Cablegate: Cash Meets Capital: Underground Financing in Wenzhou

VZCZCXRO2756
RR RUEHCN RUEHGH
DE RUEHGH #0342/01 2310828
ZNR UUUUU ZZH
R 180828Z AUG 08
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 7082
INFO RUEHBJ/AMEMBASSY BEIJING 2043
RUEHGZ/AMCONSUL GUANGZHOU 1314
RUEHSH/AMCONSUL SHENYANG 1339
RUEHCN/AMCONSUL CHENGDU 1343
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHHK/AMCONSUL HONG KONG 1489
RUEHIN/AIT TAIPEI 1152
RHEHAAA/NSC WASHINGTON DC
RUEHGH/AMCONSUL SHANGHAI 7658

UNCLAS SECTION 01 OF 03 SHANGHAI 000342

SENSITIVE
SIPDIS

FRANCISCO FRB FOR CURRAN/GLICK; NEW YORK FRB FOR
CLARK/CRYSTAL/DAWSON
CEA FOR BLOCK
USDOC FOR ITA/MAC DAS KASOFF, MELCHER AND OCEA
TREASURY FOR AMB.HOLMER, WRIGHT AND TSMITH
TREASURY FOR OASIA - DOHNER/HAARSAGER/CUSHMAN/WINSHIP
TREASURY FOR IMFP - SOBEL/MOGHTADER
NSC FOR LOI

E.O. 12958: N/A
TAGS: EFIN ECON PGOV CH
SUBJECT: CASH MEETS CAPITAL: UNDERGROUND FINANCING IN WENZHOU

1. (SBU) Summary: On August 12, Econoff visited the
entrepreneurial city of Wenzhou, Zhejiang Province to discuss
challenges facing small and medium size enterprises (SMEs).
Interlocutors noted several difficulties brought on by the
current economic slowdown. In particular, SMEs have been
disproportionately affected by government credit tightening
policies, which have been stepped up recently over concerns
about inflation. Underground ("private") lending has helped
make up for some of the financing shortages faced by SMEs in the
current credit tight environment, but government interlocutors
in Wenzhou posit that actual underground lending may be much
less than has been reported in the media. Although the local
government is adopting several measures to increase "official"
financing channels for SMEs, such as licensing small-sum loan
companies, local government contacts believe that these measures
will not play a significant role in China's capital markets when
credit policies are loosened at some point in the future. End
Summary.

Challenges Facing SMEs
----------------------

2. (SBU) In separate meetings with Econoff on August 12, Cai
Lingyue, Vice President of the People's Bank of China (PBOC)
Wenzhou Branch, and Pan Pingping, Deputy Director of the Wenzhou
Bureau of Foreign Trade and Economic Cooperation (BOFTEC),
discussed challenges faced by small and medium size enterprises
(SMEs). These challenges include financing, rising costs of
labor and raw materials, RMB appreciation, and value added tax
(VAT) rebate adjustments. Although Pan acknowledged that some
SMEs in Wenzhou are closing down, he downplayed media reports of
mass closures as "exaggerated," stating it is "natural" for
businesses to open and close based on fluctuations in the
economy.

3. (SBU) In terms of financing, Cai and Pan both noted SMEs
have been disproportionately affected by government credit
tightening policies, which have been stepped up recently over
concerns about inflation. SMEs account for more than 65 percent
of total value added of industry in China according to Chinese
Banking Regulatory Commission (CBRC) statistics; however, these
data show that SMEs receive only 30 percent of corporate loans.
In Wenzhou, the concentration of small and medium enterprises is
higher than the national average, accounting for roughly 80
percent of value added, by Cai's estimate. In the current
environment, it has become increasingly difficult for these
enterprises to secure adequate financing, as loans to SMEs are
on average considered riskier than loans to larger firms. With
required reserve ratios at 17.5 percent and restrictions placed
on loan growth, commercial banks lend first to their safer
clients, usually large firms which have more assets to use as
collateral.

PBOC Devising New Financing Channels for SMEs
---------------------------------------------

4. (SBU) Based on SMEs' contributions to Wenzhou's economy,
PBOC/Wenzhou's Cai believes it is the PBOC's "responsibility" to
develop policies and institutions to aid SMEs. Cai said PBOC is
encouraging the Postal Savings Bank of China, rural banks, small
loan companies, and other small financial institutions to meet
SME financing needs. Cai also noted the PBOC is actively
promoting the development of intermediary markets, notably loan
retailers to direct loans to SMEs, and is also working with
small financial institutions to help improve risk management.
He added that the recent PBOC decision to increase loan quotas
by 5 percent and 10 percent for the five main national banks and
local banks respectively is aimed primarily to help SMEs, small
farms and rural industries.

