Fears surface over Chinese debt amid lending practices

Workers on a residential construction site in Shanghai September 8, 2011
Image caption China's property market could see a slowdown

With its deep pockets and buoyant growth, China has been touted as a white knight for the world economy.

But fears are growing that the country may face its own debt crisis as its economy shows signs of a slowdown.

Premier Wen Jiabao this week urged stronger financial support for cash-strapped smaller businesses.

His call comes amid reports that many private sector enterprises are facing bankruptcy due to credit tightening and an explosion in informal lending.

In the eastern city of Wenzhou, one-fifth of the city's 360,000 small and mid-sized businesses have stopped operating due to cash shortages, China's official news agency Xinhua reported on Thursday.

"Effective measures should be taken to contain the trend of usury, crack down on illegal fundraising and properly handle the problems of collateral and capital shortage in order to prevent risks from spreading and evolving on a regional scale," Mr Wen said while visiting the city.

According to Chinese media reports, more than 80 businessmen have fled the city unable to pay loans taken out from underground banks and one shoe factory owner jumped off a building and killed himself.

'Time bomb'

Economists believe this could be the beginning of a larger wave of corporate bankruptcies.

Concern centres on China's informal lending or shadow banking market - rich individuals and businesses that offer loans at interest rates spanning from 14% to 70%.

Companies and entrepreneurs have turned to this underground sector, with Chinese banks tightening lending as part of the government's fight against inflation.

Credit Suisse says that hard statistics on the sector are hard to come by, but loans could total as much as 4 trillion yuan ($627bn; £406bn) - equal to 8% of the formal banking sector - and may be growing at 50% a year.

It estimates that 60% of informal loans have gone to small property developers, with the rest going to other businesses that need bridge loans.

"We consider the informal lending market the most likely short-term time bomb for the Chinese economy," Dong Tao, Asia economist at Credit Suisse, said in a recent report.

"Either Beijing takes pro-active and decisive measures to deal with the issue, or a mini credit crisis is likely to emerge in our opinion," he says.

Default swaps

Fears of an economic slowdown in China have also fuelled a surge in the trading of credit default swaps - financial instruments that insure against the risk of debt defaults.

The net value of outstanding credit default swaps on Chinese government debt has risen to $8.3bn, compared with $1.6bn two years ago, the Financial Times reported on Thursday.

Investors are worried that China's economy could experience a "hard landing" - a sudden slowdown after years of blistering growth.

The property market is thought to be particularly vulnerable, with house prices soaring in the past two years.

The country has raised interest rates three times so far this year and ordered banks to increase their reserves six times in the same period.

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