Thursday, October 6, 2011

The Huge Chinese Timebomb: Underground Credit That Could Blow Up

O Estado de Sao Paulo in Brazil has an article on what is potentially a huge timebomb in China. Wenzhou in the Zhejiang province became Symbol of private entrepreneurship in China. It also became the tip of the iceberg of a new threat to the economy: the explosion in the volume of loans outside the financial system over the past two years. At least 80 businessmen have fled, and two have committed suicide since April for failing to pay debts in the "underground" credit market , according to a survey done by the official news agency Xinhua.

The interest charged by these operations are around 24% to 36% per year, compared to the base rate of 6.56% set by the central bank for "official" operations, and in short-term loans, the percentage may even reach 60% . Small and medium enterprises and private real estate developers resort to such financing extortions because of the difficulty of obtaining loans in the banking system, especially after the monetary tightening measures imposed by the government since 2010. Many fall into a vicious circle, contracting new loans to pay for the previous, until no longer able to manage debt. The situation became more serious with the recent rise in production costs, falling profits and inflation at around 6%.

The phenomenon is far from restricted to Wenzhou. Credit Suisse estimates the "underground" market at 4 trillion yuan ($ 1.16 trillion), equivalent to 15% of total loans granted by banks officially in 2010, and has spread to all major cities in the region east, including Beijing and Shanghai. In Wenzhou, the figure is 110 billion yuan (U.S. $ 31.93 billion) or 20% of the loans.

The chief economist at Credit Suisse, Tao Dong, believes the explosion in informal credit is the most dangerous "time bomb" in the short time horizon of the Chinese economy. The resources that fuel this market come from different sources, including income families in search of greater than 3.5% annual rate that banks pay on deposits, lower than inflation, around 6%. "Unlike the official credit market, the informal credit market is a long chain of debt. If one link in this chain fails, probably the entire network collapses, "the economist wrote in a note to clients. He said the negative impact of this scenario can be generalized, with effects on corporate balance sheets, consumer confidence and bank assets.

Today, Prime Minister Wen Jiabao visited the province of Zhejiang and exalted banks to lend to small businesses and tolerate a higher rate of bad loans in this sector. According to Xinhua, small businesses account for 80% of jobs and 60% of the country's industrial output.

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