November 8, 2011

China Credit Squeeze Prompts Suicides And Violence! Excellent Piece, Great Detail!

Bloomberg news
written by Staff
Sunday November 6, 2011

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 ($4.7 million) at interest rates as high as 7 percent a month to expand the business. Many of the lenders were elderly neighbors 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 230 miles (370 kilometers) 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.

‘Huge Pressure’
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 AG. Money supply has shrunk as the government tightens lending to try and rein in inflation running near a three-year high.

‘Tip of Iceberg’
“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.

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 AG. 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.

Embraced Deng’s Reforms
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.

Taking Home Loans

“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 given to Bloomberg News 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.

Rising Costs

Wenzhou’s businesses were already facing tougher times because of declining exports to Europe and the U.S. and rising labor 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. Rates rose to 7 percent a month.

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 Ltd.

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