This is a difficult and uncertain time for China. The financial crisis that star ted in Thailand more than one year ago has sharply reduced China's export growth at a time thatdomestic demand was also slowing. The worst of the crisis now see ms to be over, but economic prospects for many countries in the Region, includin gin particular Japan, remain uncertain. In China, enormous social and environme ntal challenges are converging, while there is increased financial pressure on t he Government and on the banking system. This paper describes these challenges i n the context of China's reform efforts and suggests directions in which solutio ns can be found. This can best be introduced by stating some conclusions:

　　·Even with reduced export prospects, China should be able to maintain macroecon omic balance and a reasonable growth rate necessary for employment generation an d for the maintenance of value of State assets. Current monetary and fiscal poli cies are broadly appropriate for this purpose. With the finetuning of these poli cies and additional measures at the national and the local level to promote priv ate and other non-State investment,the reform process can stay on track.

　　Government an on the banking system. This paper describes these challenges in th e context

　　·The need to stimulate growth in China at this time of financial crisis in Asia and domestic economic and social stress,is not incompatible with the need to sl ow or reverse environmental degradation and to further reduce poverty. More fisc al stimulus program resources should be allocted to environmental projects, to t he protection of State pensions, unemployment benefits and povety alleviation

　　·To ensure the sustainability of development in China, it is necessary to integ rate economic and environmental policy making at the national and the local leve l to a much higher degree than is the case at present. This was recognized as a key objective in the Ninth and earlier Five Year Plans

　　·The old philosophy of "grow now-worry about the environment later" is still al ive at the local level in many parts of China. To overcome this outdated way of thinking, environmental education needs to be given more attention Non-governemt al organizations can place an important and constructive role in this.

　　·To achieve environmental and development objectives, China has to increase the share of National Incom devoted to environmental protection by about 1%, accord ing to a recent Wrld Bank study. Most of the needed increase will have to come f rom the non-State sector. This will require stronger and more carefully targeted incentives and penalties for creating a cleaner environment and more effective local enforcement of environmental laws and regulations

　　·The solution to some important environmental problems in China lies in the acc eleration of mrket reforms. Price incentives and mrket forces have to work for t he environment, not against it, as is unfortunately often still the case. A stro nger incentive structure needs to be backed up by equally strong institutional a rrangements and administrative capacity.

　　·China will need more and better coordinated international financial assistance for environmental improvement.

　　·China will increasingly be called upon to play an international leadership rol e in promoting sound environmental and development policies around the world. At the same time, the success of China's economic reforms and environmental polici es is of great and obvious importnce to the rest of the world CCICED provides an excellent forum for international consultations on China's environment nd devel opment as well as access to valuable knowledge and experience vailable in other countries.

　　China's Concern for the Environment

　　It is usefu to begin with some historical notes. Twenty years ago next month, Ch ina embarked on a unique modernization process involving the gradual transformat ion of its centrally planned economic system into an open socialist market econo my. It has been the longest period of rapid growth and modernization, with stabi lity, during the past century and a half of Chinese history. The decisions taken in December 1978 at the Third Plenum of the Eleventh Party Central Committee un der the leadership of the late Deng Xiaoping, were of great national and interna tional significance. As is well known around the world, China's reform process h as generated impressive results, but we have to recognize that it is only partia lly complete. Many difficult challenges, including financial and environmental o nes lie ahead.

　　Environmental concerns were part of China's reform agenda right form the start. Already in 1979 the NPC passed on a trial basis the country's first Environmenta l Protection Law which established a general legal framework for regulating agai nst environmental degradation. Since that time, the legislative and regulatory f ramework for environmental policy has deepened and broadened significantly, whil e institutions were built and people trained to set standards and formulate poli cy, For example, in 1989 the Environmental Protection Law was revised and formal ly promulgated. In1992 China was among the first nations to act on the Rio agend a by formulting an Environmental Action Plan and, in1994 the State Council appro ved "China Agenda 21, a White Paper on Population, Environment and Developement" which sets out major new policies for sustainable development. Finally, in Marc h of this year, to underline the importance attached by the Govtablished in 1985 , was elevated to full Ministerial status and renamed State Environmental Protec tion Administration.

　　Economic Reforms and the Environment

　　The refrms of the past twenty years have led to quadrupling of national income and sharp improvements in infant mortality, life expectancy and absolute poverty . China became the world's seventh largest economy, (the second largest if measu red on a PPP basis) and the nint largest trading nation. Personal freedoms incre ased greatly, as did popular interest in sports, music, architecture, arts, fash ion, foreign travel, nature conservation and, indeed, also in politics. There wa s rapid improvement across many areas of human achievement.

