Published October 17, 2011
China fights to dispel shadow over its SMEs
Move to spur bank lending to firms which are now in the grip of underground lenders
By VIRGINIE MANGIN
A GRIM battle is raging in Wenzhou to pump some life back into its dying small and medium enterprises (SMEs). The outcome may well decide what the future holds for China's SME sector.
Starved of funds and racked by debt, many SMEs in this industrial city in Zhejiang province have defaulted while 100 or so CEOs have fled the city since April. Some have committed suicide. The situation was considered serious enough for Premier Wen Jiabao to make a visit during the October holiday.
Following his visit, measures have been announced to help SMEs and crack down on illegal lending practices. Many companies have been borrowing from underground lenders at annualised interest rates that can touch 100 per cent in some cases - a situation that is strangling them.
In its statement, the Cabinet said small banks will continue to be allowed to enjoy 'relatively low' reserve requirements compared with big banks, so that small banks would be able to extend more credit to smaller companies. In addition, the Cabinet said it will reduce the tax burden on small firms.
Wenzhou illustrates the difficulties that China's SMEs are facing at the moment. Caught between rocketing labour costs, slowing exports and the current credit-tightening monetary policy, many are struggling to make ends meet.
One of the direct consequences of China's fight against inflation is that there is limited credit available. The reserve requirement ratio - the amount of money banks have to hold against deposits - has been raised by 600 basis points since the beginning of 2010.
As a result, banks have preferred lending to more creditworthy state-owned enterprises (SOEs), leaving China's SMEs scrambling for cash and accumulating debt.
In the first seven months of the year, Wenzhou enterprises posted a total of 640 million yuan (S$127 million) in losses, 220 million yuan more than a year earlier, according to local government data.
Many turned to the shadow banking system to finance daily operations. In Wenzhou alone, the local China Association of Small and Medium Enterprises, a sort of SME lobby, estimates that up to two thirds of the city's 200,000 SMEs have to resort to underground lending.
They borrow cash from 'credit guarantee companies' at rates sometimes four times higher than the benchmark rate. These companies - not all are legally registered - have become extremely profitable and benefit from relatively loose controls compared to banks.
There are now some 320 credit guarantee companies in Wenzhou alone. Similar outfits are sprouting in Guangdong province as well as Beijing, Shanghai and even Inner Mongolia. Some of China's big SOEs have also set up private financing arms.
Shadow banking has always existed in China but it is only since the recent tightening that it has become the main source of credit for SMEs. But interest rates are exorbitant.
'In the long run this will kill China's SMEs,' explains Cai Zhaijun, of the SME association. 'How can they make a profit when borrowing at rates sometimes three times higher than their margins?'
There is a lot at stake for China. Some analysts estimate that SMEs include some 40 million companies and account for 80 per cent of the country's jobs and more than half of the economic output.
And some are worried that the Wenzhou crisis could spread to other cities where an increasing number of SMEs are facing similar difficulties. 'Numerous reports of debt distress in Wenzhou have contributed to the latest iteration of China hard-landing anxiety,' said Tim Condon, Singapore-based chief Asia economist with ING Groep NV, in a research note. 'The fear is that Wenzhou is the tip of an iceberg.'
The government is trying to push commercial banks to start lending to SMEs again. The Wenzhou government has pleaded with the Zhejiang provincial authorities to apply for 60 billion yuan in emergency liquidity injection in the form of 'financial stability refinancing loans'.
And while the crackdown of the shadow banking system was welcomed by analysts, some say that the move will dry up credit altogether.
'The existing shadow banking system will continue to challenge policymakers,' wrote Wei Yao, China economist for Societe General in a recent note. 'Bankruptcies of those SMEs that borrow and engage in speculative activities may become a social problem, as people lose savings,' she said.
Analysts are also concerned that if liquidity becomes too much of a concern nationally, this could spark sell-offs in the property market and spread to the whole economy.
'We think more measures will be needed down the road,' concluded Ms Wei.
China needs to nip this in the bud, before it spreads.
That Premier Wen visited Wenzhou shows the attention policymakers are paying to the problem.
Central to the whole issue is the way the policymakers handle property loans. Much of the SPVs loans that were interlinked are tied to property.
To tackle inflation, China raised RRRs for banks and thetype of loans that were covered in the reserves; which had the effect of tightening the credit that smaller banks can loan to SMEs.
With inflation at 6.1% (vs 6.2% last mth), the policymakers may consider that inflation has peaked and be a little less forceful with the tightening.