Quotes of the Day
Mao Jiatai's disposable cups ought to runneth over. In 2002, says the entrepreneur from western China's Sichuan province, his private company raked in $2.5 million in sales by manufacturing paper containers for food and beverages. He has four production lines making paper cups in hangar-like buildings, and 20 young women from the countryside toil in the yard beside them, pasting labels featuring words such as "White Family Potato Noodles" onto single-serving bowls. Business has never been better. Yet Mao, like so many other owners of private companies in China, can't seem to catch a break in his efforts to take his firm to a higher level.
Last year Mao wanted to boost production to ride a trend of restaurants' serving tea in paper cups with colorful plastic holders. Although he had plenty of collateral in the form of sales contracts, machinery and inventory, lenders wouldn't grant him even a small line of credit to maintain a steady supply of paper. To raise funds, Mao sold his house and moved into a space above his office. That financing delay, he fears, has cost him customers who will go instead to state-owned companies with better access to capital. "The government sees state enterprises as its sons, so it helps them," Mao says dejectedly. "I get nothing, so someone else will drink up my market."
But despite economic reforms and the elevation of capitalists into the ranks of the Communist Party, small firms like Mao's remain cut off from many of the resources that grease the wheels of commerce. Like their counterparts everywhere, China's grassroots entrepreneurs gripe about taxes and bureaucratic obstacles. Their biggest complaint, however, is their inability to get bank loans. In a recent survey of 600 private companies in Sichuan by the IFC, access to financing was cited as the No. 1 problem, far ahead of unfair competition and corruption.
The reason: China's antiquated and deeply indebted banking system still lends mainly to lumbering state-owned enterprises, not private companies. Although authorities have been allowing thousands of these uncompetitive state vestiges to fail—since 1995, 56 million factory workers have lost their jobs—thousands more remain on life support, enjoying a steady supply of government-directed "policy loans" that will in all likelihood never be paid back. China's four biggest banks are technically insolvent because they are owed an estimated $500 billion in nonperforming state-enterprise loans. Yet, according to the Asian Development Bank (ADB), state firms continue to soak up approximately 70% of all loans.
Turned away by banks, Sichuan's budding entrepreneurial class must rely on unconventional lenders, including pawnbrokers and loan sharks, to meet its capital requirements. Liu Qingrong, for example, borrowed money from friends and family to set up a Chinese medicine factory in 1992. Within two years, her traditional remedies were outselling those produced by her biggest state-owned competitor by a margin of 5 to 1. But her rival, which was backed by local officials, still received every advantage, including governmental assistance to raise capital via a stock-market listing. "It was bitter medicine," Qingrong recalls.
Despite competition, her 300-employee company has managed to expand, using its $10 million in assets to secure small loans from banks. But obtaining financing still challenges her creativity. In 2000 she bought two ailing state-run factories, borrowing heavily from a real estate developer she knew to fund the purchases. Such alliances sometimes involve dangerous trade-offs: last year Qingrong was obligated to guarantee a $200,000 loan made to one of her benefactors, accepting that she would be on the hook if it defaulted. "I was terrified," she says. "If we'd had to repay, we would have had to stop production." Then again, a quid pro quo with a business associate is probably a less costly option than borrowing money from pawnbrokers that have become China's de facto commercial lenders. The booming city of Chengdu, Sichuan's capital, is home to some 200 pawnbrokers. Don't think of them as sleazy purveyors of rusting bikes and busted TVs. The tiled floors and tawny sofas of Liu Jianjun's Building China Pawnshop suggest a bank lobby, and rightly so. His loans, which can run up to $1 million each, mostly go to private businesses.
Parked in front of the pawnshop one day last month was a new Volkswagen. The owner of a construction company had hocked it 10 minutes before in exchange for a quick $10,000 to meet expenses. He would be well advised to repay it fast because Jianjun charges interest rates of up to 5.7% a month. It's all legal and above board. Although regulators and law enforcement officials in the past have cracked down on underground lenders (loan sharks tend to use gangsters to collect unpaid debts), the government currently allows pawnshops to operate because without them, small-business owners would have almost nowhere else to turn. "Banks make it difficult and confusing to get a loan," Jianjun says with a smile. "Our business is booming."
China's bankers, however, shouldn't take all the blame. Lending institutions are trying to adopt sophisticated credit-analysis techniques to apply to private borrowers, but even if they were world-class financiers, they would have a hard time offering credit to some of China's seat-of-the-pants entrepreneurs. For one thing, the government caps the annual interest rate banks can charge at 6.6%, an amount that barely compensates them for their risk. It also bars them from accepting things like sales contracts or inventory as collateral—even though small companies usually lack hard assets like land or machinery.
Moreover, it is often a pain to lend to small firms. Their owners show up in bank lobbies with account books that frequently combine grade-school math with Enron-style deceptions, making it nearly impossible to place a value on their operations. Liu Binbin has seen it all as a lending supervisor at the Chengdu City Commercial Bank (C.C.C.B.), one of a hundred or so such banks set up over the past several years across the mainland specifically to lend to small companies. One applicant, the owner of a factory that makes pickled vegetables, visited Binbin's office recently with his ledger: a single piece of handwritten paper folded in his breast pocket. Other would-be borrowers often pile receipts on Binbin's desk in lieu of a balance sheet. Even those who keep books "usually have two or three," Binbin says. "They figure out what we want and write it down."
China's industry regulators recognize that capital must flow more freely to the private sector if the economy is to retain its momentum. In addition to promoting lenders such as the C.C.C.B., Beijing this year is expected to raise the interest rates banks can charge. In January the country enacted a new law specifically to promote SMEs, in part by creating a massive fund to expand a nationwide network of loan-guarantee offices that, in effect, allows the government to co-sign loans to creditworthy companies. Similar loan-guarantee schemes have worked well in other countries. Wang Hailin, director of the policy department at the State Economic and Trade Commission, calls the program "one of the most practical measures taken in recent years to support SMEs in China."
But state-owned enterprises are muscling in on the initiative. In Chengdu last year, a government-owned machine-tool company was saved from bankruptcy after local bureaucrats ordered one of the city's four credit-guarantee offices to back loans to the factory. Officials feared that if the company closed, laid-off workers would raise a fuss. The case is not an isolated incident. Yan Guosong, general manager of a Chengdu loan-guarantee agency, estimates that more than half of government-backed business loans are now going to state enterprises. "The central government created guarantees to help small businesses, but it wound up lending to state-run companies anyway," he complains.
What makes it so difficult to cut off outmoded state ventures in favor of private firms is the government's dread of a grassroots social uprising. The number of jobs created in China barely keeps up with the armies of workers laid off by failing enterprises—and angry, laid-off workers are the biggest threat to the country's stability. Sichuan has seen its fair share of trouble: last June, traffic in Chengdu came to a halt on two occasions when workers held a protest about unpaid salaries; in September, 800 oil refinery workers in Chongqing demonstrated over paltry severance payments.
Indeed, the transition to free enterprise still has a long way to go—and in the meantime, Beijing is failing to support its most important capitalists: the small, private companies that can generate jobs for the masses. Time is running short. "If the trends don't change, China could face a real labor crisis in the next five years," warns Min Tang, chief economist for the ADB in Beijing. Meanwhile, says Tang Limin, a director of the Sichuan Investment Promotion Bureau: "State enterprises still have the government protecting them. Private companies live and die alone."
- Matthew Forney/Chengdu
- Small businesses are crucial to China's economic future. So why can't entrepreneurs get a break?