　　In two important areas, however, improvements and reform implementation lagged b ehing the growth of new problems. The first is the condition of may of China's f inancial institutions and the second is the environment. Financial sector weakne ss in China is reflected in the high, often excessive debt of State owned enterp rises (SOEs) and the fact that a large, but unknown proportion of that debt is o f questionable value. Why talk about financial debt at an international meeting on the environment? Because it helps to illustrate important analogies and linka ges between economic reform challenges and environmental issues. From a praction cal policy perspective, concerns about China's economy and its financial system, can not be meaningfully separated from concerns about its environment. Even at the regional level, they have become closely interlinked nd the subject of local politics. A lack of reforms lies at the root of may environmental and financial problems in China.

　　The non-perfrming debt of SOEs can be seen as a depletion of the State's financi al capital. It is a kind of end-of-pipe" financial pollution" resulting from del ayed reforms at the enterprise level and a tolerance for losses, often motivated by social (employment) concerns. It represents part of the contingency debt of the State, or a claim on future resources for bank recapitalization. It is poten tialy a threat to the stability of the financial system as it increases the vuln erability of the economy to internal and external shocks. The Asian financial cr isis revealed similar weaknesses in the banking systems of several countries in the Region. China's large domestic contingency debt is offset by net State asset s, but the market value of those assets is related to the performance of the eco nomy. Therefore, the maintenance of a reasonably high, sustainable economic grow th rate is important, not only for employment generation, but also for protectio n of the financial health of the State.

　　Like environmental degradation, th full extend of "financial pollution" can rema in hidden for a long time, especially in countries with a reltively stable macro economic situation such as China, but weak corprate governance and accounting pr actices. Unlike environmental degradation, however, which tends to be gradul pro cess, serious financial sector problems can suddenly erupt as the Asian financia l crisis demonstrates.

　　Environmental degradation amounts to a depletion of a country's natural capital in the form of clean air, clean water and good sils. It threatens the health of people, animals and plants and the quality of life. As in the case of "financial pollution" it is like spending resources you don't have. It represents a claim on futre resources for clean up efforts. Remedial policies for the analogous env ironmental and financial sector problems are also linked and have to be pursued in a coordinated fashion. In the past it was thought that there is a trade-off b etween development and the environment, and that the environment could wait. Tha t view may have had some validity when clean air, clean water and good soils wer e still relatively abundant, but that is now definitely not the case for eastern and southeastern China where most of the country's population is concentrated.

　　The Scale of Environmental Challenges Facing China

　　The monumental scale of environmental challenges facing China is best illustrate d with the help of some basic demographic indicatos. (Refer annex table.) Some 7 7% of China's population, or 925 million people (one and a half times the combin ed populations of the EU and the USA)live on less than 30% of its geographical a rea, implying a population density of 332 per km2; about 400 if uninhabitable ar eas are taken into account. This is a higher population density than in any adva nced industrial country except Japan and the Netherlands. China's rapidly growin g urbanization rate adds to the pressure on resurcs and put a premium on effecti ve land use planning for efficiency in transport and energy use. Aready almost 4 0% of China's population in the eastern and southeastern portion of the country lives in cities and this proportion will probably reach 50% for those areas with in the next 15 years.

　　As incomes and ecological awareness in China rise, local and national environmen tal issues will inevitably move further to the center of national and local poli cy making and politics. The dilemma is that many of the issues are already so se rious that they cannot wait. China does not have the luxury of time that the mor e advanced industrialized nations had during the last century and the first half of this one. The uncommon scale and the urgency of China's environmental challe nges require uncommen national and international responses. China will have to l eapfrog to the latest available technologies for emission control and waste disp osal. Such technological leapfrogging is already beign effectively accomplished in other areas such as, for example the telecommunications sector.

　　The facts about China's most pressing environmental problems are well known to t he members of CCICED. Many highly polluting industries and power plants are stil l located in urban areas, while most households and industries in both urban and rural areas are dependent for most of their energy needs on locally urned coal of poor quality. Coal is China's economic biessing and its environmental scourge . In most cities the capacity for wastewater treatment and the effective disposa l of solid and hazardous wastes is still grossly inadequate. Athough private aut omoile ownership is still relatively rare in China, many large cities are alread y congested, because the development of infrastructure and modern traffic manaem ent has lagged. Extremely poor air quality, by WHO and by official Chinese stand ards, is common in many big cities. Urban water supply systems and sanitary faci lities are reasonably well developed in China, But, unfortunately, the availabil ity of water is increasingly falling behind demand in many cities and agricultur al areas of the mid-northeast, because of falling ground water levels and a dryi ng of the lower reaches of the Yellow River. The growing water shortage in those areas, is among the most serious environmental and economic problems facing Chi na.

