16 November 2019

Blame Wenzhou crisis on China’s investment addiction

Business people are having a hard time in Wenzhou, the Zhejiang city that is known for its entrepreneurship and robust private sector.

Defaults, bankruptcies and foreclosures are common these days. Wenzhou was the only one of the 70 major Chinese cities that witnessed a drop in real estate prices in August. That was the 24th consecutive month that the city saw a housing price dip, making more investors negative asset holders.

Wenzhou business owners pulling down shutters and running away to avoid creditors hit news headlines frequently. Banks and private lenders find their bad debts snowballing.

All of a sudden, “Wenzhou merchant”, once an enviable title synonymous with fortune, adventurousness and business savvy, has become a term of disrepute.

How did all these happen?

China’s long-term practice of using investment to boost growth, featuring unchecked lending spree, is to blame.

When the global financial crisis struck in 2008, the government launched massive fiscal spending programs and turned on the tap of liquidity.

To propel investment, banks were given large amounts of money, and they were asked to lend it out to propel economic growth.

It was a rare period when banks courted businesses. To achieve the lending goal, banks frantically handed out loans to shadow bankers and small companies, other than their traditional customers – the big companies.

At the same time, banks loosened requirements and asset scrutiny. They used to take tangible properties as guarantees, but in those years, future contracts, third-party collaterals and reciprocal loan guarantees were accepted.

Where did Wenzhou businesses invest the money they borrowed from banks and private lenders? Most of it did not go to the real economy, but to the property market, which promised quick and high returns. Property bubbles surfaced.

So, when the stimulus came to an end — with liquidity tightened and economic growth slowing — property bubbles burst and high leverage rates bit into companies, resulting in an increasing number of defaults and bankruptcies.

Banks became worried and started to call in outstanding loans from small companies, even though the loans were not mature. The practice aggravated the financial difficulty of these companies and caused more defaults and bankruptcies. A vicious circle cycle developed and evolved into the current crisis in Wenzhou.

Investment, supported by easy credit, was the convenient booster to China’s economic growth in the past decade, when the government habitually turned to increasing spending and liquidity whenever they felt economic growth was not meeting their expectations.

Although the new leadership has realized the adverse effects of the investment mania and is rolling out measures to reduce reliance on fiscal spending and money printing, top policymakers have to resort to investment when they need to give the economy a shot in the arm.

A clear evidence that the situation has not changed was Premier Li Keqiang’s announcement of a slew of mini-stimulus measures, such as speeding up investment in railway construction, soon after he felt gross domestic product growth could easily slip below the comfort level of 7.5 percent.

Unlike his predecessor, Li is not a big fan of investment, and his wish is to break away from the previous growth tack that featured excessive reliance on natural resources, cheap labor and easy credit.

But like it or not, investment seems to be the only choice for China, especially at a time when consumption has a long way to go before it becomes a powerful economic engine. Without a sound social security network and a market-based financial system that can ensure fair distribution of economic resources, private consumption remains tepid. Now that the central government’s frugality campaign is also dampening public consumption, fixed-asset investment becomes the slippery vine to clutch at.

The good thing is that this round of pro-growth measures, initiated by Li, were apparently carefully selected and targeted, and its scale is not as big as it was during Wen Jiabao’s time.

But we must be wary of China’s investment addiction, and let’s keep our fingers crossed that Li’s urbanization drive won’t become another feast of investment and liquidity.

Zhang Xinmo, a commentator based in Beijing, has been a journalist for more than 10 years in China and Hong Kong. He writes mostly on China’s economic issues.

– Contact the writer at [email protected]



The writer is an economic commentator. He writes mostly on business issues in Greater China.