By Peter S. Goodman
Washington Post Foreign Service
Friday, January 2, 2004; Page A01

XUSHUI, China -- Sun Dawu had big plans but little capital. He wanted to expand his livestock business and he needed a bank loan. But he is a private businessman in a country still controlled by a Communist Party government. Despite the transition toward capitalism, China's banking system remains the preserve of state-owned companies.

"I applied for a loan so many times and they always refused," Sun said in an interview at his complex of factories in northeastern China, 100 miles southwest of Beijing. "In China, there are only two ways for a private businessman to borrow money. One is to get help from a party official. The other is to pay someone off."

Sun came up with a third: Be the bank. He enticed his workers to deposit their wages with his company, offering higher interest rates than state banks while promising to build a school and a hospital. It was the sort of ingenuity that has fueled the rise of China's fast-growing private economy. It allowed Sun to raise $25 million over the past decade, transforming a scattering of pig and chicken houses into the Dawu Group, one of the country's largest agribusinesses.

It was also illegal. Sun's arrest and prosecution have been widely watched by intellectuals and economists as an indicator of the party's uneasy relationship with entrepreneurs. His case was a reminder of an unspoken rule: Private businesses are free to make money as long as they leave politics to the party. Yet, the relative lenience of Sun's sentence has been construed as a signal that creative finance will be tolerated as the only way to relieve the credit crunch vexing private companies -- now the source of two-thirds of Chinese jobs.

Sun ran afoul of the law because in China no one can take deposits without the approval of the country's central bank, lest too much cash flow out of the rickety financial system and trigger a financial unraveling.

For a decade, Chinese authorities tolerated Sun's creative financing, content that his company was an engine of growth in a poor, rural area. But in recent years, Sun began boldly criticizing the government for neglecting the countryside and squandering rural savings on urban development projects. In speeches in Beijing, he called China "a fake republic" that was "worse than feudalism." He was arrested in May, jailed for more than five months, sentenced recently to a three-year suspended prison term for "causing disorder in the local financial sector," and finally sent home.

Unlike other high-profile tycoons who have been prosecuted recently, often for tax evasion or fraud, Sun is accused of bilking no one. He is celebrated by local people as a hero who delivered what the government has not: critical services such as education, health care and roads at a time when China's socialist foundation is being dismantled.

In what had been an empty expanse of fields, dozens of brick factories cover more than 300 acres. Computerized incubators annually produce 20 million chicks. Crushing plants yield 60,000 tons of animal feed per year. About 1,000 people work here -- 500 fewer than before the government prosecuted Sun, took control of the company and froze the finances, forcing layoffs.

The children of those workers, with others from surrounding villages, attend class at the school, built by Dawu Group. They play in a public park that Sun built, with two swimming pools. The new hospital was built and subsidized by Sun's company.

"He's done so many things for people in this community," said Yin Runxian, who works in a poultry feed factory and whose family has deposited its life savings there, about $1,500. "He really shouldn't have this problem."

Since the founding of China's Communist Party more than 80 years ago, the leadership has struggled to balance two competing imperatives -- rewarding those committed to its ideological cause while also securing a place for people skilled in commerce and engineering, who are needed to run a country with 1.3 billion people.

In the days of Chairman Mao Zedong, the party treated entrepreneurs as loathsome figures antithetical to the goal of a classless society. After Mao died, Deng Xiaoping's China embarked on a free-market path, dismantling the collectives that had governed farm and industrial life. Last year, at the 16th Communist Party Congress, outgoing President Jiang Zemin officially opened the party to private entrepreneurs.

That gave legitimacy to a process that had been unleashed long before: Many of China's entrepreneurs are themselves former government officials. More than 100 million people now work in the private sector, while state companies employ 45 million, according to Cao Siyuan, an economist at Beijing Siyuan Research Center for Social Sciences. By far, most Chinese workers are self-employed farmers.

But the credit needed to fuel private companies remains scarce. The stock market is made up mostly of state companies. The bond market remains in its infancy, leaving banks as the only option. Banks have historically functioned as arteries of cash for state firms, lending to protect jobs regardless of balance sheets. Through the 1990s, China's banks directed less than 1 percent of their loans to private ventures, according to data compiled by Kellee S. Tsai, a researcher at Johns Hopkins University, and published in her book, "Back-Alley Banking: Private Entrepreneurs in China."

