China is on track to become the world’s biggest exporter and fourth largest economy by 2010, a phenomenon that the OECD attributes in its first full economic survey of the country to Beijing’s willingness to adopt difficult market reforms at the expense of the state sector.

The OECD, the Paris-based organisation which represents 30 mainly wealthy nations, said China’s economic transformation had left it well placed to maintain its average 9.5 per cent growth rate of the last two decades for “some time.”

The survey, conducted in conjunction with the Chinese government, which is not an OECD member, and released in Beijing on Friday estimates that the private sector now generates between 57 and 65 per cent of non-farm GDP, depending on how it is measured. “They have not flinched (from reform), and their policies have produced big results,” said Richard Herd, the head of the OECD’s China unit.

Since 1995, the number of state controlled companies has halved, from 300,000 to 150,000, and since 1998, the sector has shed 16m workers. By contrast, local private companies increased output five fold and foreign enterprises three fold between 1998 and 2003, compared with an increase of just 70 per cent in the state sector over the same period. “Much of the rapid state withdrawal can be traced to a rise in competition as China implemented aggressive market reforms and a fiscal system that has put growing budgetary pressures on local governments,” the report says.

The domestic private sector has thrived despite a host of obstacles, including limited access to capital markets and bank finance, high minimum capital requirements and the absence of a bankruptcy law. Foreign investors continue to dominate the export sector, accounting for more than half of all overseas sales, but their impact has been beneficial in many ways for lifting the standards of local industry.

The survey found that it was in the industries where foreign competition was the greatest that domestic companies have increased the share of sales revenue devoted to R&D the most. Alongside its praise, the OECD also had many criticisms and some caveats over its confidence in China’s future growth, chief among them the country’s poor legal system and limited flexibility in monetary policy.

The report says that the economy had been exposed to volatile inflation because of the policy of fixing the exchange to the US dollar, replaced in July this year with a tightly-managed float.

“Overall, the policy of allowing greater flexibility would allow the authorities to guard against the risk of any further increases in inflation, to more easily adapt monetary conditions to domestic concerns and to allow market forces to determine bank interest rates to a greater extent,” the report says.

The OECD also gives measured approval to China’s banking reforms, which have required the spending of tens of billions of dollars for recapitalisation. Though substantial, these costs appear, “manageable”, the report says. “However, as rapidly as the financial system has been changing, the real economy has been changing much more quickly,” the report says,