The more you look under the hood of China’s economic growth model, the more trouble you see. As a recent report in the Wall Street Journal pointed out, as small manufacturers face a profit squeeze, a new class of lenders, “guarantors” are charging high interest rates when bank lending dries up.
Guarantors have become the lenders of last resort to small manufacturers who increasingly are getting squeezed by tight credit as well as soaring wages and other production costs. These private operators, using money raised from property developers, coal miners or other cash-rich individuals, aim to fill the funding void left by state banks that many say have all but stopped lending to small businesses. In return, they charge their clients a fee on top of high interest rates imposed on the loans. […]China today has become what many call a two-track economy, with a state-owned sector flooded with cash and a private one starved of funding. The financial woes of the private sector could have an impact on Chinese growth: By some analyst estimates, it includes some 40 million companies and accounts for 80% of the country’s jobs and more than half of economic output.
China’s government remains focused on large state-owned companies even though small private sector business is where the jobs growth comes. The WSJ continues:
But even as the private sector has expanded, large state-controlled enterprises have remained the focus of Chinese policy makers, especially in times of crisis. At the end of 2008, when the world economy started to wobble, Beijing responded by pumping in some $586 billion of credit to keep its economy humming at a rate close to 10% a year. Most of that money, though, has gone to railways and other state-run projects.
The real problem here is that the manufacturing squeeze is stressing Chinese manufacturers — and that squeeze is likely to continue and even escalate. On the one hand, commodities ranging from copper to oil are in tight supply around the world — the raw materials factories need are going up in price. Labor is also getting more expensive in China, especially as newly urbanized migrant workers begin to organize and fight for what they see (understandably) as their rights to higher wages, better homes and schools, cleaner air and so forth. Factories are not only faced with the need to raise wages to keep workers; they are faced with government demands for higher taxes to meet the political demands workers have.But cash strapped consumers don’t have a lot of money; it is hard for manufacturers to pass their higher costs along to those who buy their products. Wal-Mart isn’t interested in pushing up prices in its stores, and it continues to demand that its suppliers cut costs to the bone.Squeezed by these forces, small manufacturers especially start to look a little less creditworthy to conventional banks (especially in China where sizzling real estate markets still offer good returns and state owned company loans carry implicit government guarantees). That forces them into the arms of the ‘guarantors’, who charge higher interest rates — reducing profitability still more.Small manufacturers may be the business sector where the vulnerabilities of the Chinese economic model will cause the first major problems if the model as a whole begins to come unglued.Mead advice: keep an eye on this sector. It could someday provide the early warning sign of historic changes to China’s prospects and direction.