Sunday, 13 November 2011

A city built on borrowed time

The runaway debt crisis affecting Wenzhou’s entrepreneurs underscores the fragility of private-sector finances across the nation

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Guanyu 道 said...

A city built on borrowed time

The runaway debt crisis affecting Wenzhou’s entrepreneurs underscores the fragility of private-sector finances across the nation

Bloomberg in Shanghai and Hong Kong
11 November 2011

Hours after a creditor and his gang of thugs hustled Zhong Maojin into a coffee shop in Wenzhou, he says he wouldn’t yield to their demands.

They wanted to take over one of the pharmacies in a chain he’d built by borrowing from private lenders. Instead, he made an offer of traditional retribution in this city, known for loan sharks who have sometimes meted out violence to bad debtors.

“If you like, you can cut off one of my fingers instead,” Zhong, 42, says he told them.

Giving up the store would have made it impossible to pay back another 130 creditors, Zhong said. He’d borrowed 30 million yuan (HK$36.8 million) at interest rates of up to 7 per cent a month to expand the business.

At least 90 bosses in similar situations to Zhong have fled the city since April, and two killed themselves, according to Zhou Dewen, head of a local small business association.

Wenzhou’s 400,000 businesses are facing financial hardship because of rising costs, soaring black market interest rates and a sudden credit squeeze, Zhou said. Similar problems are happening across the mainland because private enterprises rely on underground borrowing rather than banks to operate, he said.

Their predicament prompted Premier Wen Jiabao to visit the city on October 4, where he pledged help for troubled businesses. National and local leaders have since announced moves to help small firms, including offering easier access to bank loans, a cap on private-lending interest rates in Wenzhou and a crackdown on violent loan sharks.

The measures have done little to help Zhong. “I am under huge pressure,” he says at a warehouse with fast-depleting stocks of medicine. “We don’t have enough money.”

The sudden collapse of informal lending networks reveals the fragility of China’s unregulated financing system when credit tightens and creditors lose confidence, said Tao Dong, an economist at Credit Suisse Group.

Tao estimates that outstanding private loans stand at 4 trillion yuan, or 8 per cent of total lending in the mainland. “Wenzhou is just the tip of the iceberg,” Tao said, adding that most of the informal lending has been pumped into a nationwide property boom that is showing signs of slowing.

The risks to the wider economy include a potential credit freeze triggered by increased mistrust among informal lenders, also referred to as roadside lenders, said Wang Tao, an economist at UBS in Hong Kong.

That could trigger more widespread bankruptcies, she said.

Wenzhou was the first mainland city to widely embrace private enterprise in the early 1980s. Businesses used family and hometown networks because bank were reluctant to lend.

The local government helped foster that by taking a lenient approach to private lending, according to Huang Yasheng, an associate professor at the Massachusetts Institute of Technology’s Sloan School of Management. A previous credit squeeze in Wenzhou 25 years ago affected 200,000 lenders, resulting in 523 kidnappings and more than 30 deaths, a local government website claims.

At his warehouse on Wenzhou’s industrial outskirts, Zhong tells how he relied on money lenders to build Blue Sky Pharmacy into a chain of 27 shops in just three years.

A doctor from a mountain village, Zhong borrowed money to pay medical bills he ran up caring for his wife who died at 23 of liver disease. After he remarried, to a woman with debts of her own from running a money-lending business, he opened up a pharmacy in Wenzhou to try to pay back their combined debt.

The couple took on more debt to fund their expansion, Zhong said, and borrowed from elderly neighbours from his home county.

Guanyu 道 said...

Small and medium-sized businesses account for 80 per cent of jobs in China, according to the country’s industry ministry. Yet they’re largely unable to get loans from banks, which prefer collateral to cash-flow.

By tapping into his hometown network, Zhong was the final link in a long chain of debt.

“For usual lending, Bank A lends to a customer and sees the cash flows,” said Tao, the Credit Suisse economist. “With informal lending, it goes from A to B to C, all the way to XYZ. Once it’s beyond C, you have no idea where this money went to.”

In Zhong’s case, the trail of debt can be traced to local residents who have turned money lending into a cottage industry. They built a lattice of interlocked credit, often borrowing from banks and other private lenders to arbitrage interest rates. Taking out bank loans at 1 per cent a month, many lent out their cash for 2 per cent or higher a month.

Wenzhou businesses were already facing declining exports to Europe and the US, and rising labor costs, said Chen Yuyu, associate professor at the Guanghua School of Management at Peking University. Minimum wages in Zhejiang province, where Wenzhou is located, have risen 19 per cent since last year.

Zhong needed cash to keep paying his suppliers, rent and staff. In a local paper he saw an ad for loans without collateral. He arranged to borrow 600,000 yuan for one month, from what Zhong called a gaolidai, a Chinese term for a loan shark. He borrowed again and started to just pay interest and roll over the principal. Rates rose to 7 per cent a month.

Informal lenders demand annual interest of between 20 per cent and 40 per cent or higher, many times the official lending rate of 6.56 per cent a year, UBS’s Wang said. The rate rose as China’s new bank loans decreased, down to a 21-month low of 470 billion yuan in September.

Zhong thought his problems would be solved in August after two friends agreed to act as guarantors to secure a loan from the local branch of Fuzhou-based Industrial Bank.

It was for 15 million yuan at 1 per cent a month, divided into two tranches. One of the guarantors put up his flat in the centre of the city as collateral in exchange for 60,000 yuan a month from Zhong, he said.

There was a snag. By now, Zhong said he owed the gaolidai 4 million yuan. The first tranche of the bank loan mostly went to paying that debt.

When word of Zhong’s shortfall spread, angry creditors flocked to his warehouse demanding their money.

In September, the alarm spread across Wenzhou after newspapers reported businessmen had fled or killed themselves because they couldn’t pay debts.

“Everyone was nervous and insecure,” said Zhong. “Panic was everywhere. Blue Sky is famous now ... for its debt. No one is going to lend me money.”

The premier’s visit to Wenzhou led to initiatives to help private businesses. The city government set up an emergency 1-billion-yuan fund. Its anti-loan shark campaign led to the October 27 arrest of a couple suspected of illegally raising 1.3 billion yuan, according to China Daily.