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Tue 8 Nov 2011 03:38 PM

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China credit squeeze prompts suicides

Debtors fear violent loan sharks as black market cash dries up

China credit squeeze prompts suicides
The collapse of informal lending networks reveals the fragility of China’s unregulated financing system

Hours after a creditor and his gang of tattooed 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 eastern Chinese 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 ($4.7m)
at interest rates as high as 7 percent a month to expand the business. Many of
the lenders were elderly neighbours who’d mortgaged their homes.

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 small business association in Wenzhou. One was shoemaker Shen Kuizheng,
who jumped to his death from his 22nd-story home on Sept 21, he said.

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 China because
private enterprises in China rely on underground borrowing rather than banks to
operate, he said.

Their predicament prompted China’s premier Wen Jiabao to
visit the city 230m south of Shanghai on Oct 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 loan sharks that
use violence.

The measures have done little to help Zhong, he says.

“I am under huge pressure,” he says, sitting in 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, a Hong Kong-based economist at Credit
Suisse Group. Money supply has shrunk as the government tightens lending to try
and rein in inflation running near a three-year high.

 “This is a much
bigger problem across the country,” said Tao, who estimates outstanding private
loans stand at 4 trillion yuan, or 8 percent of total lending in China.

“Wenzhou is just the tip of the iceberg.”

Most of the informal lending has been pumped into real
estate developers riding China’s property boom that is showing signs of
slowing, said Tao. In Wenzhou, it’s driven up home prices to among the most
expensive in the country.

Chinese media reports of similar difficulties have emerged
in the prosperous mining town Ordos in the north and the industrial heartland
of Guangdong in the south.

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The risks to China’s wider economy include a potential
credit freeze triggered by increased mistrust among informal lenders, also
referred to as curb lenders, according to an Oct. 11 report by Wang Tao, a Hong
Kong-based economist at UBS. That could trigger more widespread bankruptcies,
she said.

Wenzhou -a city of 9 million whose private enterprises range
from shoemakers in dusty road-side homes to manufacturing plants in new
industrial parks - produces 90 percent of China’s eyeglasses and exported
lighters. The city’s wealth is reflected in the Porsches and Land Rovers parked
in the streets and the emergence of downtown shopping arcades selling Hugo Boss
clothes and Omega watches.

It was the first city to widely embrace private enterprise
in the early 1980s under the economic reforms of then leader Deng Xiaoping,
developing the most advanced private lending networks in the country.
Businesses in Wenzhou used family and hometown networks because bank loans were
hard to come by.

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, according to a local
government website.

As the clacking from a nearby shoe factory drifts through
the window of 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. He couldn’t get money from the banks, he said, so he first borrowed from
elderly neighbours from his home county.

Small and medium-sized businesses account for 80 percent 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,
according to an Oct 17 report by Sydney-based investment bank Macquarie Group.

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 rows of
four-story cement housing not far from the Wenzhou airport 40 minutes outside
of town by car. Men play pool beside the ground- floor storefronts near a
darkened mahjong parlour.

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The residents turned money lending into a cottage industry,
according to interviews with six of them. 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 percent a month, many lent out their
cash for 2 percent or higher a month. They pocketed the difference to
supplement meager income from odd jobs.

Sitting on a small stool, gray-haired Jin Xiaoyu fills a
wooden box with the electrical clamps she makes to earn 10 yuan a day. Her left
eye is the milky-white color of a cataract and she says she has difficulty
seeing.

She lent Zhong 50,000 yuan and charged 1,000 yuan a month in
interest, she said.

“I worry that I cannot get the money back,” Jin says. “I
hope the government will help him out.”

Some used their housing as collateral. Among them was Wu
Suihua, who borrowed against her five-story home, she says.

“We don’t have much income,” said Wu. Her home is one
building away from a Blue Sky pharmacy which opened a few months ago, selling
ginseng and other traditional Chinese herbal remedies as well as Western
medicines.

The collateralization of homes means Zhong’s problems may
stretch back to the banks. One-third to a half of money used for private
lending originally comes from banks, said Lu Ting, an economist with Bank of
America Corp.’s brokerage unit.

Tightening cash flow for businesses continues to raise the
risk of bank loans going bad, according to a statement from Wenzhou’s Financial
Office on Oct 21. The current non-performing loan rate in Wenzhou is
controllable and below the national average, it added.

The informal lending network worked until the summer of 2010
when some of Zhong’s villagers were unable to get new loans from the banks as
government tightening kicked in, he said.

