The local police station in Huanxizhuang, a small town in Tangshan, North China's Hebei Province, was much busier than usual Sunday.

From 9 am that morning, a continuous stream of worried local residents had started coming to the station.

All the villagers were carrying a piece of paper. They told the Global Times that the papers were IOUs from a local steel entrepreneur, Chen Zhiqiang, who had fled the country and been caught by police in the Philippines earlier this month.

"I lent 10,000 yuan ($1,573) to Chen in 2011, and when I saved another 10,000 yuan this year, I lent it to Chen again, but it never occurred to me that he'd go broke before I got the high interest he promised!" a villager in her 30s, who declined to be named, told the Global Times.

She said that Chen promised interest rates much higher than those from the banks. This is the major reason so many of the villagers lent him money. "The promised annual return was as much as 40 percent," said the villager.

"So far it is still not clear how many villagers are affected, but I heard more than 1,000 people had got involved in Chen's case," a local policeman surnamed Wang told the Global Times.

Deserted mills

As Chen's creditors, many of the local villagers in Huanxizhuang have earned high interest in recent years. But about half a month ago, rumors started to emerge that Chen had fled, leaving behind unpaid debts of several hundred million yuan.

"Starting from two weeks ago, I saw lots of cars waiting outside Chen's Baoqiang Steel company every day to demand their money back. That's when I started to realize the company was in trouble," an employee who works at a nearby steel company called Nanxiang Steel, told the Global Times.

The steel industry has been a pillar industry for the local economy. More than 100 steel mills operate in the area around Huanxizhuang.

Chen was once a reliable and honored entrepreneur in the small town. He established Baoqiang Steel in 2003, and after that, he set up another five steel firms in Northwest China's Xinjiang Uyghur Autonomous Region.

However, demand for steel products began to decline when China's economy started to slow down last year and the government's tightening policies on the real estate sector also began to take effect.

Most steel companies have been suffering from shrinking profits since last year, and Chen's company was also hit by the industry gloom. Media reports said that Chen had run away because he could not pay the bank loans for his steel plants in Xinjiang.

"Expansion of a steel company requires a large amount of capital. However, once the economy slows and the market shrinks, issues like capital shortage will surface," said Wang Guoqing, a senior analyst at Beijing Lange Steel Information Research Center.

On August 6, Chen was arrested by police in the Philippines, and on Saturday, the local police sealed Chen's steel mill in Huanxizhuang after its assets had been removed by Chen's creditors.

Now, wild grass is growing inside Chen's factory and homeless people have moved in. A report from the National Business Daily said on August 14 that Chen had borrowed 1.8 billion yuan from banks and the private lending sector.

"Most local steel mills rely heavily on private lending to support their operations, given that it is hard for private steel mills to get loans from the banks," said the employee from Nanxiang Steel.

Firms that lent money to Chen were also affected. Li Deqing, owner of Yongfeng Steel Tube Company, which is just 500 meters away from Baoqiang Steel, also disappeared after he found that he may never get back the 275 million yuan he lent to Chen.

Li is from a small village near Huanxizhuang. Li himself had been borrowing from his neighbors, and then lent the money to Chen for the higher interest rates.

"Nearly every family in the village has lent money to Li in the past 10 years, and things never went wrong. But now Li and his family have disappeared," a grocery owner surnamed Liu told the Global Times.

Capital crunch

"Most private steel mills are short of capital now, as prices of steel products keep declining and sales keep shrinking," said a Tangshan-based steel mill owner surnamed Guan.

"The current situation is even worse than the economic crisis in 2008, and many private steel mills will go bankrupt in half a year if the industry gloom continues," said Guan.

Large steel companies are also suffering from capital shortages.

Media reports said that Guangzhou Iron & Steel Enterprises Group had delayed repayments of over 3 billion yuan in bank loans.

"Large steel companies have more options in terms of financing, such as corporate bonds, so their capital situation is better compared with small steel mills," Qu Xiuli, deputy secretary-general at the China Iron & Steel Association (CISA), told the Global Times.

Steel trading companies are also on the verge of collapse. "Most steel trading companies are small privately owned companies, and some are involved in private lending," Qu noted.

Others worse off

Many of China's steel mills have started to reduce output or even halt production in order to cut their losses. In the first half of this year, 33 out of the 74 member companies of the CISA cut their production, data from the association showed.

"Companies in the steel sector should be prepared for a long-term depression," Zhang Changfu, secretary-general of the CISA, told media earlier.

However, experts and industry insiders said that the capital crisis among private steel mills is not as bad as the one in the real estate sector, which has seen many entrepreneurs in Wenzhou, East China's Zhejiang Province, flee or commit suicide after their investment did not generate the returns they expected.

"I believe that the capital problems of private steel companies is still under control, since most companies do not take private lending as their major source of financing," Guan noted.

Wang from Beijing Lange Steel took a similar view. "The steel sector has a very low profit margin compared with the real estate sector, so it does not attract as much private lending."

But there is still no sign of an upturn in the steel industry's fortunes. "Maybe in the fourth quarter, when the government's supporting policies start to show some effect, companies will be suffering less from capital pressure," said Qu from the CISA.