China's economy saw two significant symbols of change last week. One was the unprecedented open reprimand of a regional government's top official for failing to accept Beijing's guideline in a plan to build roads and factories.

The other was the widely expected raise of interest rates by the central bank, People's Bank of China (PBOC), after National Bureau of Statistics registered 10.9 per cent annualized growth in gross domestic product in the first half year. This was almost two percentage points higher than the level the government prefers.

The PBOC has only officially raised the nation's interest rates of bank savings and credits twice in the past two years. The first time in October 2004 and the second in March 2005. Compared with other countries, China's rate rises far less frequent.

The central government is beginning to employ tough intervention measures, but soon cries of pains will be heard all over the country. Every sector and every industry will start complaining about how the macro-economic control is hurting business.

The Inner Mongolia regional government was made to write self-criticisms to the State Council, the local banks and financial institutions and is already "pouring bitter water" of telling their helpless stories to the press.

The regional government had committed 5.95 billion yuan (US$740 million) into seven fixed-asset investment projects, all belonging to the power industry. The projects are now banned by the central government.

According to the local financial industry, quoted by the Chinese-language press, the outstanding loans for the entire power sector in Inner Mongolia is a stunning 20 billion yuan (US$2.5 billion), if not even more.

It will be the banks and financial institutions that will be the ultimate victims of the collapse or rescheduling of those big-ticket investment projects. Interest rate hikes and a slowdown in the lending business are very likely to be accompanied by a sluggish capital market. Most Chinese enterprises survive on bank loans and will be hurting the financial industry's health in an all-round way.

This betrays a lasting piece of legacy of the planned economy in this country. Why did all the banks lend so much money on the fixed-asset investment projects without even asking whether they had been given approval by the authorities? The banks were told the projects had been backed by the regional government. Why didn't the banks, which could not be 100 per cent assured by the words of the local power industry bosses, diversify their risk by looking for projects, big or small, in other industries?

I know of a privately-owned Beijing meat processing company, which supplies all the major supermarket chains in the Chinese capital city, that has only been provided with 30 million yuan (US$3.75 million) worth of loans in its history of nearly 20 years.

Why didn't the banks lend to this would-be supplier of the 2008 Beijing Olympics? Instead, why do the bankers rush to finance multi-million yuan projects, which were not even authorized to start? What business sense is this?

While the past 20 years of economic reform has helped create millions of Chinese entrepreneurs, it has not helped China create many real bankers. All the banks just follow the habitual growth path to get assured (even though at times not assured) interest returns by lending to government-backed big-ticket projects.

They never go out to look for worthy projects and they have no skill in doing this. They never calculate their would-be risks and returns and they do not care to do so because their personal returns are not tied to the banks' financial performance. Such a banking system is not helping the central government manage the economy, as we have found out again.

Email: younuo@chinadaily.com.cn

(China Daily 08/21/2006 page4)