Cogs of China’s credit machine grind more slowly

Shoreline Capital, a Guangzhou-based investment firm which invests in distressed assets and provides debt capital in China, looked at over 700 opportunities to put money to work in China in recent months. Shoreline ended up providing capital to exactly four companies, despite the fact that the counterparties on all of the deals were willing to pay returns of at least 25 per cent and offered full collateral backing.

“So many people promise that they will pay us 25 to 40 per cent per annum and think they can use the funds to make many times their money,” says Ben Fanger, co-founder of Shoreline. “But many of these are overly speculative or even just get rich quick schemes with no actual value being created. To use borrowed money on such inflated promises to pay such returns can be, as the Chinese saying goes, trying to ‘snatch a white wolf with empty hands’.”

Beijing’s recent tight money policy has given rise to ever more money games, speculation and corruption, though the effects are only now beginning to become evident. Such money games have become a big threat to China’s prosperity and to its social harmony. These games are symptomatic of a society where everyone is on the take, looking for short-cuts.

In the autumn, the great Chinese credit machine began to slow dramatically. Total financing in China (which includes loans, fundraising in the capital markets and activity in the shadow banks) fell 30 per cent year over year in the third quarter. In September, bank loans grew at their slowest pace since October 2008. Growth in M2, the most widely used measure of money supply, is now well below the year end target of 16 per cent.

Beijing’s tight money policy has been effective in taming inflation (now 5.5 per cent) and the rise in asset prices. It has also slowed the number of property transactions and the rise in property prices, squeezing developers lacking deep pockets. At the same time, though, the difficulty in obtaining money through the official channels has given rise to a system in which state-owned enterprises that are supposed to make real things are increasingly turning themselves into financiers, borrowing at the official rate themselves and then turning around and putting the money to work in the grey market. Firms ranging from cellphone operators to shipbuilders have formed finance companies to engage in such activities.

The reversal from the loose money policy of 2009 and 2010 giving rise to an explosion of such games has been sharp. Between 2005 and 2010, bank credit had expanded at a compound annualised rate of 21.2 per cent. Since December 2008, the banks have put $4,100bn of new credit on to their balance sheets (and perhaps another 30 per cent off their balance sheets), and bank credit went from being 100 per cent of gross domestic product to about 130 per cent.

Now there is evidence that the Chinese may relax the current tight money policy at least incrementally. This week, Citic Securities issued a report entitled “Turn on the printing press!!!” Some banks are receiving increases in their loan quotas and analysts expect regulators to cut the reserve ratio requirements soon.

Still, such money games, speculation and corruption are unlikely to disappear – even when monetary policy eases – as long as the Chinese government continues to rely on the banks to allocate credit; controls interest rates, leaving savings depositors to receive a negative 2.5 per cent; and gives its people few other alternatives in which to invest.

If an entrepreneur wants to obtain funds in China, the choices are few and unattractive. Small and medium-sized enterprises are supposed to be the target of the selective easing that is now on the cards but banks don’t trust entrepreneurs because so many of them are more serious about taking money than using it. It isn‘t only the collateral that often turns out to be fake, even the proposed factories can be fake.

Many local governments have established science and technology funds to help struggling entrepreneurs in their districts. But the going rate for such funds now involves a kickback of about 30 per cent of the handout for the officials doling out the funds.

Legitimate businesses are struggling as informal demands for pay-outs multiply. One New York-based company which employs factories in China to make ornaments that it sells to the big box retailers such as Target or Walmart reports that the inspectors will only give their approval to factory conditions and product quality after generous payments.

The move from the hard work of manufacturing and value added to putting up luxury flats and playing money games is not confined to China alone. But the speed of the shift is a growing concern. In the past, there was corruption but things happened. Now, one entrepreneur in Shanghai laments, all the projects are like the reflection of the moon on the water – just an illusion.

Source: http://www.ft.com/intl/cms/s/0/6f851e30-0b8d-11e1-9861-00144feabdc0.html#axzz1do4A9hvt