Squeezed by the Credit Freeze

China's consumer price index (CPI) had surged up to 5.4 percent by March of last year. This marked the first time it had risen above five percent in almost three years, and the government made the decision that curbing inflation was to be a top priority. One of the first actions it took towards reducing inflation was to tighten credit. As of last October, the People's Bank of China had increased the reserve requirement ratio (RRR) for commercial banks to 21.5 percent, the highest in the world, and raised interest rates on commercial loans to over 6 percent.

As China has tightened its money supply, the more than 40 million small enterprises have been feeling the squeeze.

Banks usually prefer to give loans to big and high-turnover enterprises in times of tight credit. According to statistics released by the All-China Federation of Industry and Commerce, at present 90 percent of small businesses are unable to obtain loans from banks. As many as 95 percent of micro businesses in China have never taken out any bank loans at all.

"I've never taken out a loan. When I need capital, I usually proposition my relatives and friends," says Zhu Kewen, who runs a garment factory with about 30 workers in Dongguan, Guangdong Province.

As many SMEs can't secure loans from formal financial institutions, some of them resort to loan sharks who charge sky-high interest rates, usually two to three times of those demanded by banks and far beyond the ability of SMEs to repay given that their profit margins are three to five percent. The recent debt crisis in Wenzhou traces its origin to these loan sharking activities.

Because of narrow profit margins in the manufacturing industry, many entrepreneurs in Wenzhou have packed up and gone into the real estate or stock market sectors. Some entrepreneurs tried to juggle businesses in all three areas, but most have gone bankrupt in the process following recent upheavals in the stock market and government interventions to cool the real estate market.

The Government Steps In

SMEs produce 68 percent of China's industrial output and supply around 80 percent of the country's jobs. With this in mind, the recent plight of SMEs has piqued the concern of the central government. A series of policies and plans has been introduced to help them weather the rough seas of the current economic climate.

Released by the Ministry of Industry and Information Technology, the 12th Five-year Plan (2011-15) for the Growth of SMEs is China's first special plan at the national level focusing on the development of these enterprises.

"Small enterprises should be priority customers for bank credit and should also be entitled to preferential tax policies," Premier Wen stated during his visit to Wenzhou on October 5. "Banks should be more flexible when it comes to the non-performing loan ratio among small enterprises and need to reduce the cost of securing credit," he added.

One week after the premier's visit to Wenzhou, the State Council released a statement pledging stronger financial and fiscal support to small and micro-sized businesses by reducing their tax burdens and encouraging banks to increase loans to them. The cabinet's fiscal support measures for small firms include raising the thresholds for corporate value-added taxes and business taxes, extending the policy of halving business income taxes by another four years, and exempting small firms from the stamp duty on bank lending contracts for three years.

Spurred on by the government, China's commercial banks have increased their loan ratios to SMEs. They are also now prohibited from charging fund management fees, financial consulting fees and other similar charges for their services to small firms. At the end of last year the Bank of China committed itself to lending RMB 120 billion to small firms in the short term.

Back in Wenzhou, Li Zhongjian is cautiously optimistic about the future. "There's no doubt these policies are really helpful and should be effective in getting debt-laden enterprises out of their current difficulties. As for enterprises like ours which are able to maintain normal levels of production but are squeezed by higher bank interest rates, we would like to see a more relaxed monetary policy," Li says. "I also hope those SME-favouring policies will be implemented well at the local level," he added.

A Way Out

Wenzhou's liquidity crunch has been the impetus for serious self-reflection among local businessmen. "Entrepreneurs need to take a hard look at their current business practices. Discouraged by slim profit margins in manufacturing, entrepreneurs have withdrawn vast sums of capital to invest in real estate and other non-productive markets. This has greatly impaired the strength of the manufacturing industry, making it very vulnerable to ups and downs in the market. They have undermined their own capacity to achieve sustainable development," Zhou Dewen, president of the Wenzhou Small and Medium Enterprises Development Association and vice president of the China Association of Small and Medium Enterprises, told China Today.

The case of SMEs in Wenzhou is a classic example of macro monetary policies aimed at curbing inflation and property market speculation by restricting liquidity being at odds with microeconomic localized imperatives to encourage lending and growth.

Zhou Dewen agrees with Premier Wen's suggestion that governments, entrepreneurs and economists should team up to draft specific plans for the long-term development goals of SMEs that look both at and beyond the current difficulties they face.

Although the phenomenon of excessively high interest rates attached to private capital was a key factor in the Wenzhou debt crisis, Zhou Dewen maintains that it is unnecessary to completely remove private capital from the picture. He says the rapid development of Wenzhou's SMEs owes much to the abundance of private capital in the area. The government should introduce intelligent policies designed to guide and regulate private lending operations and integrate them into mainstream finance, he says.

Zhuo Yongliang, director of the Zhejiang Reform and Development Research Institute, also suggests authorities provide incentives for businesses to focus on the real economy rather than on speculative, unproductive markets. Blind expansion should be discouraged and prudence encouraged, and small enterprises should in the longer term seek to move higher up the value chain by improving the technical content and quality of their products. This is the only way they can avoid being eventually undercut by lower-cost competitors overseas, Zhuo explains.

Huangshan Longye Brass Products Co., Ltd. of Anhui Province is one SME that seems to be defying the trend by continuing to prosper over the last couple of years. The key, according to Jin Yiquan, executive manager of the company, lies in shifting their products up the value chain.

"Currently, common brass products reap a paltry profit of 0.1 percent of the selling price, but generally speaking profits of at least three to five percent can be made on products with a higher technical content and better quality," Jin told China Today. By upgrading its product line, Jin's company increased annual sales to RMB 800 million from RMB 600 million last year.

Times were too good for too long, says Zhuo Yongliang. Cruising along in an atmosphere of loose monetary policy, when credit was finally tightened, many SMEs suffocated due to a lack of working capital. Zhou Qiren, dean of the National School of Development at Peking University, explains that for the moment tight monetary policy is still necessary to tackle inflation. He is confident that in the end a lower inflation rate will be beneficial to SMEs throughout the country.