In an interview last month with The Washington Post, Premier Wen Jiabao said "not enough has been done in this field, even though the small and medium-sized enterprises play a very important role in creating job opportunities."

Last month, China's central bank, hoping to loosen credit for private companies, gave lending institutions permission to charge higher interest rates on loans to riskier borrowers.

China's entrepreneurs have been forced to be creative. Family businesses such as noodle and dumpling shops have sprung up through use of informal credit cooperatives. Underground banks have proliferated, as have pawnbrokers and loan sharks.

China's central bank, the People's Bank of China, is wary of such arrangements, cognizant that state banks rely on family savings for the money they lend in support of public works. If too many withdrew their deposits, the banks would face a crisis, given that they are burdened by as much as $500 billion in bad loans, according to private economists. Still, local governments often allow the schemes for fear of extinguishing private firms.

Sun has argued that the government's reliance on public savings for development amounts to a rip-off of the rural poor. He offered a way to counteract it: Rather than deposit in a state bank that would lend money to build office towers in Shanghai, villagers could invest their savings in his company and see a school rise in their village.

Born into a farm family in the village where his factories now stand, Sun, 50, grew up amid the extreme poverty that accompanied Mao's Great Leap Forward, the disastrous bid to catapult China into an advanced society by forcing peasants to work in industry. Fields were neglected and millions starved. "We didn't have enough rice," he said. "My father took us out to beg."

Sun's education was cut short by the upheaval of the Cultural Revolution. At 16, he joined the People's Liberation Army and remained a soldier for eight years. Then he went home and took a job at the local branch of the Agricultural Bank of China.

As Sun tells the story, he was the personnel director when the bank manager pressed him to promote an employee who had already been disciplined for embezzlement. The employee was pursuing promotion by buying bicycles for the bank chiefs, and Sun was forced to sign off. Later, the employee and the head of the bank were together arrested for taking bribes.

"I liked to tell the truth," Sun said, explaining why he left the bank.

In 1985, Sun, his wife and four other families pooled about $1,200, then secured a bank loan for an additional $2,500, using Sun's friendship with the manager. They began to raise pigs. Sun soon bought out the other partners, folding profits into a series of expansions.

But growth was continually constrained by limits on credit. In 1992, he borrowed more than $6,000 from the Agriculture Bank, using connections he retained. But on more than 100 occasions since, he said, his loan applications were denied.

In 1998, he tried a strategy that other entrepreneurs employ -- cultivating bank managers with gifts. Seeking a $750,000 line of credit, Sun figured he would need to spend between $4,000 and $6,000 on banquets, expensive clothing, liquor and watches for bank officials. According to Sun, he later learned that his staff bribed a bank official with $1,200. The official was dissatisfied with the amount, and the bank never released the loan. Sun tried but failed to get his money back. It was the last time he sought a bank loan.

In 1992, Sun began booking purchases of soybeans from farmers for his animal-feed business without immediately paying them. He offered interest rates twice those extended by the bank, plus price guarantees. About the same time, Sun began the paycheck deposit system. It was wildly popular. Villagers throughout the surrounding area began handing over their savings, too.

Sun scoffed at the notion that any of his enterprise should be considered wrong, noting that his savings operation is solvent, in contrast to the national banking system. His group now holds assets worth nearly $40 million, he said, while its debts total less than $4 million. Last year's revenue exceeded $12 million. He figured he was doing good.

"There was nothing here when I started," he said. "There were no opportunities for anyone. This was nowhere."

Now, it is a place he cannot leave without the permission of the provincial police. He can no longer take deposits from outsiders, though he is free to keep banking his employees' wages. He spends his days wandering the corridors of his school, wearing a blue blazer embossed with the company logo. He is the headmaster.

On a recent afternoon, he ate lunch in the school cafeteria. Then he walked past the hospital and up to his office. He sat on a leather sofa and studied the official rebuke from the court.

"Regret what you did before," it said. "Try to reform yourself and become a citizen who supports Socialism."

Special correspondent Wang Ting contributed to this report.