38 billion in 1980 to over $325 billion in 1998. Although most Chinese firms remain relatively small, under-capitalized and poorly managed, there are pockets of excellence in Chinese industry. Chinese firms have competed successfully with world leaders in the white goods and home electronics markets. Chinese PC manufacturers have won back market share from such firms as Compaq and IBM. These economic changes have brought relative prosperity to millions of Chinese, and that prosperity has been accompanied by a great expansion of personal liberties for the average Chinese enjoyed by most Chinese.

For over two hundred years foreign firms have been entranced by the enormous potential of the China market, a potential that remains largely unfulfilled. U.S. exports to China were only slightly more than $14 billion in 1998, only two percent of our global exports, and less than U.S. exports to China's smaller neighbors such as South Korea ($16.5 billion), Singapore $15.7 billion and Taiwan ($18.1 billion). U.S. firms are major investors in China and in 1998 actual U.S. investment in China rose to almost $4 billion, but this is still less than U.S. investment in the U.K. ($4.6 billion) or Mexico ($4.7 billion) and is only slightly more than what U.S. firms invested in South Korea ($3.1 billion). The cumulative U.S. direct investment in China is dwarfed by our investments in Europe, Japan and Latin America.

Country Commercial Guides are available for U.S. exporters from the National Trade Data Bank on CD-ROM or via the Internet. Please contact STAT-USA at 1-800-STAT-USA for more information. Country Commercial Guides can be accessed via the World Wide Web at HTTP:// WWW.STAT-USA.GOV, HTTP://WWW.State.Gov/, HTTP://WWW.MAC.DOC.GOV. They can also be ordered in hard copy or on diskette from the National Technical Information Service (NTIS) at 1-800-553-NTIS. U.S. Exporters seeking general export information/assistance and country-specific commercial information should contact the U.S. Department of Commerce, Trade Information Center by phone at 1-800-USA-TRADE or by fax at 202-482-4473.

ECONOMIC TRENDS AND OUTLOOK

A. Major Trends and Outlook

China's economic growth continued to slow down in the first half of 1999, and retail prices continued to decline causing concerns about deflation. The government expected GDP to grow by 7% in real terms compared with 1998, when official growth was just shy of the target of 8%. The 1998 result was already the lowest return in the past seven years and would have been much lower without the government's special infrastructure spending package, which helped stimulate the economy in the third and fourth quarters. Official figures put out by the Chinese government are generally acknowledged to reflect major economic trends but are affected with an upward bias by incorrect, often even exaggerated, reporting from the provinces.

Most analysts credit China for having achieved a "soft landing" for its economy -- single digit inflation and stable growth that contrasts sharply with the inflationary expansion of 1993-1994. But structural problems, especially in the industrial and financial sectors, combined with the problem of reducing employment levels in the state enterprise system, pose serious challenges to long-term, economic growth. A tight monetary policy and administrative price controls have reined in inflation, now recorded at negative 2-3 percent per year. Government policy emphasizes keeping inflation well below the real rate of economic growth but seems incapable of stimulating even a modest amount of inflation. Deflation is likely to continue until the government boosts wages significantly.

Some pressure to devalue the currency (renminbi) remains, but China has received international acclaim maintaining the value of its currency since the outbreak of the Asian financial crisis in late 1997. Some financial experts believe that China will have to widen the band in which the currency trades if exports do not pick up, investment flows deteriorate, and deflation continues. Since the crisis began, however, China has enjoyed large surpluses in its trade and investment accounts and has accumulated a war chest of $147 billion in official reserves, more than ample to defend the exchange rate.

