China’s trade surplus is soaring.
Yes, indeed. Yet the rosy figures brew unease at the Chinese Ministry of Commerce (MOFCOM). The enormous pressures of the renminbi appreciation, anti-dumping charges leveled by trading partners, and the latest anti-subsidy bombs dropped by the United States keep many in the ministry awake at night. The list of trade dilemmas confronting MOFCOM seems ready to continue in perpetuity.
Add the little known secret of bad debt to that list.
Although hardly mentioned in discussions surrounding trade issues, the risk of devastating bad debt hovers like an albatross over Chinese exporters. Lu Yue, head of the Debt Collection Division of China Export & Credit Insurance Corp. (Sinosure), knows the story better than anyone. Lu shared his five years of experience as an international debt collector in an exclusive interview with Beijing Review.
A constant question clients raised in discussions with Sinosure was, “I can buy your insurance, but can you help me collect the overdue accounts?” Guided by the principle of helping domestic companies venture into the international market, Sinosure established the debt collection division in July 2002 with Lu at the helm.
Overdue international accounts have been devastating.
The former TV giant Changhong Electric Appliances Co. is a prime example.
According to Beijing Times, Changhong’s annual report for 2002 showed that the default payment from its U.S. partner APEX had reached US$490 million. Cooperation between the two continued despite the default, but by 2004 Changhong could no longer sustain. Changhong’s bad debt ratio stood high at 28 percent, with aggregate overdue accounts amounting to US$300 million. In 2004, due to the losses incurred in the United States, Changhong lost nearly all of its net profit earned between 1998 and 2003. Since these body blows, the TV giant has stumbled in the market and is still treading water.
Has China benefited from the incredibly high trade surplus? There is no quick and easy answer.
Each year the trade surplus continues to swell. In 2006, it surged to US$177.4 billion, up 74 percent from the previous year.
Analysts explain that many Chinese exporters are involved in low value-added production, which entails high energy and resource consumption and contributes to environmental degradation. When these products are exported, China’s trade surplus grows and trade frictions increase, triggering international wrangling over China’s resource and energy consumption.
In this whirlpool scenario, competitors say China is the one who benefits. Some claim otherwise.
“While China has the surplus, the profits flow to Europe and the United States,” China’s Minister of Commerce Bo Xilai recently pointed out.
In Information Times, an industry insider was quoted as saying the average net profit ratio of major exporting industries is below 5 percent.
“It is true,” Xu Qing, an international trade manager with a Guangdong exporter told Beijing Review. Xu said the gross profit ratio of metals exported from her company, such as aluminum sheet, is only 5-6 percent.
While profits are flowing into developed countries, Chinese exporters are also suffering from long overdue international accounts, many of which turn into bad debts.
This wouldn’t seem to be much of a problem if those debts could be written off at tax time. And the debts wouldn’t be so damaging if profits were higher. In fact, bad debt is outpacing profits for many exporters.
According to Ma Enzhong, Deputy Secretary-General of the National Office of Rectification and Standardization of Market Economic Order under the MOFCOM, the ministry’s sample survey result from 2005 shows that the bad debt ratio for Chinese exporters was as high as 5-10 percent, with average default period over 90 days. In the United States during the same period, the bad debt ratio for exporters was only 0.25-0.5 percent, while the average default period was seven days.
“The trade volume is calculated by Chinese customs according to the declared amount,” said Lu. “But nobody knows when the exporters can actually get paid.”
China’s total export value in 2005 was US$762 billion. Multiplied by 5 percent, the total default payment in 2005 was US$38.1 billion, accounting for one third of the trade surplus that year.
Bad debt aftermath
From his five years of experience in debt collection, Lu has concluded that overdue international accounts may devastate exporters in two ways.
The first is that one case of bad debt may devour the total profits made by a company over a period of years.
According to the estimation of MOFCOM trade experts, the overdue international accounts of China total US$100 billion, with an increase of US$10 billion bad debts each year.
To simplify this, if bad debt last year was US$10 billion and average profitability was 5 percent, Chinese exporters had to export around a total of US$200 billion worth of goods to break even.
