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China's small businesses face severe cash crunch

Small Chinese businesses are feeling the effects of the government's monetary tightening and face a cash squeeze that may be worse than during the global financial crisis in 2008, according to an official warning.

From tile manufacturers in Shanghai to shoe factories near Hong Kong, smaller businesses have driven Chinese growth over the past two decades, accounting for about 60 per cent of gross domestic product. A sharp slowdown in their activity would weigh heavily on the Chinese, and by extension, world economy.

The world has become increasingly reliant on China as an engine of growth over the past two years and a deepening Chinese slowdown at the same time as recovery in the United States and Europe falters would be particularly worrisome.

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The Shanghai Securities News, a state-run newspaper, on Thursday carried the warning from the All-China Federation of Industry and Commerce, a state-backed chamber of commerce that surveyed 16 provinces.

In late 2008, during the financial crisis, a collapse in global export markets and aggressive monetary tightening drove the Chinese economy to a near standstill. Beijing estimated that 20 million migrant workers, many of whom were employed by the same kinds of small firms that are now short on cash, lost their jobs.

Dong Tao, a Credit Suisse economist, said China could now face trouble again, as companies delay bill payments and factory owners abscond without paying wages.

"If this continues, and these smaller companies start to fail in large numbers, then the economy will slow more than the market anticipated and the government bargained for," he said.

The prospect of millions of unpaid factory workers greatly concerns Beijing, which is wary of anything that could spark social unrest. On Monday, more than 200 people besieged a government building, setting fire to cars in the southern city of Chaozhou, after a worker was stabbed on the orders of his factory boss for asking for unpaid wages, according to Chinese media reports.

The cash crunch has come despite repeated prodding by the government to help private businesses. Chinese banks have traditionally preferred to lend to state-owned groups, judging that they pose negligible credit risk due to their government backing.

This bias is especially pronounced when the government restricts credit, as it has done over the past year. China has raised benchmark lending rates by 100 basis points to 6.31 per cent, but small businesses have seen much steeper increases.

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Monthly lending rates at credit unions and informal lending institutions in the entrepreneurial cities of Wenzhou and Xiamen have reached 5 per cent in the past few weeks, up from 1.5 per cent just nine months ago, according to Credit Suisse.

Earlier this week, in an effort to boost access to credit, the Chinese banking regulator said it would ease tough capital rules on bank lending to smaller businesses. In one measure, loans of less than 5-million renminbi ($770,000 U.S.) need not be counted toward banks' loan-to-deposit ratios.

Policies to spur more lending to small groups have not been successful in the past, and analysts say the reforms announced this week may pose new problems.

Bank analysts at Barclays Capital said the changes would probably alleviate the cash crunch. But they warned that the approach risked overlooking the high-risk nature of lending to smaller businesses and suggested that government guarantees and subsidies for such loans might be wiser.

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