Everyone who turns an economically sensitive eye to today's China sees quite quickly that among the country's various problems one has overwhelming prominence: the misallocation of credit. While reform and opening up has transformed the industrial, entrepreneurial, educational and cultural dynamics of the society in an almost incomprehensibly positive direction, the woes of the financial system are able to scare even the most ardent China-boosters.

So tangled has the network of politically guided lending become that it is unlikely anyone is in a position to place a reliable figure on the total of bad debts in the country. There can be little doubt, however, that they now amount to a considerable proportion of both national financial assets and GDP.

By routing the task of industrial restructuring through the nation's banks, by way of politicized lending, China has perhaps postponed the task of dismantling its loss-making SOEs - and the attendant wave of unemployment in smoke-stack dominated regions - but only at the expense of the health of its overall financial system.

While China's giant State-owned banks are probably immunized against the possibility of catastrophic crisis, the more invisible problem of credit-starvation among the most productive sectors of the national economy continues, year after year, to be a serious impediment to optimum economic development. An enormous proportion of the country's available capital is channelled into staving-off disaster among sick SOEs, at the cost of potentially far more productive investment among the country's myriads of small-scale entrepreneurs. They are attempting to turn ideas into realities and build the leading companies of the future, in an environment where the pool of investment capital has already been quaffed dry by State-owned dinosaur businesses in yesterday's industries - many staggering with painfully slow steps to eventual bankruptcy and extinction.

Proving that wider social goals need not be compromised by putting credit into the hands of those who can use it most productively, Du Xiaoshan, Professor of Economics and Rural Development at the Chinese Academy of Social Sciences, has been promoting "microcredit" initiatives in the country, directing small loans to hard-pressed rural families and businesses who would otherwise fall through the cracks of the national banking system.

Such microcredit systems demonstrated their viability in Bangladesh, where Grameen Bank adopted the approach with huge success, enabling enterprising villagers to improve agricultural efficiency and set up essential services (such as pay-per-use phone calls) with sums most city-dwellers - not to mention behemoth SOEs - would consider risible. Bad loan rates were exceptionally low, with trust based on peer pressure rather than collateral.

While transformation of the SOEs will undoubtedly be painful, sabotaging the country's future in the name of its least successful businesses is not a winning strategy in the long term.

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