Credit Crunch

Small and medium-sized enterprises (SMEs) have faced the brunt of credit tightening. Typically small firms in the Chinese mainland use retained earnings or private sources of capital to fund themselves. So, when cash flows were strained this year – in large part due to falling export orders and rising input costs – and credit conditions tightened, absent of established adequate credit lines, small firms were pushed to unsustainable sources of credit in the shadow banking sector. Private funding is estimated to be worth the equivalent of at least 20 percent of lending during the past two years. The surge of defaults in Wenzhou, east China's Zhejiang Province, is just a start. Worse is to come as private lenders traditionally call their outstanding loans before the Chinese New Year. The State Council has already announced a few measures that will direct funding to SMEs.

The People's Bank of China (PBOC) has already acted to support activity, cutting the reserve requirement ratio (RRR). Inflation has fallen from a cyclical peak of 6.5 percent year on year in July, down to 4.2 percent year on year in November. In response, the PBOC announced a "pre-emptive" reduction to the RRR – by 50 basis points to 21 percent. The reduction is the first one in exactly three years, freeing 380 billion yuan ($60.3 billion) of bank capital. In 2012, headline inflation will average just below 4 percent, providing space for more reductions. The RRR will fall to 18.5 percent by the end of the first quarter of 2012 and interest rate cuts are not expected in 2012 but yuan appreciation will continue. The yuan/USD is on course to appreciate from 6.36 to 6 by the end of 2012, adding purchasing power to the nation.