Posted by: mulrickillion | October 17, 2011

Beijing Battles Brewing Crisis in Financial Sector

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Premier Wen Returns to Zhejiang on Business Inspection Tour

By Willy Lam, China Brief, Vol.. 11, Iss. 19, Oct 14, 2011 —

Given that China is expected to contribute 24 percent of world growth this year, the fast-rising quasi-superpower is generally deemed a bastion of stability in the financial maelstrom that is hitting Europe and the United States. While Beijing, which is the largest holder of U.S. debt, has yet to make substantial purchases of the European bonds, it has expressed a theoretical willingness to help embattled EU countries. One of the goals of an upcoming session of the Chinese Communist Party’s (CCP) Central Committee is to project Chinese soft power by playing up the viability of the “China model.” Confidence in Beijing’s ability to manage China’s finances however has been shaken by a series of bad news about the nation’s private enterprises and its labyrinthine underground banking system.

Since early summer, thousands of once vibrant small and medium-sized enterprises (SMEs)—which account for more than half of China’s GDP and which create 80 percent of its jobs—have gone under. In Wenzhou, Zhejiang Province, the world-famous quasi-capitalist showcase, dozens of “red bosses” simply vanished last month without paying either their creditors or their employees. Wenzhou officials have increased visits to factories that appear to be in trouble with a view to forestalling mass layoffs should these firms fail. In the first seven months of the year, Wenzhou enterprises recorded losses of 640 million yuan ($100 million), or 220 million yuan ($34.5 million) more than 2010. While China’s private bosses are known for being savvy and resilient, many have turned from manufacturing—where labor and material costs are rising dramatically—to the much more lucrative business of speculating in the real estate market. The downturn in property and related sectors however means some of the most successful SMEs have gone bust. The so-called Wenzhou phenomenon is being duplicated elsewhere, including several cities in prosperous Guangdong Province (Wall Street Journal, October 1; Xinhua News Service, October 10; China News Service, August 26).

The financial disruptions hitting private firms is linked closely with the country’s gargantuan “underground banks.” These unlicensed lenders range from local-based businessmen’s cooperatives and brokers to credit and trust companies that are offshoots of official banks, insurance companies and other financial institutions. While illegal on paper, underground banks have been tolerated by the authorities for more than a decade. Even though China has given so-called “national treatment” to quite a number of foreign enterprises and joint-ventures, non-state firms routinely face discrimination from creditors. Most government-controlled banks, including the "Big Four"—Industrial and Commercial Bank of China, China Construction Bank, Bank of China and Agriculture Bank of China—prefer to do business with large state-owned enterprises (SOEs). Non-state companies, particularly SMEs, have for the past decade or so been forced to borrow from underground financial institutions. This is despite the fact that interest rates have been between 30 percent to 100 percent during the past year (Bloomberg, September 27; Global Times, September 30). Since Beijing tightened the official banks’ credit to the real estate sector early this year, underground banks have also become the prime financier to property developers. The shadow bankers have lent 208 billion yuan ($32.6 billion) to real estate companies so far this year, or nearly as much as the 211 billion yuan ($33.1 billion) worth of loans that official banks have extended to the sector. Estimates of the total size of China’s underground lending range from 4 trillion yuan to 8 trillion yuan ($627 billion to $1.3 trillion, respectively), or respectively around 8 percent to 16 percent of the official credit market (Reuters, September 23; Financial Times, October 6). It is obvious that a sudden downturn in the economy—such as a bursting of the housing bubble and domino-style defaults by borrowers—could wreak havoc on this shady banking industry.

Complicating the problem is the fact that many of the shadow financial institutions are so-called trust companies that are either directly or indirectly connected with either official banks or government-controlled business conglomerates. . . .

The Jamestown Foundation: Beijing Battles Brewing Crisis in Financial Sector

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