Statement by Khalid Alyahya at the Board meeting of May 28, 1998

International Bank for Reconstruction and Development 87625 International Development Association International Finance Corporation Multilateral Investment Guarantee Agency FOR OFFICIAL USE ONLY CONFIDENTIAL EDS98-240 May 28, 1998 Board Meeting of May 28, 1998 Statement by Khalid Alyahya China: Country Assistance Strategy - Progress Report I welcome this CAS progress report on China. I commend the authorities for an economic performance that is the envy of the rest of the world, and congratulate them for being able to withstand the impact of the Asian Crisis without having to resort to devaluation. This has indeed been a factor in providing a certain degree of stability to the reforming countries in the region. The authorities, however, are aware that as they move into the next stage of economic development, they will be facing very tough issues that need to be resolved. In most of these issues, there seems to be no straight answers or easy solutions. Indeed, many of them require some balancing act in terms of sequencing, degree and pace of reform. Of course, these are issues that face many reforming countries, but in China’s case and given the sheer size of the country, they take on even a more significant role. Let me turn to some of the issues that will require careful attention as the country moves deeper into reform. The first issue concerns China’s ability to maintain a high rate of economic growth. The CAS Progress Report indicates that in order to offset the negative impact on growth of the Government’s commitment not to devalue, the Government intends to increase investment in infrastructure and housing. The report cites in paragraphs 4 and 5, the negative but manageable impact of the Asian Crises and the possibility of reduced foreign direct investment as two factors that could lower future growth. I believe, however, that the external environment is important but not necessarily the major issue for the country. Weak domestic demand is the main issue. Therefore, a decision to stimulate the economy through increased investment in infrastructure and housing is indeed a good decision in any case. However, it would be important not to go overboard with such a stimulus because of its potential effect of increasing inflationary pressures. The second issue that needs to be addressed urgently but carefully is the reform of the financial sector and State-Owned enterprises. The circular relationship between both of these sectors is acknowledged in the progress report. The challenge is how to proceed with re-capitalization of the state banks and at the same time proceed with reforming the State-Owned enterprises in order to avoid  2 subsequent re-capitalization of the banks. There is no single easy answer to this. What is important however, is to deepen and broaden the financial markets, especially the capital and stock markets, to enable enterprises to finance themselves directly rather than to continue relying on indirect borrowing from the banks. Regarding the financial sector, there are basically four state banks servicing the whole country. I was wondering whether a certain degree of domestic competition in the banking sector is needed at this stage, and whether the authorities are considering this within the framework of Bank support to this sector. Perhaps the staff can elaborate on this. The third issue concerns the need to have in place an effective and sustainable social safety net. I have noted from paragraph 12 of the progress report the number of laid-off workers who still maintain links to the SOEs but have not yet found alternative jobs in 1997. The numbers are staggering and explain the point I made above about the sheer size of China and therefore the impact of policy decisions. As the Government intends to accelerate the pace of reform, having in place an effective social safety net becomes even more urgent. In this context, I have noted from paragraph 16 the social protection measures currently in place. However, while I welcome the Bank Group’s support to reduce poverty as described in paragraph 32, I am not sure that these measures are adequate. In fact, reading the progress report I get the sense that much more should be done in this area. I would like the staff’s response. The fourth issue is related to the funding of education and health programs in the absence of IDA lending after FY99. It seems to me that there are two potential sources of financing the social sectors besides IDA. The first source would be to borrow on concessional terms from other Multilateral Development Banks. In this regard, I noted from paragraph 45 that the Asian Development Bank is currently not involved in the social sectors. Is borrowing from the ADB for the social sectors an option? Or would the ADB terms also be unfavorable for such borrowing? The second source would be increased budgetary allocation. In this context, I believe the much needed tax reform could provide substantial resources. It seems to me that besides the above challenges, there is a specific challenge facing the Bank. The challenge for the Bank is to maintain a strong pipeline of IBRD projects after FY99, and preserve the high quality of the portfolio in China as we begin to support more operations inland. In both cases, the ongoing shift of Bank staff and decision making to the field could make a difference. Yet, I am reminded by Mr. Li Yong that borrowing from the Bank is not cheap any more – that the increasing requirements for studies and assessments to meet the Bank’s procedures have made it too costly for countries to borrow from IBRD. I wonder how long will it be before we begin to lose business with some of our excellent borrowers such as China. Finally, I wish the authorities every success in meeting the difficult challenges that lie ahead. I am confident that they will be able, in their own way, to more than balance the potential adverse impact of needed policies with positive outcomes.