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Cablegate: Credit Tightening Squeezing Small and Medium Enterprises In

VZCZCXRO0753
RR RUEHCN RUEHGH RUEHVC
DE RUEHGZ #0398/01 1890913
ZNR UUUUU ZZH
R 070913Z JUL 08
FM AMCONSUL GUANGZHOU
TO RUEHC/SECSTATE WASHDC 7386
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEATRS/DEPT OF TREASURY WASH DC
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEHNSC/NSC WASHDC
RUEAIIA/CIA WASHDC
RUEKJCS/DIA WASHDC
RHHMUNA/HQ USPACOM HONOLULU HI

UNCLAS SECTION 01 OF 03 GUANGZHOU 000398

SENSITIVE
SIPDIS

STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/LEE
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER
STATE PASS SAN FRANCISCO FRB FOR CURRAN
TREASURY FOR MOGHTADER

E.O. 12958: N/A
TAGS: ECON EFIN EINV PGOV CH
SUBJECT: Credit Tightening Squeezing Small and Medium Enterprises in
the Pearl River Delta

REF: A) Guangzhou 214, B) Guangzhou 228, C) Guangzhou 291

1. (SBU) Summary: Monetary tightening measures taken by the China
Banking Regulatory Commission (CBRC) have greatly reduced the amount
of credit available in south China, according to bank executives and
industry watchers. Small and medium enterprises (SMEs) are having
difficulty obtaining credit, causing many businesses to borrow from
unlicensed lenders. While the central government has increased
efforts to ensure that SMEs in favored industries have access to
credit, observers question the effectiveness of these measures.
Concern is growing about the potential for increasing non-performing
loans (NPLs) and greater chances of labor unrest as the business
climate worsens for SMEs in south China -- which could create
significant social and economic unrest with which the local
leadership would have to deal. End Summary.


Credit Tightening Affecting SMEs
--------------------------------

2. (SBU) In recent conversations with bank executives, academics,
and financial journalists, Congenoffs noted wide agreement that the
CBRC's monetary tightening policies have resulted in a large
reduction of bank lending in south China. The Xinhua News Service
website published an article from the official Shanghai Securities
News ("Shanghai Zhengquan Bao") reporting that lending by Guangdong
banks declined 15% year-on-year in the first quarter of 2008.
Brendan Wong, General Manager of Bank of Montreal's Guangzhou
Branch, told us his bank has received numerous inquiries from
companies that were denied by larger banks that had already reached
their CBRC-enforced loan quotas. Wong described this new business
as so brisk that his bank also quickly hit its own lending quota and
was forced to start turning away applications that it previously
would have approved.

3. (SBU) The reduction in lending has left some companies unable to
secure credit from legitimate sources. Shenzhen Development Bank
Chairman and CEO Frank Newman told Consul General Goldberg, "It's
clear now that the supply of legitimate lending does not meet the
demand." Dr. Lu Jun, Director of Sun Yat-sen University's Banking
Research Center, told us that young SMEs are the group most affected
by China's credit contraction, as banks currently favor companies
with established cash flows and real estate holdings that can be
used as collateral. Dr. Lu asserted that even SMEs with 10-year
credit histories are having trouble securing loans, with no help
coming from capital markets as the much-anticipated launch of
Shenzhen Stock Exchange's new "SME Board" continues being delayed
(ref A). Similarly, an unnamed Guangdong government official was
quoted in the Shanghai Securities News as saying that banks in the
province are currently able to satisfy just 40% of SME credit
demands.

4. (SBU) Dr. Lu commented that this tightened liquidity has led
banks to seek creative ways of circumventing government-imposed loan
quotas. Some banks, he said, are providing credit guarantees rather
than loans, since the former are off-balance sheet and do not have
to be reported to regulators unless they go bad. With bank lending
growing scarcer, many companies are making greater use of commercial
credit. Still, Andy Zhang, Bank of America's Guangzhou Branch
Manager, told us that such alternative sources of credit are also
becoming more difficult to obtain, as the tightening has begun to
reduce the credit available for even the strongest firms who might
be willing to help cover their weaker business partners.

Turning to Unlicensed Lenders for Credit
----------------------------------------

5. (U) Companies unable to secure bank or commercial credit are
increasingly turning to unlicensed lenders. Short-term financing is
readily available from pawn shops, while longer-term loans can often
be obtained from informal networks of friends or underground banks.
According to Shanghai Securities News, a surge in demand for
short-term credit recently caused the interest rate for one-month
term loans at Guangzhou pawn shops to spike from an historic average
of 3% to as high as 6% (Note: the higher rate is equivalent to an
annual interest rate of 72%. End note.) The same article reported
that similar loans in Foshan City of Guangdong had risen from
monthly interest rates of 5-6% to as high as 10%. Although
relatively little information is available about underground banks,

GUANGZHOU 00000398 002 OF 003


the Chinese government announced last fall that it shut down a
Shenzhen-based operation that had conducted transactions in all 32
provinces and made loans totaling 4.3 billion RMB (624 million USD)
over an 18-month period.

