20110730 Beware a hard landing in China

Beware a hard landing in China

By Wu Hui-lin 吳惠林

It is a well-known fact that China’s economy is going through great structural changes. Small and medium-sized enterprises (SMEs), which make up more than 99 percent of all Chinese companies, require a healthy operating environment and such an environment normally includes free entry to the market, fair competition, a mature and reasonable financial order, a sound legal system, transparent regulations and controls, as well as effective execution. However, for some time now the Chinese operating environment has placed major restrictions on the development of SMEs. In particular, these companies have been treated differently when it comes to financial assistance.

The interest rates on 62.3 percent of loans to SMEs are higher than the benchmark interest rate, while only 27.2 percent of large enterprises are subject to a higher rate. In addition, large enterprises receive more preferential loans. SMEs also tend to have less sound credit, which makes it difficult for them to obtain loans. Now that China is tightening access to credit, SMEs tend to be the first to have their loans put on hold by banks, compounding their already difficult situation.

The city of Wenzhou offers evidence of the difficult operating environment for Chinese SMEs. The tightening of China’s monetary policy and the strengthening of the yuan has led to a steady increase in costs. A survey conducted by the Bank of China branch in central Wenzhou found that the interest on loans issued by the city’s largest banks had increased by between 30 percent and 80 percent.

Bank loans may not be cheap, but only a minority of companies are able to get them anyway. Many of the companies that are not eligible for bank loans are forced to rely on private funding.

In the middle of this year, a few SMEs in Wenzhou experienced a disruption in capital flows and had to declare bankruptcy or close down. While the news that Three Flag Group — an old company from the cities of Wenzhou and Leqing — was on the verge of bankruptcy was still reverberating, a well-known food and beverage chain in Wenzhou closed because of its debt-related problems.

Judging from the situation in China, the manufacturing industry is clearly deteriorating. While it is true that this sector has been affected by the continued appreciation of the yuan, rising raw material prices, rising labor costs and the international financial crisis, the factor that has most directly undermined the manufacturing and -processing industries is the difficulty accessing capital as a result of financial controls and tightening credit.

On April 30, an article in the Chinese magazine Economic Review revealed that many Chinese SMEs are experiencing problems.

Rising costs have led to declining profits and many businesses facing a situation where stopping production will cause them to close, while continued production will lead to an even faster demise. Needless to say, a wave of SMEs are having to close.

One entrepreneur said that the biggest problems for Chinese SMEs is that: “Regardless of whether they are selling to the domestic market or for export, there is a clear shortage of orders and it is very common to see factories running at half capacity and making a loss. Even if they run at full capacity, they will not make any profits to speak of and everyone is doing all they can just to hold on.”

Last year, there were more than 10 million registered SMEs in China and the final value of their products and services was equal to about 60 percent of the GDP. They provided 80 percent of urban employment and their tax payments made up 50 percent of all tax revenue. SMEs are clearly vital to China’s economic and social stability, and the current wave of closures will undoubtedly have an impact on the nation.

Now there is increasing talk of the Chinese economy’s possible collapse. Not long ago, “Dr Doom” himself, renowned economist Nouriel Roubini, included China’s demise as one of four factors in a perfect storm. Even those who used to have a bullish outlook are now changing their tune.

Recently, the Mainland Affairs Council issued a warning that the Bank of China’s tightening financial policies have made it impossible for many SMEs to get a bank loan and China may be on the verge of a wave of business closures. Another negative influence is the real-estate bubble, which will have an impact on local finances. China is in for a hard landing.

If China’s economy really does collapse, contract manufacturers that have set up shop there will be the first to suffer. This includes many large Taiwanese electronics contract manufacturers, making it a certainty that trouble in China will have an impact on Taiwan. It seems that not only must Taiwan avoid relying too heavily on China, it must also keep its distance to stay safe. It is always best to rely on one’s self — Taiwan must focus first and foremost on strengthening its own economy.

Wu Hui-lin is a researcher at the Chung-hua Institution for Economic Research.

TRANSLATED BY PERRY SVENSSON