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R 070913Z JUL 08
FM AMCONSUL GUANGZHOU
TO RUEHC/SECSTATE WASHDC 7386
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEATRS/DEPT OF TREASURY WASH DC
RUCPDOC/DEPT OF COMMERCE WASHDC
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UNCLAS SECTION 01 OF 03 GUANGZHOU 000398 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/LEE 
STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER 
STATE PASS SAN FRANCISCO FRB FOR CURRAN 
TREASURY FOR MOGHTADER 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV PGOV CH
SUBJECT: Credit Tightening Squeezing Small and Medium Enterprises in 
the Pearl River Delta 
 
REF: A) Guangzhou 214, B) Guangzhou 228, C) Guangzhou 291 
 
¶1. (SBU) Summary: Monetary tightening measures taken by the China 
Banking Regulatory Commission (CBRC) have greatly reduced the amount 
of credit available in south China, according to bank executives and 
industry watchers.  Small and medium enterprises (SMEs) are having 
difficulty obtaining credit, causing many businesses to borrow from 
unlicensed lenders.  While the central government has increased 
efforts to ensure that SMEs in favored industries have access to 
credit, observers question the effectiveness of these measures. 
Concern is growing about the potential for increasing non-performing 
loans (NPLs) and greater chances of labor unrest as the business 
climate worsens for SMEs in south China -- which could create 
significant social and economic unrest with which the local 
leadership would have to deal.  End Summary. 
 
 
Credit Tightening Affecting SMEs 
-------------------------------- 
 
¶2. (SBU) In recent conversations with bank executives, academics, 
and financial journalists, Congenoffs noted wide agreement that the 
CBRC's monetary tightening policies have resulted in a large 
reduction of bank lending in south China.  The Xinhua News Service 
website published an article from the official Shanghai Securities 
News ("Shanghai Zhengquan Bao") reporting that lending by Guangdong 
banks declined 15% year-on-year in the first quarter of 2008. 
Brendan Wong, General Manager of Bank of Montreal's Guangzhou 
Branch, told us his bank has received numerous inquiries from 
companies that were denied by larger banks that had already reached 
their CBRC-enforced loan quotas.  Wong described this new business 
as so brisk that his bank also quickly hit its own lending quota and 
was forced to start turning away applications that it previously 
would have approved. 
 
¶3. (SBU) The reduction in lending has left some companies unable to 
secure credit from legitimate sources.  Shenzhen Development Bank 
Chairman and CEO Frank Newman told Consul General Goldberg, "It's 
clear now that the supply of legitimate lending does not meet the 
demand."  Dr. Lu Jun, Director of Sun Yat-sen University's Banking 
Research Center, told us that young SMEs are the group most affected 
by China's credit contraction, as banks currently favor companies 
with established cash flows and real estate holdings that can be 
used as collateral.  Dr. Lu asserted that even SMEs with 10-year 
credit histories are having trouble securing loans, with no help 
coming from capital markets as the much-anticipated launch of 
Shenzhen Stock Exchange's new "SME Board" continues being delayed 
(ref A).  Similarly, an unnamed Guangdong government official was 
quoted in the Shanghai Securities News as saying that banks in the 
province are currently able to satisfy just 40% of SME credit 
demands. 
 
¶4. (SBU) Dr. Lu commented that this tightened liquidity has led 
banks to seek creative ways of circumventing government-imposed loan 
quotas.  Some banks, he said, are providing credit guarantees rather 
than loans, since the former are off-balance sheet and do not have 
to be reported to regulators unless they go bad.  With bank lending 
growing scarcer, many companies are making greater use of commercial 
credit.  Still, Andy Zhang, Bank of America's Guangzhou Branch 
Manager, told us that such alternative sources of credit are also 
becoming more difficult to obtain, as the tightening has begun to 
reduce the credit available for even the strongest firms who might 
be willing to help cover their weaker business partners. 
 
Turning to Unlicensed Lenders for Credit 
---------------------------------------- 
 
¶5. (U) Companies unable to secure bank or commercial credit are 
increasingly turning to unlicensed lenders.  Short-term financing is 
readily available from pawn shops, while longer-term loans can often 
be obtained from informal networks of friends or underground banks. 
According to Shanghai Securities News, a surge in demand for 
short-term credit recently caused the interest rate for one-month 
term loans at Guangzhou pawn shops to spike from an historic average 
of 3% to as high as 6% (Note: the higher rate is equivalent to an 
annual interest rate of 72%. End note.)  The same article reported 
that similar loans in Foshan City of Guangdong had risen from 
monthly interest rates of 5-6% to as high as 10%.  Although 
relatively little information is available about underground banks, 
 
GUANGZHOU 00000398  002 OF 003 
 
 
the Chinese government announced last fall that it shut down a 
Shenzhen-based operation that had conducted transactions in all 32 
provinces and made loans totaling 4.3 billion RMB (624 million USD) 
over an 18-month period. 
 