“This means the profits from the US$200 billion in exports were made in vain, as those profits must be used to cover the bad debts generated by the US$10 billion in exports. However, the trade surplus of last year was only about US$180 billion,” Lu explained.
“You can’t imagine how many small and medium-sized companies have been stuck in a debt dead end and vanished,” said Lu. “People tend to remember success stories but not many about the losers.”
Lu provided figures from an exporting company in Zhejiang, a province in east China flooded with small exporters. The total export value of the company was US$5 million with a profit margin of around 2 percent. Due to the lack of credit risk awareness, the total default of international accounts receivable was around US$100,000. The company thought the delinquent amount was rather small compared with its total export volume. However, its profit margin was only 2 percent, which means that all the profits from exports last year were used to recover the loss generated by the seemingly tiny amount of overdue accounts. The company, in effect, labored hard a whole year for almost nothing.
The second consequence of bad debt is the potential financing cost for exporters.
“Exporters may go into rapture if their accounts receivable are recouped after two or three months of default, as if they had lost nothing,” Lu said. “However, though thrilled, they are getting paid, Chinese exporters often forget to count the financing cost and bank loan interest of their business cost.”
The Chinese central bank raised one-year bank loan interest in the first quarter this year to 6.39 percent. During the two-month delay in payment, Chinese exporters have to pay excessive loan interest for their buyers. “If they can get the money on time, they needn’t pay excessive interest to the bank,” Lu said. “But in a country where it is very hard to get finance, hardly any of the exporting companies have ever calculated the excessive bank interest they’ve paid.”
Exporters on the alert
For Chinese companies, especially small and medium-sized ones, the lack of a risk management sense leads to countless trading problems. They are eager to do business, but know little about international credit risk.
After suffering large bad debts, those companies turn to Lu for help.
“Many of them are credulous,” sighed Lu. “Some companies send their products merely upon receiving a phone call from overseas. In this way, it is hard to track down the debtors.”
There are many causes of the bad debts. Lu stressed three. First, there are unavoidable cases, where the debtor has gone bankrupt. Second, some buyers set up shell companies and will get rid of debts as soon as they secure the commodities. The third is probably the most depressing for exporters. “Some buyers will start with a small order and pay on time to gain the trust of Chinese exporters,” Lu said. “But after one or two years, when their business ties seem indispensable, the buyer will make a large order and then disappear without trace.”
Lu suggested two ways to avoid bad debt.
First, it is vital to buy insurance for buyers’ credit with an export credit agency. Currently, Sinosure is the largest insurer specialized in export credit insurance.
Second, at the first sign that a bad debt is going to occur, companies should immediately turn to professional debt collectors. “The sooner they place a claim, the more chances they have of recovery,” said Lu. “In order to retain sound relationships with their clients, China’s exporters tend to stall in hopes their trading partners will pay them back. Only when they realize their wishful thinking hasn’t led anywhere, will they come to us.”
“When we take over those claims, the average default time often exceeds two years,” said an exasperated Lu. “They have missed the best time to collect debts.”
After receiving a claim from clients, Lu’s debt collection division communicates with the debtor to investigate the cause for the default. “If amicable collections don’t work, we will take legal action against the debtor with the consent of the creditors,” said Lu. “Backed by our unique Sinosure Databank and SinoRating information, it is more efficient for us to track down debtors.”
Currently, Lu and 12 of his team members are handling 567cases.
For most businesses, the bigger the market, the better. But for Lu’s debt collection division, it’s just the opposite.
“If our debt collection business continues to boom, the Chinese economy will suffer,” Lu said. “We have a joke inside our team: Everyone wants his/her business to grow as large as possible, but we actually expect it to shrink.”
Lu compared his job to a doctor. “We are just like doctors, always expecting to see fewer people get sick.”
Working overtime is a common occurrence for Lu’s team. Since they are functioning in an international environment, they must track down delinquent accounts in Europe and the United States, which often means working at European and American time.
Lu said in terms of profitability, the debt collecting business doesn’t bring any profit. They follow the international principle “no cure, no pay.”
“We can only make ends meet,” said Lu. “However, we feel extremely satisfied and get a sense of self-achievement after winning a case and getting the money back for our clients.”
In the long run, Lu hopes for the best.
(Beijing Review, April 20, 2007)