By John Pomfret
Washington Post Foreign Service
Tuesday, August 11, 1998; Page A14

BEIJING—Until June, Helen Zhao was a Chinese success story. After graduating from college, she moved from Beijing to southern China during the 1993 boom and landed a job at an advertising agency in the special economic zone of Shenzhen, near Hong Kong. After two years, her salary topped $800 a month -- a fortune in China.

But in June, several Western clients canceled contracts, Chinese clients followed suit, and all of a sudden Zhao -- one of the highest-paid employees in her small company -- found herself facing an increasingly common fate in today's China: She got her "squid fried," Chinese slang for the pink slip.

Two months later, Zhao, 27, who favors Italian shoes and Gucci handbags, still can't find a job. She sold her car and is considering dumping her mobile phone. Like many of her peers, she is applying to graduate school to avoid what she and many businesspeople, government officials and economists have started to call "China's slump."

China finally is starting to feel the bite of the Asian economic crisis that has ripped through the Indonesian, South Korean, Thai and Japanese economies since last year, and it is starting to rein in some of its ambitious reforms as a result. Its economic growth rate -- still a healthy 7 percent -- could drop to as low as 5 or 6 percent this year, according to the international ratings agency, Standard & Poor's Corp., which recently downgraded China's long-term outlook to negative. Indeed, China won't be the fastest growing country in the world this year; it probably will be fifth or sixth, economists estimate.

The black-market rate for the Chinese yuan briefly jumped to nine to the dollar recently from about 8.2 because of fears that the government would devalue the Chinese currency and spark another round of competitive devaluations in Asia. The Chinese government has said, however, that it has no plans to devalue its currency.

Slower growth could mean trouble in China's cities where millions of people are losing their jobs as part of a bold plan to reform China's creaking state-run enterprises. The World Bank has said that China must maintain a growth rate of more than 5 percent to avoid unrest and absorb the laid-off workers. Trouble in the cities could spread to the countryside where some peasants, according to the state-run media, are becoming incensed at the state's inability to pay cash for their crops. Incomes among China's 800 million farmers haven't risen this year and, according to a report by one U.S. grain company, they are actually falling.

The economic bad news has prompted China's premier, Zhu Rongji, to pull back on his biting economic reform programs, which had been set to transform the lives of most of China's city-dwellers. Zhu's goal, announced at an unprecedented news conference in March, was to restructure China's loss-laden state companies, banks and lumbering bureaucracy within three years. But success always has hinged on an economy expanding at a pace that would create enough jobs to absorb those fired as Zhu's reforms were implemented. Other hurdles -- such as Chinese bureaucracy's resistance to change -- also are blocking Zhu's way.

"Zhu is entering a period of intense political dealmaking," said a Western economist in Beijing. "Some of the things he's trying to do are pretty tough. Lots of people are complaining. It's as if the process of him taking power isn't really quite finished yet. And the economy isn't helping him at all."

Zhu vowed in March that his reforms would continue "no matter whether there is a minefield ahead of me or whether there is a deep ravine in front of me."

Today, the straight-talking economic czar has been forced to slow his plan to allow city-dwellers to buy their own homes. Zhu had ordered that the distribution of state-owned apartments stop on July 1. The State Council, China's highest government body, recently announced that the distribution could continue until the end of the year; the council also said that the pace of the housing reform is up to local governments.

Brakes also have been applied to Zhu's proposal to cut 30 million workers from the rolls of state-owned enterprises, which employ 100 million people nationwide. Zhu's plan to allow stronger state-owned firms to merge with weaker ones has been slowed because of protests from workers fearful of losing their jobs, Chinese officials said. A civil service reform package designed to cut millions from government rolls also is being delayed or scaled back. China's Foreign Ministry, for example, was slated to lose as much as 40 percent of its work force but now it will lose only 20 percent, according to one government source.

To increase growth, Zhu and other economic officials have decided to stimulate the economy by ordering its bevy of state-owned banks to dole out loans to state-owned firms. This plan is controversial among economists, who fear that it could roll back another area of needed reforms -- in the financial sector.

China's banks are a mess and desperately need reforming. Officially, 20 percent of their loans are nonperforming. In June, Moody's Investors Service, the international credit-rating agency, estimated that the actual levels of bad loans were "much worse than even the most pessimistic of the official indications."

But Chinese authorities earlier this year directed banks to suspend recently introduced credit assessments and resume loans to state-owned companies and infrastructure projects. The banks have responded quickly. The fixed investment growth rate soared 16.8 percent in June, up from 10.3 percent in the first three months of the year.

Several questions arise: Will these state-run firms produce or build anything that anyone wants to buy with this easy money? Will the stimulus package simply add to China's already enormous inventory problem? Will any of the loans be repaid?

Andy Xie, an analyst with Morgan Stanley Dean Witter in Hong Kong, is not very optimistic.

China already has a dire inventory problem because production has been outstripping demand. In the first quarter of 1998, industrial inventories rose by $11 billion, about 6 percent of all industrial output. Since March 1992, China's industries have accumulated $207 billion in inventories at current prices -- the equivalent of 23 percent of China's gross domestic product for all of 1997, he said.

"The effort at stimulation is going to end up continuing the problems of oversupply in the market and digging the banks in a bigger hole," said John Seel, an economist with Bear, Stearns & Co. in Hong Kong.

An example of Seel's concern can be found in Qufu, the hometown of China's great sage, Confucius, in the eastern province of Shandong. Like many state-run firms, the Confucius Family Group, which makes red wine, Chinese-style pungent spirits and a foul-tasting brandy, has seen its profits slide 50 percent this year, according to factory officials.

But an easing of credit has prompted the company to go on a production binge, churning out new products.

Company officials say the easy credit will enable them to continue employing the firm's 3,500 workers without laying anyone off. Officials in Qufu say they are happy about this. "No one wants to see labor problems here," one official said.

But economists say they worry that China is sacrificing its long-term economic health for short-term stability. Chinese officials respond that they have heard this accusation before and point out that their country still is growing faster than most.

"The ironic thing about China is that they're still doing extremely well by anybody's standards," Seel said. "The problem is that they've set expectations so high. Eight percent growth is impossible. If you throw out the reforms just to achieve it, you're just creating a drag on growth down the line."