China should raise its energy prices further and start to collect dividends from State enterprises in its next stage of reform, said a Beijing-based World Bank official.

David Dollar, chief of the World Bank's China Programme, said that allowing energy prices to move towards the international level is an essential measure the Chinese Government should take to make the country more energy-efficient.

"Raising energy prices will cool off some investment in industry and energy intensive sectors," Dollar said in an interview with China Daily.

"And it will encourage the shift towards a more consumption- and service-based economy."

Facing soaring international oil prices and intensifying constraints from the shortage of energy, China has made energy efficiency one of the key priorities in its 11th Five-Year Plan (2006-10).

The country's energy prices, which are mostly controlled by the government, have been inching up, but are still much lower than the global price.

Dollar said the government's concerns about the pains from higher energy prices were legitimate; industrial enterprises, taxi drivers and car owners, among others, will all be affected. But the pains are something that cannot be avoided.

"The high (worldwide) energy price is with us to stay," Dollar said, adding that long-term benefits for China from higher energy prices outweigh the short-term pains.

Dollar said the country currently has a favorable environment for such reform. Rapid economic growth, low inflation and generally rising incomes will all help cushion the impact.

"I think it's in the government's interest to announce right away that domestic energy prices will move towards international pricing" so people factor it in when making plans for new investments and new purchases of cars and apartments, Dollar said.

The second most important thing Dollar recommends the government do is to collect dividends from State-owned enterprises.

In the process of reforming the State enterprises during the past two decades, the government never demanded dividends from them. For years, the majority of State firms were struggling to survive. The government seemed content so long as they did not cry for more subsidies and those in better condition were able to pay taxes.

However, a World Bank study concluded that China's State enterprises were registering a modest rate of profit in recent years. And they tend to use the profits as new investments. Many of these are unwise investments that exacerbate the overall overheating investment growth in the country.

Dollar said the government can collect the dividends and use the money in sectors like health and education, both of which are considerably underfinanced.

"That is a direct thing the government could do to help the rebalancing of the economy," he said.

In addition, Dollar said that raising energy prices and collecting State dividends should be complemented with countermeasures to mitigate potential negative effects.

Simply raising energy prices tends to be inflationary. But if the country can allow moderate appreciation of renminbi's exchange rate, which tends to be deflationary, then the net effect could be price stability.

Similarly, collecting dividends from State enterprises could reduce their investment and slow down growth, but spending on health and education will become fiscal stimulation.

"All these things have to be put together in a pretty careful package to keep the macro economy growing at a healthy rate," he said.

It is inevitable that many of China's further reforms will be controversial, Dollar said. A key reason is that there are more interest groups in China now than in the past, such as the powerful industries and the powerful provinces and municipalities.

"It is harder to reach consensus for reforms when you have more interest groups," he said.

He took the case of corporate income tax as an example. Foreign-funded enterprises have been enjoying preferential rates for the corporate income tax in China.

"I think there is a pretty broad agreement that the domestic companies and the foreign companies should be taxed at the same rate, " Dollar said. But, he added, the unification of tax rates has been postponed time and again under heavy lobbying by foreign investors, who are now an interest group, and some cities in the southeast, which share some common interests with the foreign companies.

Another hindrance for further reforms is the success of past ones. Thanks to the reforms in recent decades, China has developed a growth pattern that has been serving itself very well. "It is understandable that people grow attracted to the model that is successful," he said.

But in the long term, the model is not sustainable, either in terms of the current investment rate, the rate of natural resource use, or the rate of export growth, Dollar said.

Some short-term problems, such as a sudden downturn in the growth of the rest of the world, spell troubles for the current growth pattern, he said.

"The model has to be changed," Dollar said.

In the financial sector, another key area in China's reforms, the country also has much to do, Dollar said.

China has taken some bold steps in transforming the major State banks, by allowing them to introduce strategic investors and make initial public offerings.

However, the financial sector is still lagging behind many other areas in terms of reforming themselves. It is still difficult for small and medium-sized enterprises to get access to credit. Some basic financial institutions remain rather underdeveloped.

In addition, for an economy that has been booming for years, the stock market has not shown much progress in becoming a more effective instrument for resource allocation. There seems to be a disconnect between the stock market and real producers in the country.

Indeed, the country's reform agenda in many sectors is still unfinished.

But the government should not balk at difficulties in pushing ahead with necessary reforms, Dollar said.

"The challenge for a middle-income developing country like China is to keep up the institutional reform."

(China Daily September 19, 2006)