SHANGHAI, CHINA - MADAM Chen, who runs a private, 16-person firm making shirts in Shanghai, has had her bank loan applications rejected twice since late 2007, when the government announced it was shifting to a tight monetary policy.

'They told me the bank's loan quota had been allocated to more important projects - they said they had to cancel many credit plans late last year,' Mdm Chen, a 49-year-old state firm manager turned private entrepreneur said.

Cheap and easy money, which helped fuel China's economic boom this decade, is moving beyond the reach of a growing number of companies as the central bank tightens monetary policy and enforces curbs on new bank lending to fight inflation.

The tight policy is contributing to a stock market slide as firms sell equity holdings to raise money, and threatens to boost bad debt at banks as small real estate developers struggle. It also makes it hard for small banks to get money market funding.

So far, the policy has done little to slow growth in the overall economy - many bigger companies and banks, with good political connections and strong relationships to the top state-run banks, still have ample cash on hand.

But the pain being suffered by many thousands of small company managers like Mdm Chen - and the additional pain that could result from a threatened United States recession - may force China to soften its policy in coming months, analysts believe.

'Conditions for corporate financing are set to be very harsh in the first half of this year, and that doesn't take into account the impact of the latest developments in the US subprime crisis,' said economist Shi Lei at Bank of China.

'If a policy shift occurs, it could be implemented in a short time of just a few weeks.'

Bank loans

The biggest headache for many firms is the central bank's ruthless enforcement of quarterly quotas for banks' new loans. It aims to cap new yuan lending in 2008 at about last year's level of 3.63 trillion yuan, banking sources said.

Five banking sources said this week that many banks used up most of their planned loan allocations for January in the first three days of the month, because they were satisfying demand accumulated during a harsh clampdown on loans in December.

That means many firms may have to wait one, two or even three months to reach the front of the queue for fresh bank loans.

'As the credit squeeze spreads, even demand from some large companies cannot be met in a timely manner,' said Mr Gene Ma, chief economist with China Economic Monitor in Beijing.

'Though the impact on the overall economy still appears limited, small or medium-sized firms in sectors which typically have high liabilities, or which have shown signs of overheating such as property, are likely to be battered.'

Tight policy has also hit the capital markets. The cost of issuing bills of up to one year has risen about two percentage points over the past year to around 6 per cent - when companies can issue bills at all.

Banks have cut back their discount trading in bills, which is included in their loan quotas, and investors are shunning bills from small issuers as the credit squeeze increases default risks.

'Most short-term bill issues in the foreseeable future are likely to be additional ones by existing firms which have established reputations,' not issues by new or up-and-coming companies, said a bills trader at a major bank in Shanghai.

Looser policy

Corporate bonds are not the solution either. Market reforms last year - which now look poorly timed - banned banks from giving guarantees for the bonds, and the insurance regulator has continued to prohibit insurers from buying unguaranteed bonds.

'The corporate bond market faces a lot of uncertainties, and for now, companies cannot raise funds effectively there,' said Mr Dai Xu, senior bond analyst at Galaxy Securities.

Even some banks, mainly small ones, find it hard to raise funds in the money market. On Wednesday, desperate banks were willing to pay over a percentage point above the three-month bill yield to take three-month deposits from the finance ministry.

China's corporate funding squeeze probably remains less than a crisis. But with economic storm clouds gathering overseas, the central bank may decide not to take the chance - it could soften or suspend its tight credit policy and allow appreciation of the yuan plus price controls to bear the burden of taming inflation.

Possible signs of that appeared this week. Bonds have been rallying for several days, and a senior central bank official said that some officials there worried it might have tightened too much, given pressure on many firms to repay loans.

On Thursday, the central bank urged commercial banks to step up lending in areas of China hit by harsh winter weather. This apparent easing of policy was presented as a way to help energy, transport and farm sectors recover from natural disaster - but it may prove to be a first step in a general softening of policy. -- REUTERS