The government has stepped up its efforts at downsizing the state sector, but investment in this sector accounted for nearly all of new investment in 1998. State-owned enterprises (SOEs) represent a long-term drag on the economy, a problem which the government recognizes and seeks to correct through such pilot projects as in the plan to downsize 1,000 key SOEs. The SOEs have close linkages to the banking system through delinquent "policy loans" that constrain the pace of financial market reforms. Tight monetary policies and constraints on bank lending have also led to a build-up of inter-company "triangular" debt, estimated at almost RMB 1 trillion. Total inventories in the SOEs at the end of 1998 remained high and grew by 25% in real terms, accounting for 28 percent of total sales. The growth of these stockpiles, which consist of goods that are not marketable because of poor quality or lagging demand, distort data the data on industrial output. SOE sales were up in the first four months of 1998, but profits were down sharply.

The central government acknowledges that unemployment as well as interregional and intra-regional income disparities are serious concerns. The average per capita disposable income of urban residents in 1998 was RMB 5425 (US$656) while rural per capita cash income was RMB 2,160 (US$251), with some areas having incomes of below half that average. The World Bank estimates that as many as 400 million Chinese live below the poverty line.

China's chronic and growing labor surplus is not reflected in the official unemployment rate of 3.2%. The official data do not account for the approximately 23 million considered to be underemployed in the state sector or the 80-120 million surplus rural workers who make up the so-called "floating population" that migrates between agriculture and construction jobs and that are at other times unemployed. A more accurate estimate of urban unemployment, cited by private researchers, would be 10-15%.

B. Principal Growth Sectors

The value added by industry to GDP rose reached RMB 3.4 trillion in 1998, an increase of 8.9% over 1997, in real terms. Growth rates in different industrial sectors continue to shift the composition of output away from SOEs to the non-state sector, which has grown by two to three times the rate of state-owned industry.

Retail sales in 1998 indicated only a slight growth in consumption. Retail sales of consumer goods reached RMB 2.9 trillion, up 6.8 percent over 1997 in nominal terms and about 9% with deflation taken into account. Retail demand rose only 7% in the first four months of 1999, contributing to deflation.

C. Government Role in the Economy

Since the beginning of reform in 1980, the role of the government in the economy has been strong. Adjustments in purchase prices for grain and other commodities, wage increases for state workers, and difficulty in collecting national taxes have contributed to a decline in official government revenues as a share of GDP. "Off-budget revenues" in many government agencies, however, may, in some cases, equal official budget allocations.

The current policy of administrative price controls is at variance with achieving maximum efficiency through market-oriented reforms. Controls on the price of transportation services and some grains were eliminated at the beginning of 1996. Further elimination of controls on commodity and energy prices, including coal prices, would benefit lower-income interior areas. The cautious stance on price reform and the importance placed on other state planning functions is likely to continue.

D. Infrastructure Investment

Infrastructure investment is a key element of China's economic growth potential, with major infusions scheduled for the road, railway, port, telecommunications, oil and gas, and coal sectors. The economy faces a glut of electricity in the coastal areas, but transmission systems and development in the interior will require continued investment. 1998, infrastructure investment grew by more than 20 percent in nominal terms, and the funds earmarked for investment rose by 21 percent, to about RMB 1.1 trillion.

The tight credit policy which Chinese officials have implemented in recent years to control inflation has narrowed the range of projects the central authorities will support. The credit squeeze means that only the highest priority projects, like the Three Gorges Dam, are likely to be approved. Domestic capital accounted for over 90 percent of investment in infrastructure in 1998. These funds come from an increasing variety of sources, including special construction fund, generated from surcharges, for example, on electricity usage and rail freight, provincial and local government sources, and domestic loans from the China Development Bank and other policy banks.

Chinese officials have said they want roughly 15-20% of infrastructure investment to come from foreign sources, but shifting foreign investment away from export-oriented industries presents some difficulties. Infrastructure investments have long payback periods, with no ready source of foreign exchange. Concerns about China's legal structure, enforceability of contracts, access to foreign exchange, the cumbersome approval process, etc., all work against foreign participation in infrastructure projects, particularly in the road, rail and power sectors. But obstacles to foreign involvement in infrastructure projects are slowly being removed. For example, changes in rules governing current account transactions have gone a long way toward solving the problem of guaranteeing foreign exchange convertibility.

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