　　Many rural areas in eastern and southeastern China are also plagued by pressing environmental problems. Athough major clean up efforts for some rivers, lakes an d coastal waters are underway and the political lcommitment underpinning these e fforts is strong, surface and ground water pollution is at dangerous levls in ma ny parts of the country. Another serious form of rural environmental degradation is the indiscriminate and illegal cutting of trees on mountain slopes in the up per reaches of the Yantze River basin. Such activities have contributed signific antly to the massive floods of last summer. Even rural air pollution can be seri ous due to the very large numbers of low-efficiency boilers in use by small indu stries. The most serious air pollution problem threatening human health, however , is commonly found in poorly ventilated indoor areas, due to cigarette smoke an d the burning of coal and other fuels for heating and cooking.

　　It is essential for China's long-term sustainable development that environmental degradation is arrested and trends reversed, as soon as possible. It is also cr itical, however, that the accumulation of nonperforming debt on the balance shee ts of State financial institutions is stopped and that State banks are recapital ized. This is necessary for financial stability. but ultimately also for sustain able development. China needs a strong financial system to sustain its moderniza tion drive. HOw are these twinenvironmental and economic reform challenges linke d at the practical level? What can be done to advance effective integration of p olicy making in these two areas? The answers lie in the implementation of genuin e market reforms, in the effective integration of economic and environmental pol icy making and in the strengthening of regulatory institutions. A good example o f an area where improvements in all three are needed is river basin management a cross administrative boundaries. Incentives alone cannot do the job. There must also be a regulatory authority with powers across other administrative boundarie s and a shared concept of developmental objectives for the basin.

　　Integrating Environmental and Development Policy Making

　　In preparation for this paper, the draft minutes of the meetings of the Project Group of the Joint Program on Ecomonic Planning and Environmental Protection in China that were held in Beijing on July 10-11 this year were reviewed. Those mee tings yielded many useful suggestions for improved collaboration between relevan t institutions, for the conservation and long-term development of forests, for t he development of environmental industries and for investment and sechnolgy choi ces in the energy sector. This paper agrees with those suggestions, and believes that they do not go far enough. There must also be a harmonization and integrat ion of environmental and economic development objectives at the highest levels o f macro policy making, involving the State Development and Planning Commission, the Ministr of Finance, the Central Bank and their agencies. Fiscal and monetary policies and their implementation, especially at the local level, are also impo rtant for China's environment. Effective environmental policy making cuts across most major areas of macro and sectoral policy making, at the national and the l ocal level.

　　The following examples illustrate the point: a conservative monetary policy comb ined with hard budget constraints, will force loss making enterprises to reform faster, retool, or disappear. Enterprise reform is good for the financial system , but usually also for the environment. Fiscal incentives can promote the choice of modern production techniques and equipment that is cleaner and more efficien t than in the past. Local taxation and pricing policies can also greatly influen ce water and energy conservation as well the patterm of urban development and tr ansportatin choices. China has barely begun to use such policy instruments for e nvironmental purposes. Fuel, water and electricity tend to be underpriced in Chi na. The social costs of pollution are rarely reflected in prices.

　　Because of the high population density in eastern and southeastern China, carefu l land use planning through direct administrativ controls (for example zoning la ws) and indirect price-or fiscal incentives, is imperative. Some large cities in China have developed or are developing urban transport plans. The principles of energy efficient spatial planning for cities, industries, agriculture, forestry and recreational areas, have to be applied in the entire densely populated east ern and southeastern part of China. There are few practical examples to follow f or China. No developed country has ever had to face environmental challenges on the scale that China is facng now. The only densely populated developed country that has systematically tried to plan the use of its limited space at the nation al level over an extended period, is the Netherlands. Even that country, however , has been unable to avoid monumental traffic jams as part of a daily reality an d some other serious environmental problems.

　　As stated above, the recently adopted fiscal stimulus program, which amounts to about 2.7% of GDP, is broadly well conceived and shoud enable China to maintain a reasonable growth rate in the near term future. Preliminary World Bank estimat es suggest that this program will add 0.5-1.0% to the 1998 growth rate and 1.5-2 .0% in 1999. The total impact of this program on GDP growth will be larger than the orignal stimulus, due to multiplier effects. The finetuning referred to earl ier could aim at making the investment program more directly useful to environme ntal protection and to poverty alleviation. There are large environmental progra ms, such as for example tree planting and flood repairs in poor areas that would accomplish both objectives in parallel. More direct support for the payment of unemployment benefits and State pensions in poor areas, is also worth considerin g.

　　Role of the CCICED

　　China has taken environmental concerns very seriously from the start of its refo rm program twenty years ago. The international community has a large stake in Ch ina's success. The China Council provides an important forum for consultations a s well as access to a world-wide network of knowledge and practical experience. The Council is entering its seventh year and has contributed significantly, ofte n through various specialized subgroups to environmental policy making in China. The Chinese themselves are the main driving force behind the Council. This is k ey to its continued success.

　　Novemer 9,1998

　　Population Density in Selected Chinese Provinces (Accounting for 77% of Total Ch inese Population) and in Selected European Countries, USA and EU

　　Table