Government Efforts to Help SMEs 
------------------------------- 
 
¶6. (SBU) Aware that SMEs are the companies most affected by 
restricted bank lending, the Chinese government has tried to help 
cushion the blow -- at least for those SMEs in favored industries. 
Bank of Montreal's Wong told us the People's Bank of China has 
repeatedly requested that his bank expand its SME lending, even 
though their business plan only includes lending to large 
international companies.  In March, the CBRC issued a circular 
(number 71) requesting that banks maintain SME lending growth rates 
at least as high as  each bank's overall lending growth rate.  In 
addition, municipal governments in Guangdong are using their jointly 
owned guarantee companies to help secure credit for SMEs in 
government-endorsed industries.  Sun Wanqing, CEO of Guangdong Yinda 
Guarantee, the province's largest guarantee company, told us his 
company mostly supports SMEs that are investing in higher-value 
production industries favored by the government. 
 
Bankers Doubt Government Solutions 
---------------------------------- 
 
¶7. (SBU) Several international bank executives with whom we spoke 
expressed skepticism that government measures to promote SME lending 
would make much difference for the companies.  Peter Qiu, Guangzhou 
Branch Manager for Citibank, told us the liquidity contraction will 
primarily affect smaller companies that lack government connections. 
 He said Guangdong's economy is likely to experience "unhealthy 
growth" in the next couple years as inefficient state-owned 
enterprises with strong government ties receive preferential 
treatment when applying for scarce bank loans, a big difference from 
what will happen to smaller, private companies.  Bank of America's 
Zhang told us SMEs simply aren't a high priority for the Chinese 
government, which is more worried about inflation and the health of 
top-tier companies.  There are also indications that guarantee 
companies are losing their ability to encourage policy-inspired 
lending: Shanghai Securities News reported that the lending value of 
Guangdong's guarantee firms declined by 30% in the first quarter of 
2008, and some banks had gone as far as suspending their 
partnerships with guarantee companies. 
 
Growing Problems 
---------------- 
 
¶8. (SBU) Little doubt remains that south China's lending contraction 
is coming at a particularly bad time for SMEs. Thousands of Hong 
Kong and Taiwan-owned factories in the Pearl River Delta (PRD) have 
closed in the last few months, due to rising costs (ref B). Many of 
these factories were closed illegally, as owners have sought to 
avoid paying the obligations incurred by closing legitimately (ref 
C).  Peter Pak-yan Leung, the Director of Hong Kong's Economic and 
Trade Office (ETO) in Guangzhou, told us that he expects thousands 
more factories to close in the months after the Olympics, and that 
in most cases, he expects these factory managers to simply leave 
town in the middle of the night without paying their workers. 
 
¶9. (SBU) Surging SME failures could also lead to a rebound in the 
number of NPLs held by Chinese banks.  Most bank executives with 
whom we met indicated that they expect NPLs to emerge as a growing 
problem for banks that aggressively lent to south China's SMEs. 
Bank of America's Zhang said several of his counterparts at China's 
Big Four banks have told him they are "very concerned" about NPLs in 
this segment.  Citibank's Qiu was somewhat sanguine: while he 
expects NPLs to become a more serious problem, he thinks most of the 
nation-wide commercial banks will avoid trouble.  Qiu argued that 
few of these banks -- except Shenzhen Development Bank and a couple 
other leading SME lenders -- have significant exposure to SMEs, so 
he predicted that NPL problems will largely be confined to municipal 
commercial banks. 
 
Comment 
------- 
 
¶10. (SBU) It is clear that the PRD economy is in transition, with 
 
GUANGZHOU 00000398  003 OF 003 
 
 
many low-margin and small-scale exporters struggling due to a 
difficult economic environment and greatly reduced availability of 
credit.  Tightening monetary conditions primarily through 
quantitative credit controls rather than by raising the cost of 
credit through higher interest rates is disproportionately impacting 
south China's SMEs.  The question is whether the current economic 
weaknesses will be confined to certain industries, as Bank of 
America's Zhang asserted, or if inefficient capital allocation or 
other market forces could cause economic distress to extend into 
other areas of the economy, as Citibank's Qiu suggested.  If, as 
Hong Kong ETO's Leung predicts, thousands of Hong Kong businessmen 
will sneak out of town by the end of the year, leaving behind empty 
factories and tens or hundreds of thousands of unemployed and unpaid 
migrant workers, Guangdong's leadership could be dealing with a 
significant and destabilizing economic and social condition. 
 
GOLDBERG