Time to plug the funding holes

Updated: 2012-01-06 08:53

By Wu Jiangang (China Daily)

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Better private financing channels vital to avoid Wenzhou situations

Though the government has been trying hard to help small- and medium-sized enterprises (SME)in Wenzhou, East China's Zhejiang province, the number of units that are being shut down and the factory owners who are fleeing is steadily increasing.

With a huge chunk of the private loans still unpaid, and more funds required for cash payments like salaries and year-end bonuses, there seems to be no immediate respite for the financial muddle in Wenzhou.

There is very little that the government can do to ease the financial problems in Wenzhou and pave the way for easier SME financing.

Although the government expects commercial lenders to disburse more loans to troubled enterprises by lowering the loan requirements, banks are reluctant to and cannot play an important role in such a situation, because of their risk-control requirements and loan budgets.

Though there has been opinion in some quarters that the government should bail out the failed enterprises, there are also others who argue against such a move.

Critics of the move feel that government should not use taxpayer's money to bail out troubled SMEs, as most of the factory owners have fled not because of adverse market or manufacturing conditions but rather due to rampant speculation.

While there is little that the government can do directly, it can certainly help maintain normal financial order and punish the criminals.

Since of the "vanished factory owners" or "failed enterprises" can cause disruptions in payment chains, the government can help by bringing back the vanished factory owners and by liquidating and restructuring failed enterprises, and providing tax breaks and guarantees on short-term loans.

Though these measures may be useful in the short term, non-bank lending will continue to be the main driver in the long run.

Wenzhou can once again be the forerunner of SMEs in China if it is able to develop a successful pilot zone for private financing.

Of the over 450,000 private enterprises in Wenzhou, many are struggling or surviving with wafer-thin annual gross profit margins of less than 5 percent. It is difficult to fathom how these enterprises can borrow money with annual interest rates of over 48 percent.

There is a saying that those who use usury for speculation must eat their own bitter fruit. Considering that the government has been taking prompt steps to prevent the issue from snowballing, it can be safely assumed that the usury troubles in Wenzhou will soon be a thing of the past.

But what the government should do in the long term is to provide a fair and competitive environment for private enterprises.

SMEs not only play an irreplaceable role in job creation, technical innovation and social stability, but also are China's hope for the future.

The difficulties of private enterprises in Wenzhou show that this hope is now under serious threat. At the same time the problems in Wenzhou are akin to the problems faced by several other cities in China.

Institutional factors such as high taxes, government rent-seeking behavior, monopolies by State-owned enterprises, financial repression and weak protection of property rights affect small and medium enterprises.

Macroeconomic factors like dwindling overseas demand, weak domestic demand, appreciation of renminbi and increasing production costs, such as capital, labor, land and raw materials also affect SMEs.

As both institutional and macroeconomic factors will have long-term effects, there are hardly any short-term solutions for private enterprises.

It is not surprising that some factory owners were finding it hard to make money from manufacturing and hence turned to speculation years ago. Property, mineral resources, and some commodities are the most preferred candidates.

Property speculation has been prevalent for several years, but started running into rough weather after the government decided to clamp down on the sector. Speculation on mineral resources and commodities became popular in recent years but was quickly suppressed by the government.

With most doors for speculative gains closed, factory owners have virtually no option but to do a disappearing act rather than face their creditors.

In the short term, the government should reduce taxes and provide more funds to support SMEs while private enterprises must help each other. In the long run, the government must create an institutional environment in which private enterprises can not only fight for survival, but are also able to foster core competitiveness.

China must create private economic giants if it wants to realize its ambition of being a global economic giant. The ideal candidate for this is Wenzhou, the cradle of private enterprise.

The author is a lecturer at the Management School of Shanghai University and a research fellow at the China Europe International Business School Lujiazui International Finance Research Center.