Underground Lending Provides Some Relief
----------------------------------------

5. (SBU) According to Cai, the primary financing channels for

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Wenzhou SMEs include bank loans, direct financing or trust
loans, underground lending (loans made outside of officially
sanctioned channels) and loans from other financial institutions
such as credit unions, pawn shops and collateral companies.
Though bank loans are still the primary source of capital for
SMEs, underground lending has also played a significant role in
covering SMEs' capital shortages. Although Cai believes private
lending has its advantages, he emphasized its risks, notably its
lack of transparency and undermining of Central Government
macro-control policies. He also downplayed its weight, claiming
it accounts for 10 percent of current total lending in Wenzhou
as opposed to 30 to 40 percent in the 1980s.

Who Has the Right Numbers?
--------------------------

6. (SBU) The newspaper Wen Weipo, citing experts familiar with
underground lending, reported the practice could account for up
to 30 percent of all lending in China. Likewise, a University
of International Business and Economics (UIBE) Professor
estimates underground lending accounts for 25 percent of all
lending activity. Comment: Given the relatively high
concentration of privately owned SMEs in Wenzhou and suspicion
that most underground financing goes to SMEs, Cai's estimate
that 10 percent of total lending in Wenzhou is from private
lending suggests (though anecdotally) that the actual amount of
capital in underground financial markets may be considerably
smaller. End Comment.

7. (SBU) Cai said the Wenzhou PBOC has chosen over 600 sites in
rural and suburban areas from which it monitors local lending
rates and the flow of private capital, including to which
industries the capital is flowing. The data is collected by the
PBOC's own local staff based in different counties across
Wenzhou. From this data, he estimates current monthly
(non-annualized) private interest rates to be roughly 3 to 4
percent, though there are reports of monthly interest rates
reaching 8 percent or higher for some very short term loans.

Small-Sum Loan Companies only Temporary Solution
--------------------------------------------- ---

8. (SBU) In May 2008, the CBRC and PBOC jointly promulgated the
"Guiding Opinions on the Pilot Operation of Small-Sum Loan
Companies" delegating authority to provincial governments to
issue guidelines and grant licenses to small-sum loan companies,
with the express purpose of helping SMEs find financing.
Zhejiang Province is the first province to have issued
regulations and to begin granting licenses. Cai said this is
part of the government's effort to develop financial
intermediary markets, helping to connect entrepreneurs and
investors, and increasing the overall efficiency of China's
capital markets.

9. (SBU) Sixteen licenses already have been granted in Wenzhou
under heavy competition. In order to obtain one of these
licenses (as established by Zhejiang regulators), companies must
have more than 50 million RMB in net assets and have recorded
profits for three straight years with total profits exceeding 15
million RMB. In less developed areas the restrictions are
slightly relaxed, requiring only 20 million RMB of net assets
and 6 million RMB of total profit. Asset liability ratios are
not allowed to exceed 70 percent. Cai expects that interest
rates for small-sum loan companies will not be over four times
the benchmark interest rate determined by the PBOC.

10. (SBU) Cai and Wenzhou BOFTEC's Pan expressed skepticism
over the efficacy of these small-sum loan companies in easing
the overall credit-tight environment. Pan noted the companies
can only raise capital from investors, ensuring they would
remain secondary to commercial banks which raise capital through
deposits as well as from investors. Cai likewise did not see a
prominent role for small-sum loan companies in China's financial
system, noting they would likely fade even further into the

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background when credit policies are relaxed at some future date.
He hopes such efforts nevertheless will help bring capital out
of the underground market.

Comment
-------

11. (SBU) One unintended consequence of China's credit
tightening policies is the disproportionate burden placed on
SMEs. Underground financing has arisen to relieve some of the
burden, but estimates of its true extent are few and of
questionable accuracy. PBOC/Wenzhou Cai's estimate that 10
percent of financing in Wenzhou comes from underground lending
casts doubt on other estimates that suggest underground lending
nationally accounts for 25 to 30 percent. This also raises
questions over the ability of the underground financial system
to meet the financing needs of struggling SMEs. Small-sum loan
companies have been discussed as another possible solution for
helping resolve financing difficulties faced by SMEs, though
interlocutors did not see them as having much effect beyond
temporarily improving intermediary financial markets. This
suggests the government is still unwilling to allow any serious
alternative to the major state-owned banks, even at the expense
of the most productive actors in the economy.
JARRETT

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