SHANGHAI -- With China's economic growth no longer red-hot, privately run companies are grappling with higher fund-raising costs.
President Xi Jinping and the Communist Party leadership are pushing ahead with structural reform, which is essential if China is to ensure mid- to long-term growth. In short term, however, the reform drive could trigger a wave of business failures and put banks under piles of nonperforming loans.
The preliminary HSBC Purchasing Managers' Index for January, released Thursday, dipped 0.9 of a percentage point, to 49.6, from a month earlier. It came in below the boom-bust threshold of 50 for the first time in six months. As the index covers small to midsize private companies and exporters, it can reflect even slight changes in business sentiment.
President Xi has implemented tighter fiscal and monetary policies. As a result, short-term interest rates have jumped on the interbank market, and Chinese lenders have started passing along their higher costs to borrowers. As a result, many businesses are saddled with ballooning interest payments. More and more, small and midsize enterprises with poor credit standing are teetering on the brink of failure.
Agrochemical maker Changzhou Wintafone Chemical, located in Jiangsu Province's Changzhou, about 160km northwest of Shanghai, said Jan. 17 that it had filed for legal bankruptcy proceedings. "Because of the changing business environment," a Wintafone representative said, "we are unable to pay back loans by the deadline."
The interest rate on commercial paper -- basically IOUs that corporations use when lending to one another over short periods -- closely reflects corporate fund-raising costs. In China, the average interest rate on commercial paper issued by companies with high and near-high credit ratings stood at 7% in early January. It has not been that high since October 2011.
Let's look at the shipbuilding industry, which has investors worried due to a supply glut. Evergreen Holding Group, a private shipbuilder based in coastal Ningbo, Zhejiang Province, in December issued 400 million yuan (about $66.1 million) worth of commercial paper with an interest rate of 9.9%.
Due to China's slowing economic growth and other factors, speculation for a default is growing among market players. "It is highly probable that companies will fall into default in the first half of this year," said Chen Li, chief China equity strategist at UBS Securities.
Private companies are being especially hard hit by the high cost of credit; they lack the safety net -- government credibility -- that gives state-run companies a bit of a break.
"We are having a hard time borrowing funds from banks," a representative of a steel-trading company said.
China's private companies could soon find themselves in a vicious circle. Once earnings suffer, their financing costs will take another leap, further weighing on their performance.