China's Credit Crunch Is Killing Exporters

By Quartz  FEB 05, 2013 10:30 AM

A sign reading "Dongguan City People's Court" is taped over a shuttered factory, one of many in the once-thriving export hub.

 


Edward Tsui-ping kwong owns a factory that makes nuts, screws and rivets in Dongguan, a sprawling industrial city near Hong Kong that before the 2008 global crisis was an economic powerhouse fueled by small, energetic exporters manufacturing basics such as auto parts and furniture.

He says the district of Dongguan where his factory is based, called Fenggang, is dying.

“Back in 2008, Fenggang had around 1,000 factories. Now we have under 600,”says Tsui, a Hong Kong native and vice president of Hong Kong’s China Manufacturing Association.

And one of the city’s biggest problems is a shortage of bank funding.

“Exporters have a lot of problems, such as the economic situation in the US and Europe and rising wages. But when small- and medium-sized companies here need finance to support themselves, it is really difficult to get the support from the bank.”

Tsui’s company, which is called Shing Hing Industrial and employs 680 people, is doing okay thanks to good relationships with Hong Kong banks. But he says most small exporters he knows that have gone out of business shut up shop because they could not get loans.

China is suffering a credit crunch as its banks grapple with a rising pile of bad debts. Back in 2009-2010, these lenders doled out a record 17.5 trillion yuan, under orders to keep the economy motoring despite the global crisis. Local governments began building huge and questionable projects, such as this planned replica of Manhattan, and racked up a lot of debt. The nation’s banking regulator has warned about a pile-up of bad loans so lenders are avoiding all but the largest, government-backed companies.

“When there is only so much money to go around, bank branch officials will lend to the large, state-owned companies first and the others have to fight over what is left,” says David Chow, head of the principal investment group at Taiwanese bank CDIB and a former managing director at Beijing government-owned China Development Bank (HKG:1062).

The Wall Street Journal is reporting that Chinese banks are lavishing funding (paywall) on state-backed companies. That approach by the banks seems shortsighted. In China, privately owned small- and medium-sized enterprises (SMEs) have long been the country’s main force for job creation as well as exports.

For small private companies, loan costs have rocketed. Last September in Fenggang, the state-owned banks wanted 7-8% a year annual interest from exporters, Tsui says. He adds the banks are now asking for 10-12% annual interest and often want factory owners to pledge assets that are worth 100% of the value of the loan. China’s benchmark lending rate is 6%.

“If you are not a big successful enterprise you probably do not have valuable property or equipment that the banks will accept as a guarantee,”Tsui adds. “So many SMEs here just do not have credit.”

On top of that, small Chinese exporters are grappling with rising wages and a thinning order books due to the ongoing weakness in the US and European economies.

Unlicensed moneylenders known as the “gaolidai” are charging companies 30% annual interest a year in Fenggang, Tsui says. “Companies who borrow at this rate often cannot pay back and then close down.”

The problem is the same all over China’s southeast, where exporters have long congregated because the area’s good transport and ports make it the best place from which to ship goods to the West.

In Wenzhou, another wealthy manufacturing city in the southeast, almost 90% of families have taken part in “gaolidai” syndicates to profit from lending to struggling importers at these high rates. In 2011, Wenzhou was swept by a wave of bankruptcies which spurred factory bosses to commit suicide or flee the city after failing to repay their moneylenders. And banks in the city were caught up in the crisis. The Wenzhou branches of major Chinese banks are sporting bad loan ratios of up to 10%, according to Chinese media (report in Chinese), which is making them more reluctant to extend credit to exporters.

Steve Dickinson, a China-based attorney for Seattle law firm Harris Moure, says he also recently observed the funding crisis in Fuzhou, a southeastern manufacturing hub around 900 kilometers north of Dongguan. “I just visited Fuzhou for work,” says Dickinson. “It seems no-one down there can get a loan either.”

“But the problem is general for small businesses in the export trade.”

China’s new leaders, led by incoming president Xi Jinping, are thought to favor government-backed companies over the private sector. Xi and the majority of the rest of China’s top governing body, the Politburo Standing Committee, are mainly so-called “princelings.” These are descendants of Chinese Communist revolutionaries whose families are often financially entwined with China’s SOEs and who tend to promote SOEs’ fortunes.

But the government also wants its export industry to move inland from the coast and be replaced with high-tech enterprise.  So perhaps banks are allowing private enterprises in the southeast to wither as part of Beijing’s plan to move industry to central China, where people are poorer and wages are lower.

Foxconn (PINK:FXCNY), Apple’s (NASDAQ:AAPL) Taiwanese supplier and mainland China’s largest foreign employer, was lauded by China’s state-controlled media when it opened a huge facility in Zhengzhou, capital of the inland province of Henan, in 2010.

And despite the credit crunch, Chinese banks are finding extremely creative ways of funnelling cash to state-approved borrowers, such as using retail depositors’ savings to fund off-balance sheet loans. So while China’s so-called “shadow banking” sector is growing at a worrying pace, the denial of funding to southern exporters does seem policy-driven.

“I have heard Chinese officials explain this policy as one of ‘empty the cage, change the bird,’” says CY Huang, chairman and CEO of Taiwanese investment bank FCC Partners.

“The policy is one of no longer wanting gigantic manufacturing plants in the southeast that take up land and create pollution and waste. But basic manufacturing is seen as beneficial for the middle of China, in places like Henan,” said Huang. “Still, perhaps the lending policy is too dramatic and drastic. I think the Chinese banks are lending 80-90% to SOEs.”

But China will struggle to create a high-tech economy rivalling Taiwan or South Korea. As Quartz has argued before, highly controlled dictatorships such as China that censor the internet and frown on free speech do not foster creativity.  China may not be producing enough creative minds or skilled managers (pdf), argued Edy Wong of the University of Alberta in a paper earlier this year. And university education remains a scarce luxury (video). China’s export sector may hollow out without being fully replaced.


This story by Naomi Rovnick originally appeared on Quartz.

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