By Jane Lanhee Lee
WENZHOU, China (Reuters) - After China's cradle of private enterprise was rocked recently by woes of its vast underground banking market, a full-blown debt crisis was averted -- but the real test is still to come.
That test will take place in January, when companies and individuals have to settle their bills ahead of the Lunar New Year.
Wenzhou, a hive of entrepreneurship on the coast around 400 km (250 miles) south of Shanghai, came into the spotlight in the past month for the cracks appearing in its vast underground lending market, whereby loan sharks and pools of depositors extend credit to small companies that have trouble getting loans from banks.
In late September, worries in Wenzhou, a city of about 2.3 million people, grew sharply. Media reports said that some company chiefs fled and that one shoe-business boss jumped to his death after not being able repay their high-interest loans -- sometimes rumored to carry annual rates topping 100 percent.
The government has since intervened, with Premier Wen Jiabao visiting the city this month and ordering banks to support small businesses, which often have turned to the underground market after getting rejected by banks.
Wen's move helped improve sentiment and pushed back the possibility of a series of bankruptcies, which analysts have said could spread into the formal banking system.
Still, many people in Wenzhou are awaiting with dread the most tense time for businesses even in very good years -- debt collection time.
"Chinese like to settle their debts between January 1st and the start of the Lunar New Year," said Hu Zhenhua, a professor of economics at Wenzhou University. The first day of Lunar New Year celebrations is January 23.
"If we don't pay attention to this period, we may see more bosses running away," Hu warned.
POSSIBLE DOMINO EFFECT?
To be sure, a blowout of the informal lending market in Wenzhou would not itself pose a serious threat to the Chinese financial system or economy.
The underground credit market nationwide was worth 2.4 trillion yuan ($377 billion) at the end of March 2010, less than 6 percent of China's total lending, according to estimates by the central bank. Wenzhou accounts for just a small portion of that total.
But there is still reason for authorities to worry about the possibility that bankruptcies in Wenzhou could start a domino effect of defaults.
Any social unrest that would ensue could be seen as a preview of what might happen elsewhere in the country should the property market or broader economy experience a harder-than-expected landing, potentially leading to defaults in both the formal and informal banking systems.
In Qiaotou, a button-making town on the outskirts of Wenzhou, luxury sedans and SUVs line the streets. Many button bosses have poured money into a 33-story luxury apartment building, now under construction, that is surrounded by farmland, with polluted streams and fume-belching factories in the background.
Yet outward signs of confidence and wealth mask an underlying state of suspense that hangs over the business community here. Many business people wonder whether their debtors will pay them and whether they, in turn, will be able to pay their creditors come January.
"There's a lot of concern about whether clients will be able to pay back the money they owe for the goods," said 34-year-old button maker Chen Wensheng, who left school at 15 to join the family business.
The problem is not just Chen's clients, who currently owe him around 500,000 yuan ($78,000) and, he says, are seeing their clothing business slow.
PRESSURE TO DIVERSIFY
More important is that many businesses have themselves started relending money or borrowing for speculative purposes -- a practice that paid off handsomely in good times but is now exposing many to big losses.
"I just wish that my clients, if they have cash, wouldn't invest in things like stocks, gold, and property. If it's not properly managed, it will be dangerous for our industry," said Chen.
Throughout China, the people of Wenzhou are known not just for their entrepreneurial spirit, but also for their betting on everything from property to commodities.
For many of Wenzhou's entrepreneurs, even if they survive the winter unscathed, hard questions will remain about how a city that built itself on producing low-cost products will be able to evolve. Traditional industries such as button-making and shoes are becoming less viable as China's costs rise.
Even Hu Xuchang, who runs a pipe company that has more than $100 million in sales a year and considers himself a relatively conservative businessman, feels the pressure to diversify his business if he is to survive given razor-thin margins.
Hu has made sure not to over-extend himself as many other business have done, but has himself gotten into the private equity business, making investments in start-up technology and finance firms elsewhere in China.
"I considered expanding the main pipe business in a big way. But profits have slowly fallen over the years and it would have been difficult. So I looked for a business with higher profits and value added," he said.
Come the Lunar New Year, Hu and other businessmen in Wenzhou may be wondering where is the value in their investments.
(Writing by Jason Subler; Editing by Brian Rhoads and Richard Borsuk)