Chinese SMEs Financing Report of Current Time

Yikun Yu
Setting the Wenzhou problem as the introduction, specify the situation and reasons of current time of small and medium sized enterprises (SME) and what the stakeholders here could do to turn the situation to be a better one.

FIN 651 BANK FINANCIAL MANAGEMENT Prof.Arjun K.Mathrani 11/28/2011

Introduction
Wenzhou, one of the earliest cities in China applying the policy open the gate, has been put in focus of Chinese media after some entrepreneurs in the city committed suicide or shut down their factories and fled, because they could not pay their debts or salaries. Many of the factories in Wenzhou, Zhejiang province, have a profit margin of about 5 percent and, hence, cannot afford to pay 30 percent (or higher) interest rates on the money they have borrowed from loan sharks. More than 80 entrepreneurs have fled without paying billions of Yuan in loan. The amount, however, is just a part of the informal debts in the city, which amounts to hundreds of billions of Yuan. Instead of facing a financial crisis, Wenzhou is caught in a speculation bubble situation. It is surprising, though, that Wenzhou's entrepreneurs would agree to pay such high interest rates when the government rule says an interest rate more than four times 6.56 percent is illegal and a debtor can refuse to pay the extra amount. Those ones taking risk to invest are paying the price. The most critical time of the bubble has passed, but since small and medium sized enterprises (SMEs) generate 60 percent of the exports and provide 75 percent of the employment in China and many SMEs are concentrated in Wenzhou, it is worth taking a look in this matter. Wenzhou was famous for being one of the first Chinese cities to produce private enterprises. As a result, its entrepreneurs were among the first in China to get used to the market and become rich. Apart from being reinvested in factories, the extra money they generated needed to find ways to multiply. That's why they began speculating in real estate and other fields across China; they even invested abroad. The same Wenzhou's entrepreneurs now have to face serious problems. In fact, private enterprises in almost all Chinese coastal cities are facing difficulties and their problem is likely to continue.

How can the same entrepreneurs turn to be the sources of bubble and harms cash flows?
First of all, the rise in cost and competition, and the decrease in demand from Europe and the United States markets are a long-term trend. They have to compete with not only countries such as Indonesia, Vietnam and India, but also China's central and western provinces such as Jiangxi, Henan and Qinghai, and Chongqing municipality. Since most of Wenzhou's private companies have no brand, high technology, customer loyalty or their own sales channels, they had to choose between moving their factories to places where the cost of production is lower or facing bankruptcy. Unfortunately, many chose to turn to financial speculation.

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Also, because private investment has fewer choices, some people chose to indulge in high-risk informal loans. Wenzhous entrepreneurs turned to speculation in the early 2000s. They did not have or use much capital in the beginning, but when they found that speculating in housing or other commodities generated more profit than the manufacturing sector, many of them loaned out more money. The additional capital they generated found even fewer investments. In other words, the prospects for private enterprises and private investment were getting worse, leading to the debt panic in Wenzhou. The last straw that broke the camel's back was the government policy on real estate, in which field many Wenzhou's entrepreneurs had invested. The policy not only decreased the liquidity in the real estate market, but also hampered their cash flow. The purpose of this new policy is one way to control the price of real estate, but it also harms those companies which are suffering under the depression of world economic. As the deposit requirement keeps rising, there is less money is available for borrowing from banks and the money had been put with much stricter terms---all of these limits cash flows; in a world that cash plays the king, decreasing cash flows kill many ones. What we can see from the facts above is the difficulty of financing money from the market. It is not an easy even an impossible way for the entrepreneurs fund themselves when they get into troublesbanks are the roles that chasing after you for possible lends while say no to you when you need to borrow. Thats an unreasonable role the banks are playing in Chinas economic system: banks shall do the right things to reduce possible risk and keep the economic develop in a stable way. Here we put an eye on the financial issues.

Who shall take the responsible for the bubble and the worse situation at present time?
A, the entrepreneurs (SME) All of the businesses have the risk, expected and unexpected ones. Once the entrepreneurs are doing their business as doing gambling, failure comes upon is just a matter of time. While making their business plans, entrepreneurs shall not put all of the eggs in one basket: spread investment as well as risk. They didnt do it in a reasonable way but turned to hot money. It would be their own fault to loss everything. Once they have no access to new sources of money supply, they have turned to illegal private funds, whose money is funded from commons. They just put more people under risk.

B, the banks In one responsible economic system, banks play the role of buffer among risks. Controlling the supply of money in the market is one of the most common ways the banks regulates the markets. The banks have responsible to the whole economic. However, what the banks had done during the bubble was pumped? They are just another push power of it. Before the
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problem comes out, there is no limitation about applying funds to buy new real estate, no matter how many he or she already had. As the real estate went to hot, they sell what they had and bought new ones; they did it like its a common good market even it is not. The real estate market matters to the whole economic and everyone. If the banks did something before the problems come out, there shall not be so many losses. What is considered by the banks is only profit, which increases risk. However, the situation of the global economic has not turned out to be better as expected; it even went worse as the Euro market got stuck. The export keeps at a low level which made the situation be a worse one to SMEs. SMEs need to get their business adjusted to the new situation, but it needs money and time. At this point, banks cut money supply; what the banks want to do is only avoiding risk of their own but leaves their customers aside.

C, the government Guidance and regulation is what the government takes responsibility for. Once the situation went wrong, it is the proof of absence of government when it is needed. Whats more, government shall do its best to lead illegal funds to be a legal source

What shall they do?

1, the entrepreneurs If the entrepreneurs want to survive, the first step is doing right things by themselves: make up more reasonable business plan and reduce risk from the investment; improve management skills to reduce the cost and increase cash flows; keep the information updated with the shareholders---its a way to hold the faith and trust from related parts.

2, the banks The banks shall bear their responsibility to solve the problems in Wenzhou at present time; they shall not only control the cash flows but also support SMEs: build the system of pricing the risk from loaning to SMEs and build up suitable financial products for the SMEs; improve the communication between banks and SMEs.

3, the government To solve Wenzhou's problems, the government has to take some swift measures to deal with the loan bubble. The government has to put a stop to the illegal loan market, though it is justified in fixing the upper limit for interest on loans at four times the standard rate. The government can deal with the existing debt disputes through legal procedures, too, and along

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with big State-owned banks it can offer specific types of help to Wenzhou's companies and their employees. In the long run, the government should improve the market environment for private enterprises and private investment. First, the government shall introduce the concept of private financing ways of SMEs, which could set the illegal ones under monitoring. Second, the central bank should make more efforts to control inflation and raise the interest on deposits before inflation is controlled. The government has kept the deposit rate so low that people seek other ways to make their money grow. Since there are few choices, people will join the illegal loan market. Third, the government shall limit the monopoly of SOEs and State-owned banks, and allowing efficient private enterprises to participate in the market, issue bonds or go public. And last, the government should reduce tax to ease the tax burden on private enterprises, so that they are left with enough money for research and development.

Statement: I positively affirm that this paper is entirely my work. I have placed any quotes used in quotation marks. I recognize that violation of this rule will result in a failing grade for this course.

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