Government Efforts to Help SMEs
-------------------------------

6. (SBU) Aware that SMEs are the companies most affected by
restricted bank lending, the Chinese government has tried to help
cushion the blow -- at least for those SMEs in favored industries.
Bank of Montreal's Wong told us the People's Bank of China has
repeatedly requested that his bank expand its SME lending, even
though their business plan only includes lending to large
international companies. In March, the CBRC issued a circular
(number 71) requesting that banks maintain SME lending growth rates
at least as high as each bank's overall lending growth rate. In
addition, municipal governments in Guangdong are using their jointly
owned guarantee companies to help secure credit for SMEs in
government-endorsed industries. Sun Wanqing, CEO of Guangdong Yinda
Guarantee, the province's largest guarantee company, told us his
company mostly supports SMEs that are investing in higher-value
production industries favored by the government.

Bankers Doubt Government Solutions
----------------------------------

7. (SBU) Several international bank executives with whom we spoke
expressed skepticism that government measures to promote SME lending
would make much difference for the companies. Peter Qiu, Guangzhou
Branch Manager for Citibank, told us the liquidity contraction will
primarily affect smaller companies that lack government connections.
He said Guangdong's economy is likely to experience "unhealthy
growth" in the next couple years as inefficient state-owned
enterprises with strong government ties receive preferential
treatment when applying for scarce bank loans, a big difference from
what will happen to smaller, private companies. Bank of America's
Zhang told us SMEs simply aren't a high priority for the Chinese
government, which is more worried about inflation and the health of
top-tier companies. There are also indications that guarantee
companies are losing their ability to encourage policy-inspired
lending: Shanghai Securities News reported that the lending value of
Guangdong's guarantee firms declined by 30% in the first quarter of
2008, and some banks had gone as far as suspending their
partnerships with guarantee companies.

Growing Problems
----------------

8. (SBU) Little doubt remains that south China's lending contraction
is coming at a particularly bad time for SMEs. Thousands of Hong
Kong and Taiwan-owned factories in the Pearl River Delta (PRD) have
closed in the last few months, due to rising costs (ref B). Many of
these factories were closed illegally, as owners have sought to
avoid paying the obligations incurred by closing legitimately (ref
C). Peter Pak-yan Leung, the Director of Hong Kong's Economic and
Trade Office (ETO) in Guangzhou, told us that he expects thousands
more factories to close in the months after the Olympics, and that
in most cases, he expects these factory managers to simply leave
town in the middle of the night without paying their workers.

9. (SBU) Surging SME failures could also lead to a rebound in the
number of NPLs held by Chinese banks. Most bank executives with
whom we met indicated that they expect NPLs to emerge as a growing
problem for banks that aggressively lent to south China's SMEs.
Bank of America's Zhang said several of his counterparts at China's
Big Four banks have told him they are "very concerned" about NPLs in
this segment. Citibank's Qiu was somewhat sanguine: while he
expects NPLs to become a more serious problem, he thinks most of the
nation-wide commercial banks will avoid trouble. Qiu argued that
few of these banks -- except Shenzhen Development Bank and a couple
other leading SME lenders -- have significant exposure to SMEs, so
he predicted that NPL problems will largely be confined to municipal
commercial banks.

Comment
-------

10. (SBU) It is clear that the PRD economy is in transition, with

GUANGZHOU 00000398 003 OF 003


many low-margin and small-scale exporters struggling due to a
difficult economic environment and greatly reduced availability of
credit. Tightening monetary conditions primarily through
quantitative credit controls rather than by raising the cost of
credit through higher interest rates is disproportionately impacting
south China's SMEs. The question is whether the current economic
weaknesses will be confined to certain industries, as Bank of
America's Zhang asserted, or if inefficient capital allocation or
other market forces could cause economic distress to extend into
other areas of the economy, as Citibank's Qiu suggested. If, as
Hong Kong ETO's Leung predicts, thousands of Hong Kong businessmen
will sneak out of town by the end of the year, leaving behind empty
factories and tens or hundreds of thousands of unemployed and unpaid
migrant workers, Guangdong's leadership could be dealing with a
significant and destabilizing economic and social condition.

GOLDBERG

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