Wenzhou’s businesses were already facing tougher times
because of declining exports to Europe and the US and rising labour costs, Chen
Yuyu, associate professor at the Guanghua School of Management at Peking
University, said. Minimum wages in Zhejiang province, where Wenzhou is located,
have risen 19 percent in 2011 from last year, according to London-based
Standard Chartered Plc.

Zhong needed cash to keep paying his suppliers, rent and
employees. Scanning the local paper one day, he saw an ad for loans without
collateral. He dialed the number and 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, he
said.

Black market rates have doubled this year, far exceeding the
return of companies in Wenzhou that typically have wafer- thin profit margins,
according to Ren Xianfang, a Beijing-based economist with IHS Global Insight.

Curb lenders demand annual interest of between 20 percent
and 40 percent or higher, many times the official lending rate of 6.56 percent
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.

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Zhong thought his problems would be solved in August after
two friends agreed to act as guarantees and he finally secured a loan from the
local branch of Fuzhou-based Industrial Bank Co. It was for 15 million yuan at
1 percent a month, divided into two tranches. One of the guarantors put up his
downtown apartment 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. The lender said Oct 20 he was no longer in the business when reached by
phone, declining to comment any further.

The Industrial Bank’s Wenzhou branch wouldn’t comment on
Zhong’s case.

When word of Zhong’s shortfall spread, angry creditors
converged on his warehouse demanding their money back, Zhong and villagers
said. Zhong says he struggled to calm them down as they started tossing cups on
the floor and grabbing boxes of medicines.

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 the mustachioed
Zhong, sockless in leather shoes, standing near a darkened conference room with
a bust of Chairman Mao. “Panic was everywhere. Blue Sky is famous now - for
owing debt. No one is going to lend me money.”

Zhong’s problems are shared by many other business owners. A
few weeks ago, a group of about 20 gathered in one of the marbled private rooms
to feast on lobster and steak at Hai Yan Lou, a Cantonese restaurant across the
street from the local offices of China’s banking regulator.

The mood was grim. They talked about the recent suicide of
shoe factory owner Shen because he couldn’t repay debts, and the disappearance
of another boss who owed them money, according to Yang Xi, the owner of a
company that makes dyes for shoes and textiles, who was there.

Each man present downed a bottle of Moutai, an expensive
brand of Chinese liquor made from sorghum, because they feared they may never
be able to afford the luxury again, she said.

By October, the deteriorating situation in Wenzhou prompted
the visit by the premier, which triggered a raft of initiatives to help private
businesses.

“After Premier Wen’s visit, I sent text messages to friends
all over the world that Wenzhou will be rescued,” Yang said.

China’s banking regulator said later it would let banks sell
bonds to raise money for loans to small enterprises and tolerate higher rates
of non-performing loans among other measures to encourage bank lending.

In Wenzhou, the local government set up an emergency 1
billion yuan fund. Its anti-loan shark campaign led to the Oct 27 arrest of a
couple suspected of illegally raising 1.3 billion yuan, according to the China
Daily.

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A few businessmen who had fled Wenzhou have returned since
Wen’s visit, according to Zhou of the small business association. Others have
been tracked down and arrested, according to the official Xinhua News Agency.

Analysts are trying to ascertain how effective the measures
are and how widespread the fallout from Wenzhou will be across China. The city
is now the country’s biggest source of private capital, marshaling about 800
billion yuan, equivalent to 2 percent of China’s total economic output,
according to Ren of IHS Global. Money from Wenzhou is invested in everything
from real estate in Dubai to coal mines in Shanxi province, in China’s
northwest.

After a research trip to Wenzhou, Bank of America’s Lu said
in an Oct 25 report that the chances of a nationwide liquidity squeeze were
low.

Others see Wenzhou as symptomatic of broader problems, such
as an over-reliance on investment to grow the economy that steers money toward
state-owned companies, said Michael Pettis, the Beijing-based chief strategist
at Guosen Securities Co.

“You can solve Wenzhou, but you’re simply transferring the
problem someplace else,” he said.

Zhong, the pharmacist, says he’s filed a report to the local
government hoping to benefit from the bailout plan.

He spends his days and nights in the warehouse of his
crumbling dream. He’s sold off his BMW and lives in a company dormitory. His
wife sleeps in one of their stores and they’ve sent their daughter to live at
school.

Zhong recounted his night at the coffee shop.

Alerted to the incident by Zhong’s wife, a more sympathetic
creditor came by demanding his release, saying the pharmacist owed him even
more money. The ruse worked, Zhong said. His offer for a finger was declined.

He says he’ll probably still lose his business. He’s
negotiating to transfer it to his 130 creditors. They would keep him on as a
paid manager.

“My wife and I will probably have nothing left,” he said.

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