China’s Silent Nationalization By Stealth

November 9, 2011 Posted by China Briefing Reading Time: 3 minutes

Op-Ed Commentary: Chris Devonshire-Ellis

Nov. 9 – As China Inc. battles with a stubbornly high inflation rate of 6 percent, a global slowdown in orders from its manufacturing base, an increasingly austere credit environment, and significant rises in labor costs, it goes without saying that small to medium-sized enterprises (SMEs) are facing some tough times.

What isn’t generally recognized, however, is the silent collecting of SME assets back into the Chinese state as a result. Whether by accident or design, Chinese SMEs are being asked for increasing amounts of security from Chinese banks, requiring loan guarantees in the form of land use rights, property certificates, and even factory land and equipment as collateral. While this would be considered normal in the West, in China it has a deeper resonance as the banks are state-owned – meaning private entrepreneurs are being asked to provide assets back to the state to guarantee loans having to be made partly as a result of the repercussions of China’s state fiscal and economic policies.

Additionally, we learn of Chinese banks getting around the officially regulated interest rate of 7 percent to 8 percent for loans by insisting that borrowers submit to acquiring more money than they actually need, with a request that they redeposit up to half of the loan back into the same bank at a reduced interest rate. The practical effect is that the borrower pays a higher overall interest rate than the official rate. It also calls into question the exact status of business loans within Chinese banks, and the effective asset grab by them from Chinese SMEs requesting cash flow assistance. Depending on the numbers involved, it also suggests that China’s banks are increasingly reliant on Chinese SMEs to fund their own cash flows and asset sheets by inflicting loans upon businesses beyond that actually required. This cannot be healthy – for either party.

What hasn’t yet been determined is the bank’s policy in dealing with off-balance sheet assets – land, property or heavy equipment they now effectively have a charge over – and how they will disperse this should loans go bad. Nor is the legal situation entirely clear over the discharging of liabilities to the bank in the form of the return of guarantees. Such regulations and protocols remain ill-defined, and for the large-part, untested in litigation. It remains to be seen whether banks will regard primary business assets already under their security as on-going collateral to extract further capital from small businesses, or how resistant they would be regarding the return of guaranteed assets once debt is repaid. It is certainly a collision of two ideologies that involves substantial political and financial risk on the part of the Chinese entrepreneur – and at a greater level than we would see internationally. It also calls into question just how free are China’s small businesses – where the capitalist entrepreneurial instincts are fine when self-funded, but revert to state ownership as soon as credit is extended. China’s experiment with capitalism appears, to this observer at least, rather ectoplasmic when entrepreneurs have to deal exclusively with state-owned financiers.

Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates, and the publisher of China Briefing. Dezan Shira & Associates was founded in China in 1992, and provides corporate establishment, tax, accounting and business advisory services for multinational and small-medium clients in the country. The firm has expanded in recent years into emerging Asia, and in total has eleven offices in China, five in India, two in Vietnam and one each in Hong Kong and Singapore. Please email the practice at info@dezshira.com for business advisory or other services throughout Asia, or visit the firm’s web site at www.dezshira.com. A weekly subscription to the best of Asia Briefing news can be obtained free of charge from our subscriptions page.

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