By Steven Mufson
Washington Post Foreign Service
Saturday, January 17, 1998; Page A22

BEIJING, Jan. 16—China unveiled new measures today to overhaul its insolvent banking system, including a $6 billion fund to write off delinquent loans and a reorganization of regional central bank offices modeled on the U.S. Federal Reserve system. Analysts said the bank reform package was the result of a wider effort by China to learn from the economic crisis that has gripped most of the rest of Asia and to prevent the financial virus from spreading to China.

"We will learn the lessons from Southeast Asia and adopt a more cautious approach," Dai Xianglong, governor of the People's Bank of China, said during a two-hour news conference today in which he sought to allay fears about a weakening of China's economy. Dai said Beijing would avoid setting a timetable for making China's currency freely convertible, keep a ceiling on overall bank loans to "prevent a bubble economy" and punish private companies that conceal foreign dollar-denominated loans from the central bank.

Dai's remarks were just the latest signs of Chinese concern about the recent crash of currencies and stock markets around Asia. Chinese newspapers have been running articles analyzing the roots of the financial crisis in Asia, including a column in the state-run People's Daily on Jan. 6 that blasted the United States for "forcing East Asia into submission." Sources said Chinese government ministers have been holding private meetings with Hong Kong-based economic analysts to better understand what went wrong in the region.

"At the moment, top [Chinese] leaders are in a state of shock," said Joe Zhang, an economist at Credit Lyonnais in Hong Kong. "They are trying to understand what's going on."

"They want to learn the lessons from East Asia," said He Di, vice chairman of SBC Warburg Asia Holdings Ltd., who has taken part in meetings with Chinese officials.

Lesson No. 1 in the view of most analysts: The banking system must be fixed. Analysts note that the Chinese banking system is rife with deadbeat loans and -- like banking systems elsewhere in Asia -- it fails to exercise any check on imprudent investments. Banks here suffer from the sort of crony capitalism that helped undermine other countries in the region. Although Chinese leaders have talked about reforming the banking system here, people who have met with key economic officials over the past two weeks say the officials now appear ready to take action.

"It's the banks themselves that are the real time bombs for China," said John Seel, a Hong Kong-based economist for Bear, Stearns & Co.

Dai said today that between 5 percent and 6 percent of Chinese domestic bank loans are unrecoverable. He said that 25 percent of loans made by Chinese banks are nonperforming, although he noted that that figure includes loans that are as little as one day overdue. Loans that are more than two years overdue account for 8 percent to 10 percent of total bank loans, Dai said.

Because of the magnitude of those figures, many analysts say that the money appropriated by the government for erasing bad debts from the books of commercial banks is too small. Although the fund for bad loans was doubled from last year, it still will cover only a tenth of the loans Dai said never will be repaid.

Dai said that the money committed in each of the next two years to write off more bad loans would rise to more than $7.2 billion. In addition, China has been consulting former officials of the Resolution Trust Corp., the U.S. government agency that led the reorganization of insolvent savings and loan institutions in the United States in the early 1990s.

China also is taking a cue from the Federal Reserve. Dai said China gradually will close existing provincial branches of the People's Bank of China and create regional offices. Establishing branches that transcend municipal and provincial boundaries and answer to the central bank in Beijing could reduce pressures on branch managers from local political leaders who often favor pet projects.

"We will improve the independence, authority and professionalism of the central bank," Dai said.

Lesson No. 2, analysts say, is to remove protective political cover for ailing industries and press ahead with reforms of state-owned enterprises. The crisis in Asia is serving to modify plans for reshaping Chinese industry. The Communist Party congress last September endorsed the idea of companies diversifying to form larger conglomerates, but government officials have been warned by the negative example of South Korean conglomerates diving into businesses they did not understand. That is exactly what many Chinese companies have been encouraged to do to find employment for workers who no longer are needed but are still on the payrolls of state firms.

A third lesson has been to take measures to puncture bubbles in the economy. "Efforts will be made to restrict bank loans to luxury real estate projects so as to prevent bubble elements in the economy," said Dai. A "bubble economy" is one in which growth is spurred by too much speculation, as opposed to investing, and the values of things are over-inflated.

A fourth lesson is to monitor the country's foreign debts and make sure that there isn't a crunch of short-term debt, as there was in South Korea and Thailand. In South Korea, the government and its $30 billion in foreign exchange earnings were squeezed when private companies borrowed in dollars to get lower interest rates on loans. But more than half of the country's $170 billion in debt was due in less than a year.

Chinese officials are taking a new look at the country's foreign debt structure. In a speech to bankers on Tuesday, Vice Premier Zhu Rongji said that only 15 percent of China's $152.2 billion in foreign debt was short-term. One Hong Kong analyst, however, estimates short-term debts could account for as much as 27 percent of the total.

In any case, China had massive foreign exchange reserves totaling $139.9 billion at the end of 1997, Dai said. That amount would nearly cover all of China's foreign debt.

Even when it comes to foreign debt, however, the experience of the rest of Asia has spooked Chinese officials. After South Korea went to the International Monetary Fund for what turned out to be a $57 billion bailout, the Seoul government learned that South Korean companies in fact had $50 billion in debts that hadn't been reported to central authorities. When the additional foreign debt was revealed, it sent South Korea's currency spiraling downward again. Today Dai issued a special warning to Chinese companies to report their debts.

The fall of Asian currencies has made China even more cautious about adjusting the exchange rate of its own currency. Full convertibility, once thought likely when China's reserves were half as big, now seems remote.

Dai said that even though China will experience greater competition in export markets, the benefits of a devaluation of China's currency, the yuan, would be limited. Dai said that about 50 percent of Chinese exports employ imported materials and the prices of those imported goods aren't affected by the yuan exchange rate. In addition, Dai said, labor costs are still two to six times greater in other parts of Asia.

If China faces a slowdown because of weakening export markets, government economists said, it would attempt to stimulate domestic demand. Dai said that the government planned to foster a residential housing market and expand the mortgage business.

The competition for investment could be tougher. Government officials have said privately that as much as 80 percent of China's foreign investment comes from places -- Hong Kong, Japan, South Korea, Malaysia -- where people and companies are badly strapped for cash after the recent spate of currency crises.

Instead of luring new investors with a lower exchange rate, however, China has been trying to clear some of the many bureaucratic hurdles and restore some tax breaks for imported capital equipment.