Impact of China’s Latest Rate Rise – Part 1

Here is the first of two posts that will analyse the implications of China’s decision to raise interest rates for the third time this year 

 

By John Richardson

CHINA’S decision to once again raise interest rates will put further pressure on the hard-pressed small and medium-sized enterprises (SMEs) that make up the bulk of the country’s chemicals and polymer buyers.

Cheap and plentiful capital is still available to the state-owned enterprises, real-estate developers, infrastructure investors and local and municipal governments, said Michael Pettis  - a professor at Peking University’s Guangzhou School of Management. 

But life has been made more difficult for the SMEs each time benchmark interest rates and bank-reserve requirements have been increased, as they are the last in the queue for whatever favourable lending remains in the banking system.

The SMEs have to often go to the “shadow banking system” to source their lending where borrowing costs have risen even more sharply than in the formal trade-financing system, according to an article in the Financial Times.

“China has raised benchmark lending rates by 100 basis points to 6.31%, but small businesses have seen much steeper increases,” wrote the FT before yesterday’s increase to 6.56%.

“Monthly lending rates at credit unions and informal lending institutions in the entrepreneurial cities of Wenzhou and Xiamen have reached 5% in the past few weeks, up from 1.5%, according to Credit Suisse.

“Small Chinese businesses are feeling the effects the government’s monetary tightening and face a cash squeeze that may be worse than during the global financial crisis in 2008, according to an official warning.

From tile manufacturers in Shanghai to shoe factories near Hong Kong, smaller businesses have driven Chinese growth over the past two decades, accounting for about 60% domestic product. So, a sharp slowdown in their activity would weigh heavily on the Chinese, and by extension, world economy.”

The government has launched an initiative to try and help the SMEs which involves banks not being forced to count loans of less than Rmb5m ($77,000) towards their loan-to-deposit ratios.

“This seems to me a very complicated way of alleviating the cash crunch among SMEs,” continues Pettis.

“The proper way would be to reduce the demand for credit from real estate developers and infrastructure investors, but of course Beijing loves its administrative measures.

“The only efficient way of reducing demand from real estate developers and infrastructure investors would be to have them pay a fair cost for their capital – and remove the implicit credit support. This however would threaten to throw a huge number of essentially insolvent projects and companies into bankruptcy, so the preferred solution is to keep their cost of capital low and to keep their borrowings growing.”

He is not convinced that the new initiative will provide any relief for the SMEs

China’s banks are expected to issue Rmb6.7 ($1.04 trillion) of new loans this year compared with Rmb7.95 trillion in 2010, according to the China Securities Journal.

This is further bad news for the SMEs because, as we have already said, they are the last in the queue for official lending. A reduction in formal credit growth is likely to increase their reliance on shadow banking.

Making their plight even worse is the labour-intensive nature of many of China’s smaller companies. Wage costs have risen by 20-30% so far this year as central and local authorities try to reverse the widening gap between the rich and poor.



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