No interest rate increase. That looks like one of China's big accomplishments in its quest to cool off the economy. By ordering the banks to stop lending to certain sectors, the authorities have slowed the growth in investment in steel, auto, and real estate -- without raising the benchmark bank lending rate of 5.31%. In theory, that means companies with good projects can still borrow at affordable rates.
Problem is, that theory ignores the reality on the ground. The cost of credit in China is up -- way up -- but mostly for private companies. Yes, fewer state enterprises are getting loans these days, but those they get are at the official rate. Private companies, by contrast, now typically pay rates of 20% or more on the gray market -- if they can get credit at all. "It's an undeniable truth that private companies have been hit harder" by the restrictive credit policies, says Dong Tao, chief regional economist at Credit Suisse First Boston (CSR ) in Hong Kong. In May, Tao says, official bank lending to private companies fell by 17% year on year, while overall loans surged by 19%.
The gathering credit crisis for the private sector is one more blow to the part of the economy that Beijing should be encouraging the most. Today, the nonstate sector accounts for perhaps 60% of China's gross domestic product and 70% of total employment. But as Beijing tries to slow the economy, these private upstarts have to scramble for funds instead of focusing on their businesses. Some simply bribe bank officials to jump to the front of the lending queue, which amounts to a de facto rate increase (and many businessmen say bribes are bigger now). And there's an assortment of middlemen ranging from well-heeled state enterprises to illegal (though often tolerated) private credit unions. They're all willing to lend to private businesses -- at a steep premium.
Punishingly high rates aren't the only cost to the private sector. Since many of the private loan operations are illegal, Beijing can't control or regulate their lending. That means greater risks for everyone involved. And the game is getting tougher, with some gray market lenders refusing to roll over loans to private companies. "If the government relied more on market mechanisms [such as interest-rate hikes] to tighten credit, it would be a fair game for the state and private sectors," says Xu Xiaonian, a professor of economics at the China Europe International Business School in Shanghai.
What's to be done? For starters, Beijing could raise rates for everyone and lend based on merit. More important, China should consider legalizing the gray market in finance. Creating lawful and reliable alternate sources of corporate funding would pressure China's state banks to start making loans based on sound business considerations rather than connections. Only then will China stop misallocating capital, the first step in creating the kind of balanced growth it says it wants.
By Dexter Roberts