GO
Loading...

As credit dries up, smaller companies in China feel the pinch

Hunan Xinwei Bags Company, a manufacturer of knapsacks and handbags, is struggling to survive. The Chinese economy is slowing. Wages are rising amid a shortage of blue-collar workers. And competition from countries like Vietnam is growing.

But what has really hurt Hunan Xinwei in recent months has been a credit squeeze facing small and medium companies all over China. Exorbitant interest rates and a scarcity of loans at any rate have turned the financing of everything from raw materials to equipment into a crippling challenge for businesses and individuals without political connections to borrow at regulated rates from the state-controlled banking system.

Brent Lewin | Bloomberg | Getty Images

"The current monthly interest rate that people like me are paying is around 3 percent," compared with just 0.5 a month for regulated loans, said Yin Haibian, president of Hunan Xinwei.

The credit troubles stem from the central bank's efforts to break the country's addiction to the debt-fueled investments in infrastructure and real estate, part of a host of reforms underway. But the government is reining in credit at a time when concerns are mounting about the health of the economy, putting Beijing in a difficult position.

The latest growth figures released on Wednesday showed that the gross domestic product in the first quarter was up 7.4 percent from a year earlier — marginally below the government's annual target of 7.5 percent. But much of that growth actually took place in the second, third and fourth quarters of last year.

Read More China GDP puts to rest worst fears over the economy

As growth wanes, the credit problems affecting companies like Hunan Xinwei — and other short-term economic stresses — will test China's commitment to long-term reforms. If the short-term costs are too high, the government may yet retreat to the time-tested approach of ever greater investments in infrastructure and real estate.

"The underlying economic situation is distorted. They need economic reform," said Tao Wang, a China economist at UBS.

A welter of statistics in recent weeks has prompted worries that China, the largest single contributor to global economic growth, may finally be facing a broad, long-term slowdown.

Real estate investment is weakening as price increases have begun to slow after more than a decade of credit-fueled leaps with few interruptions. Investments in new factories have also weakened. And exports, long a source of strength, have settled to a slower pace as rising wages have begun driving some industries, like shoemaking and garment manufacturing, offshore.

On Tuesday, China's central bank announced that the broadly measured money supply grew 12.1 percent in March, compared with a year earlier. That would be a brisk pace for most countries, but it was the slowest in China since comparable record-keeping began in 1997.

A series of senior Chinese officials have said that they saw no need for further stimulus beyond recently announced measures like accelerating railroad construction and redeveloping shantytowns at the edges of big cities. But a growing number of economists are calling for the government to start spending money on a greater scale to sustain short-term growth, even at the risk of continuing the rapid buildup of debt in the economy.

Railroad construction and shantytown redevelopment "should provide tailwind for a growth recovery in the coming months, but this is no easy task and more substantial loosening measures are needed in our view," Goldman Sachs economists said in a statement on Tuesday.

Read More China's bespoke demand spawns wave of startups

At first glance, it seems extraordinary that anyone in China would have trouble finding credit, given how much money is already sloshing around the country. China's broadly measured money supply passed that of the United States in August 2009, and it has been soaring ever since. China now has two-thirds more money than the United States, swirling through an economy that is a little over half the size of the United States'.

But after allowing the country's money supply to swell sharply, the central bank has begun tapping the brakes on credit. Regulators have also begun to scrutinize more closely the activities of lending trusts, a semi-regulated sector of shadow banking that had been a fast-growing source of loans for small and medium businesses.

The first to run into trouble have been entrepreneurial companies. Many struggled for financing even when the economy was experiencing double-digit growth and now find themselves almost completely excluded from a tightening credit market.

The central bank has been gradually pushing up open-market interest rates, in the hope that competition will start playing a greater role than political influence in deciding who can borrow money. That policy could help small and medium businesses obtain loans in the long term, but it has had the short-term effect of pushing up borrowing costs.

Many larger businesses have turned to Hong Kong to bypass the mainland's credit crunch. Arthur Yuen, the deputy chief executive of the Hong Kong Monetary Authority, the region's de facto central bank, said at a rare news conference on Tuesday that officials had been closely monitoring rapid growth in lending from the semiautonomous Chinese territory to the mainland and were not especially worried at this point.

One reason, he said, was that virtually all of the lending was going to China's biggest banks and biggest state-owned enterprises, and to the mainland operations of multinationals, rather than the small and medium enterprises that are more vulnerable to the economic headwinds. The schism in the credit environment is echoed more broadly in this vast economy. Even as certain sectors struggle, large areas of strength endure.

At the opening on Tuesday of the Canton Fair, China's main international trade exhibition, throngs of buyers from around the world showed up to haggle with vendors from all over the country. In some categories, like household tools, China still dominates global supply and is starting to benefit as demand in the West begins to recover.

Read More Small China developer goes on a $3.3 billion buying spree

Leo Ma, the export manager for paint rollers at the JOC Great Wall Corporation, a partly state-owned industrial conglomerate based in Shanghai, was untroubled by a recent weakness in orders and said that his business expected annual growth of more than 30 percent to continue in the years ahead. "After Chinese New Year this year, as in past years, there is a bit of a lull," he said.

But China's knapsack and handbag industry, with dozens of small, fiercely competing companies, illustrates many trends now buffeting the country. Blue-collar wages have more than quintupled in the last decade as far more young people attend universities and as the "one child" policy has begun to reduce the number of young workers. Borrowing money to finance inventories of raw materials has become a costly ordeal.

All of the top international companies are reducing the proportion of bags they buy from factories in China and shifting production to less-expensive countries like Vietnam, Indonesia and the Philippines, said Tatiana Olchanetzky, a leading handbag manufacturing consultant who moved last summer to Ho Chi Minh City in Vietnam after 18 years of living in Hong Kong and focusing on southern China.

Within China, customers have become very conscious of labels, forcing companies like Hunan Xinwei to develop their own brands. "Business lately has been very, very tough," said Mr. Yin, Hunan Xinwei's president.

Contact Asia News

  • CNBC NEWSLETTERS

    Get the best of CNBC in your inbox

    › Learn More

Asia Video